Johnson Turnaround

Steven Liew Woon Choi

Sharifah Khadijah Syed Agil
Mohd Hanif Mohd Helmi
Syumzurizham Zainul

Azmi had just joined Johnson Pte Ltd. (JPL), a public non-listed subsidiary of a fast moving
consumer goods (FMCG) group of companies based in the southern Indian region, as its chief
executive officer in November 2009. He had been handpicked by the Chairman to purposely
plan and execute an appropriate turnaround strategy. He8's now reviewing the financial
statements (Appendix C) and looking at the various options available.

On the first day of office. the chairman invited him for a chat over lunch. The Chairman said:
"Azmi, the company has been besieged with problems ever since we took over its operations
from the previous owner. Figures do not lie, our sales figures are on a decline but our operating
costs are up and you know what it adds up to. Go and check what's happening with our credit
control and inventory management, I think something is not right somewhere. Your mission:
plan and execute a turnaround programme for the company before it's too late!"

Back at the office, Azmi reviewed the financial statements (Appendix C) he obtained from his
finance manager and was pondering the way forward for JPL.

General Company Background

The Hong Kong group of companies were involved in a similar industry operating within the Asia
Pacific region. JPL manufactured and distributed a range of products, including frozen chicken,
noodles, pastries, bread products, yeast and fats It also traded in commodities such as oil It
owned a chain of restaurants and retailing outlets.

Before the takeover, JPL was wholly-owned by the Indian government. Then, 20 years after it
began operations, the Hong Kong group of companies acquired 80% of the shareholdings. The
takeover was made successful through arrangements made by an Indian local businessman
who had substantial influence on the Indian government.

Excerpts from detailed information on the FMCG industry are provided in Appendix A.
Generally, players in the FMCG industry faced pressure to reduce prices that stemmed from
market forces compelling them to buckle up with appropriate measures to address this issue.
Due to low entry barriers, the existence of multiple private labels in addition to knowledgeable
consumers that preferred quality products hand forced players in the industries to focus on
continuous improvement both on product quality and efficient distribution channels. The
existence of external forces such as rising raw material prices also posed a threat to players in
the FMCG industry.
Despite the gloomy picture, establishments operating in the developing economies could smile
a little in that they could expect bottom line improvements due to consumer higher earning
power in the region. In contrast, the scenario in developed economies portrayed with weaker
sales growth caused FMCG players struggling to capture consumers' brand loyalty1.

Organisation and Management Structure

The company was structured into four main functional units, each headed by a director, namely,
the Sales and Marketing, Finance and Accounting, Production and Services and Human
Resource Management. Each of the functional directors together with the chief executive officer,
formed the executive management team of the company.

The company had a paternalistic approach, where it occupied important positions by

maintaining good rapport with the local community. This was cultivated from the public sector
culture of the Indian government, which dominated the board membership and its strategic
decisions. Membership to the board were recruited from former executives after they retired
from full time service in the company. When Azmi joined the company, there were two non-
executive directors on board alongside an executive board of four who sat in the committees
under it.

The objective of the takeover, which was well recognised by the parent company's board
members, was the strategic priority to increase its international presence. It was a way to gain
quick international market share as well as to increase its ability to service an expanded and
geographically dispersed customer base in the Middle East and the Indian subcontinent states.

Sales and Marketing

The company was one of the key market players, other than Nestle and Unilever that dominated
the consumer-based market in the Asia Pacific region. In 2007, the company had 30% of the
regional market share and the balance was shared by the other key players. Azmi realised that
JPL. had to compete based on quality, cost and service.

Production and Services

The objective of the production arm of the company was to meet the desired quality and
production standard as per the Haphazard, Analytical, Critical, Control Points (HACCP)
requirement as well as best industrial practices In a nutshell. the standard provided a vital

1
Specifically where food is concemed, countries can have very strict food safety guidelines to protect consumers and public health.
In order to ensure food safety in the production process, food manufacturers should implement the internationally recognized
Hazard Analysis Critical Control Point or HACCP standard. Alternatively, they can use the newly published ISO22000 Food Safety
Management Systems -Requirements for Any Organisation in the Food Chain. Certain countries require HACCP certification before
food like meat and seafood enter the country.
common business for buyers and suppliers to understand product or service requirements for
their target markets.

Industry records show that as far as the food and beverages competition was concerned, both
Nestle and Unilever would take turns to win. lt was thought that these two companies invest
heavily in research and development, advertisement and promotion. These are the market
leaders and they spend in the range of 2-3% of their turnover to improve or at least maintain
their market shares. This information was unearthed in their recent meeting with the sales and
marketing division.

The noodles brand were marketed based on many product flavours, for instance, chicken
noodles in a variety of flavour. Records show that of all the company's sales mix, noodles line of
products had the highest gross profit margin, although it had to compete wIth the likes of
Maggie noodles under the Nestle group.

Financial data showed that the company owned 45 retail outlets. Of these, there were a few that
persistently incurring losses. perhaps because of non-strategic locations. Such a negative
financial situation exacerbated the conventional high operating costs facing JPL. In order to
boost turnover, the company had consistently investigated opportunities in new markets.

Accounting and Finance

Despite its huge losses, to the extent that the shareholders' fund plummeted from $300 million
to $I80.96 million over a period of 10 years, the Hong Kong group of companies saw prospects
in JPL for the accomplishments of their strategic mission.

Johnson operating conundrums were reflected in the unaudited accounts through to Azmi's
attention (see Appendix B & C, which is an abridged version of the accounts). Azmi had to table
the accounts for the approval of the board. The accounts for the year ended 31 December 2008
showed that the company was in the red with a loss of $10.14 million. Azmi could not help
noticing the excessive spending in advertising and promotional costs which amounted to $5
million in 2008. Poor management or the account receivable contributed to the company’s
inability to service its debt, which was rocketing high. There was a significant $40 million total
provision made for bad debts in the accounts over a 10 year period. Azmi thought the monthly
provision for bad debt was not a healthy financial trend for the company. Upon investigation, he
discovered that the problem stemmed from wholesale distributors who were defaulting.

Azmi also noted that in 2008, as well as the preceding years, the company had been having
negative cash flows. This he reckoned was due to the mismanagement of inventory and
accounts receivable as well as the poor asset management.
Guarantees (Bank, Corporate, Personal)
Detailed investigation into the credit control management records revealed that there were
insufficient bank guarantees given by the dealers and wholesalers for the goods taken on credit
up to one month. The company's overall account receivable showed an average overdue of
more than 90 days and this piece of information had caused the Hong Kong head office to press
the alarm bell in the debt recovery effort. Azmi noted the practice in the company of accepting
the placement of motor vehicles as part of collateral for the goods obtained.

Economic Value Added

The Hong Kong head office required Azmi to report based on the Hong Kong Accounting
Standard (HKAS) in the EVA (Economic Value Added) reporting format. That is NOPAT (Net
operating profit after tax) less the WACC (Weighted average cost of capital) would increase
value creation to equity shareholders and vice versa. Azmi was also required to explain in the
segmental reporting on each product range and account the reasons why certain products had
negative EVAs. Under such a situation where the particular product costs had exceeded its
benefits, the products would be reviewed. The underlying purpose for the parent company's
emphasis on EVA reporting. apart from the reporting requirement, was that EVA could provide a
basis for determining both value added as well as value creation components of operations.

Management Information System - Computerisation

of Inventory and Account Receivable (Retailing
Division & Distributors)
In order to improve the efficiency and effectiveness of JPL financial management system Azmi
took the initiative to improve the current accounting system at the retailing division for better
inventory and cash management.

Asset Information and General Management

When the company took over from the government-linked company, Azmi observed that there
were a number of empty factories with old steel structures intact for the last 10 years. Azmi
recently inspected the company's assets and he found heaps of obsolete spare parts left
untouched in the storeroom. Whilst running through the fixed asset motor register, Azmi realised
that most of the vehicles were more than 5 years old and had zero net book values.
Human Resource Management
JPL had on average. 1,000 employees including 80 general and administrative staff. In respect
of pay, JPL received an instruction to undertake cost reduction programmes and to cut down its
senior management's pay by 5% - 30%.

In an unprecedented move made by the company, Azmi was told through a telephone call in
February 2008 that he was to attend a meeting in the Hong Kong office. The gist of the
message was that the group of companies was recently delisted by the major shareholders. The
Shareholders apparently wanted minimal public exposure and also to avoid the intricacies of
having to comply with the numerous accounting compliance requirements of the HKAS. The
main concern to delist was to reduce the unnecessary compliance cost and to speed up the
decision making within the group. After being delisted, the chairman obtained a sweeping power
to enforce lean management. He trimmed the first layer of unproductive management staff by
allowing most of the expatriates to leave. He then replaced the expatriates with local expertise,
thereby earning a substantial cut on manpower costs.

Instructions from Head Office

Azmi had been instructed by the group chairman from Hong Kong Headquarters that he was to
plan and execute an appropriate turnaround strategy. Azmi had to take into account the
financial statements and that all unnecessary spending was to be avoided.

Reference
Chong, S., Wong, W., Abraham, M., and Tan, G., (2008), Make Standards Work for You - A
Guide for SME, SPRING Singapore.
Appendix A
Fast-Moving Consumer Goods Industry
Executive Summary

Retailer Power
Consolidation of distribution channels had increased pressure on the FMCG industry
Consolidation of retailers has strengthened their buying power. Consumers addicted to low
retailer everyday prices are continuously repeating prices to fall, not rise. This had resulted in
retailers increasing pressure on FMCG companies to reduce prices. To do this, FMCG
companies have increased sourcing from low-cost countries across the globe, allowing them to
meet retailers' demands. FMCG companies were transforming their organisations to better
manage the global supply chain, investing in new technologies to help them streamline supply
chain operations. Technology innovations have also helped them partner with retailers to
forecast demand in a real time environment.

Threat of Substitutes
FMCG companies were also threatened by private labels both within the industry and by those
of large retailers. To maintain their low everyday prices, large retailers have increased sourcing
from low cost countries, apart from sourcing branded products from FMCG majors. FMCG
companies have no choice. They have to contend with retailers playing a dual role of buyer and
competitor. Some FMCG companies derived more than 10% of their revenues from single large
retailers like Walmart. The products thus sourced as in-store brands, which offered more
margins for retailers. Walmart sourced nearly $20 billion in goods from China every year FMCG
companies also faced competition for their branded products in developing countries from local
manufacturers who have lower pricing than their branded products. This had forced many
FMCG companies to set up factories in local geographies to produce products catering to local
demand.

Shiting Center of Gravity for Growth

FMCG companies were witnessing weaker sales growth from matured economics, but
exponential growth in developing economies where higher earning power had resulted in larger
disposable incomes. Globalisation-motivated lifestyle changes have also increased customer
aspirations for branded products. Hence, all FMCG companies are concentrating on emerging
markets. The strategies for growth were to increase the geographical reach of existing higher
margin brands, extended product portfolios organically or inorganically, and grew exponentially
in developing countries where volumes would drive margin growth.

Select European and American global corporations were seeing sales or their products grow
rapidly in the Asia Pacific market. in the Middle East, there was an increasing global market
penetration. For example, in Dubai and Qatar. Overall, FMCG financial performance in Europe
and the United States was showing moderate growth in household products and personal care
products, with, however, noticeable growth projected in the next five years for natural and
organic personal care products.

In India, the FMCG market was projected to show greater growth in the rural and semi-urban
markets than it wOuld in the urban market. As can be expected. a key nation to watch was
China, which was projected to become the world's second largest global consumer goods
market in less than ten years.

Consumer Power
Today's consumer is more knowledgeable. More consumers were shopping in discount stores,
which had resulted in commoditization of consumer goods. Consumers preferred high quality
goods and were willing to pay extra if they were convinced about quality, though the general
preference was to pick up the lowest priced item for non-durable goods in particular. FMCG
companies were spending heavily in marketing to make their non-durable goods attractive to
consumers. In durable goods, brand value was making a difference. Some FMCG companies
were oftering variants of both low cost products and value-added high end products to not let go
of the consumer's share to competitors. FMCG companies were listening more closely to
consumers, understanding their needs and aspirations, and consequently producing products
that fulfill these needs increasingly using the power of technology to get closer to the consumer.

External Forces
The global fast moving consumer goods (FMCG) industry was suffering margin threat from
rising raw material prices, rising food prices and energy price increases. The sub-prime crisis
had affected credit lending in the US, which in turn had impacted consumer spending. Rising
gasoline and food prices have also affected global spending to some extent along with other
factors like higher interest rates, inflation, etc.

Singapore
The Singapore consumer price index increased at 2.1% in July 2007 over June 2007, partly due
to the 2% increase in goods and service tax in July 2007. The wholesale trade index increased
to 1.9% in July 2007 over July 2006. Excluding petroleum, domestic sales went up 6.5%.
Conversely, lower sales were reported in the wholesale sector of electronic components
(17.7%) and household goods and furniture (9.5%) in July 2007 compared to July 2006.

India
The consumer price index rose to 6.9% in July 2007, compared to July 2006. The All India
General Index increased, mainly due to rising food prices.
Indian consumer spending slowed in the second quarter of 2007 according to a study by Future
Capital Holdings. An interest rate hike had affected consumer spending in India in 2007. Food
prices, which had been rising for some time, have also fallen. The wholesale price index for All
Commodities declined 0.1%. Inflation was at 4.05% in August 2007, compared to 5.08% in
August 2006.

Domestic consumption accounted for 67.7% of India's GDP. with private consumption
accounting for 56% in 2006. India's FMCG sector had an estimated market size of about $15
billion in 2007. It was expected to grow exponentially to $33.4 billion in 2015.
Appendices B - E
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Appendix F
Calculating EVA
Calculating EVA or "Economic Value Added'" is a worthwhile exercise when analysing corporate
financial data as it measures performance while taking into account capital investment required
for the economic return.

EVA=Economic Profit−(WACC × Invested Capital)

The calculation of the Economic Profit essentially is Net Operating Profit After Tax (NOPAT)
calculations needed for the Weighted Average Cost of Capital (WACC) and also for the Cost of
Equity required by the WACC equation.

The WACC calculation is:

WACC =Cd (1−T ) × D /( D+ E)+ Ce × E/( D+ E)

Where:
Cd being pre-tax debt rate
Ce being cost of equity
E being market value of equity
T being corporate tax rate
D being market value debt

The cost of C ecalculation is:

C e =R+ M × β+L

Where:
R being risk-free rate
β Equity risk beta
M Market risk premium
L Liquidity premium
Example of Calculating EVA
EVA is sales less operating costs (including taxes) less all financing costs. Put another way,
EVA is net operating profit after tax (NOPAT) less the cost of all capital, equity as well as debt.

For example, consider a company that earns NOPAT of $100 and ties up S800 in capital from
debt and equity sources to support its business assets. Assume further that the firm's overall
cost of capital is 10%, a rate that blends the after-tax cost of debt and equity at the proportions
management would intend to use as a target. In this case, the firm must set aside $80 ($800 x
10%) to "rent" its capital from the market, and its EVA is $20, the profit residual.

EVA=NOPAT −(Cost of Capital ×Total Capital)

$ 20=$ 100−(10 % × $ 800)

EVA may also be expressed as the monetary spread between the return on capital (ROTC) and
the cost of capital.

EVA=(ROTC−Cost of Capital)× Total Capital

$ 20=(12.5 %−10 %) × $ 800