Case study july 2012 illustrative script 1 ICAEW

It also provides some good analysis of the KPD, extending the case data to produce useful ratios such as average number of products per appointment and average revenue per appointment

FIRST ILLUSTRATIVE SCRIPT AND EXAMINERS’ COMMENTS

The commentary below follows the order and numbering of the script, with reference to the topics in the marking key It should be read in conjunction with the review of the Second

Illustrative Script and full Examiners’ Report for this session

Examiners’ comments – overview

This script was well within the top 25% of all assessed scripts It is a clearly-presented report dealing with many of the key issues, offering sound commercial advice where applicable, and of about average length The content is highly focused, addressing the case requirements as presented There is some irrelevant material and also the language is slightly clumsy in places Good grades were earned for the executive summary and for all three main topics, as well as across the four areas of Professional Skills, with AJ being the weakest In essence, this was a well-balanced script The candidate went a long way towards success by the simple technique

of dealing with all the main components of Requirement 1 (including KPD and the incentive scheme) and Requirement 3 (including ethical issues) Most areas of Requirement 2 were also tackled but coverage of some, such as practical considerations, was relatively brief

Terms of reference and executive summary

The summary begins with a neat introductory paragraph encapsulating the headline financial performance It goes on to identify in a series of succinct sentences the main features of each salon’s performance for the year – albeit without any illustrative numbers or any mention of KPD, despite the impressive coverage under Requirement 1 itself (see below) The last part of this section comprises a clear conclusion on the Newcastle bonus issue

In respect of the Wallsend fire, the candidate starts by giving his/her calculated lost profit but makes no comment on the assumptions used in arriving at this figure Instead, (s)he goes straight on to discuss the staffing and related issues, making good use of information about Newcastle waiting times (AI, foot of p20) As in the main body of the report, there are some tangential points here about the incentive scheme and LL’s refurbishment plans

For Requirement 3, the primary issues are again concisely captured, with appropriate focus on the main ethical aspects (tanning; Marie) The last phrase ( “ despite being a cheap way to finance a fitting of the salon may pose risks to quality and reputation of LL”) is a good example

of the high-level commercial approach evident through much of this script

The executive summary ends with a set of conclusions and recommendations embracing all three parts of the case This is a strong close

Overall, the executive summary was good, addressing the main points covered in the body of the report under all three requirements It could have achieved even better grades by providing the key figures for each salon and referring to the KPD at Requirement 1; highlighting the

assumptions underlying the insurance claim at Requirement 2; and providing a definitive

conclusion at Requirement 3 in respect of both the York opportunity and the Indigo contract, rather than appearing to “sit on the fence”.

Comparison of salon performance [Requirement 1]

This part of the report achieved a large number of passing grades It is set out clearly with an introduction and then a section dealing in turn with each of the main captions from the exam

requirements Unlike many scripts, it compares the salons, rather than looking at them in turn

without deriving any overall observations It could have done better still by including more about gross profit and by reviewing the bonus scheme arguments in more depth

The section begins with an overview of LL’s financial performance, followed by a ‘scene-setting’ paragraph The candidate has used own research (Mary Portas) here, but could perhaps have linked it more directly to LL’s situation

After this opening, the script goes on to explain the changes in revenue at each salon, referring effectively to pointers provided in the AI, skilfully weaving KPD into the narrative and generally integrating material from throughout the case in an eye-catching way For example, in the

passage “The increase in revenue in services is largely attributed to increase in appointments

by 4.9%; this is likely to be an effect of better services offered as reflected by an increase in recurring clients of 100, up from 4,400 increased revenue per appointment from £39.10 to

£39.69 which is a small indication of better cross-selling ”, the candidate has drawn together (i)

the basic fact that appointment numbers have gone up (Exhibit 13); (ii) a reference to recurring client numbers (Exhibit 14); (iii) a calculation based on the KPD; and (iv) a reference back to Newcastle’s previous cross-selling problems (Exhibit 6) Other KPD-based calculations have also been brought forward appropriately from the appendix (eg product sales per appointment)

to enhance the discussion

Under ‘gross profit’, the script begins by benchmarking LL’s overall result against the industry norms provided in the AI It then considers features of Newcastle and Gateshead but makes no mention of Wallsend The section on Newcastle again assimilates a range of case data into a seamless commentary, connecting the rise in staff costs with the percentage of senior stylists (AI, p19 / p23) and industry wage norms (AI, p14 plus some own research)

The weakest part of Requirement 1 is that relating to the Newcastle bonus The candidate does refer to each of Irina’s three issues but the coverage is rather superficial and does not seek to challenge Irina’s assertions (S)he does, however, go on to calculate the overall impact of the adjustments and hence to conclude that Newcastle should have qualified for the bonus

The section ends with a strong and focused list of conclusions and recommendations These summarise the key findings from the financial statement analysis and bonus discussion, and go

on to offer advice on how LL can spread some of its best practice across the salons and on re-evaluating the bonus scheme The recommendation to “work to improve occupancy rates which currently stand at 50% [AI, p19]” gives a further indication of how well the candidate knew the

case material.

Evaluation of proposed discount [Requirement 2]

This was also answered well, with passing grades being earned primarily for the calculation (see also commentary on Appendix 2 below) and for the discussion of staffing issues

The candidate begins by straightaway giving the calculated lost profit figure, then going on to challenge some of the underlying assumptions – more than many candidates did – in relation to seasonality, take-up rates / client numbers and product spend (S)he also queries the gross margin, but that is not necessary as the margin is clearly defined in the insurance policy (Exhibit 9) and does not offer any scope for variation

The script then makes a series of pertinent comments on staffing and related issues, once more making astute use of case material: clients ‘following’ stylists (AI, p12); relationship between chair and stylist numbers (AI, p19) However, the next sentences, dealing with bonuses, are largely irrelevant since we do not have any information about the proposed 2013 scheme

Under ‘Other issues’, the candidate addresses some practical aspects of the insurance claim, linking the already long wait times at Newcastle with the likely impact on LL’s regular client

feedback questionnaires and the company’s image, as well as rightly wondering how existing Newcastle and Gateshead clients will react if transferees from Wallsend receive preferential treatment This part of the answer could have been developed further to consider such issues

as the size of the discount and the likelihood that the Wallsend salon will return to normal

immediately in January 2013 Both of these points would have been readily apparent from a

close read of the Knightwaves article at Exhibit 11e – this seems to be the only page of the AI that has escaped the candidate’s attention!

The candidate again closes with long lists of conclusions and recommendations These have earned passing grades by incorporating the key findings, but there is perhaps an overemphasis

on more peripheral points such as the future of LL’s incentive scheme, refurbishment and health

& safety

Assessment of new salon opportunity [Requirement 3]

This was another good section that gained 50% of passing grades The candidate has made many key relevant points and could have done even better by demonstrating judgement across the range of issues

The candidate makes sure to cover all the elements of the requirement by using the headings

‘Strategic aspects of new salon’, ‘Operational aspects’, ‘Ethical aspects’, ‘Product supply’,

‘Conclusions’ and ‘Recommendations’, and the respective sections are broadly equal in length

In dealing with strategy, the script covers a range of issues, including beauty and tanning, as well as the risks of opening in an unfamiliar region It cleverly links the developer’s claims of visitor numbers and profile with LL’s own ambitions – but fails to recognise that these claims might contain an inherent bias

With regard to operations, the candidate has incorporated several relevant items from the AI in addressing some of the important issues, notably the ‘Jobs Weekly’ article (p36), the exclusion

of tanning from LL’s current insurance policy (p31) and – in reference to Sullivan’s plans – LL’s previous experience of local competition (p19 / p24)

The section on ethics addresses the two main issues arising – proximity to Marie’s salon and the risks of tanning In the first of these, the candidate could have referred to the legalities of restrictive covenants (AI, p12); and in the second (s)he could have been more explicit about the potential damage to LL’s reputation

The script also contains a good section on Indigo, packed with pros and cons of the proposed supply arrangement and referring to most of the key issues – financing, margins, suppliers, online sales The passage “Existing LL clients may be unhappy if existing brands are not

stocked at the branch The online system appears also to stock Indigo products; there may be terms restricting its use to sell other products ” in particular demonstrates some really well-developed commercial thinking on the Indigo plans The candidate could also have gone on to consider some of the practical aspects, such as the detail of how the salon would be fitted out

As with Requirements 1 and 2, the last part of the section presents the candidate’s key

conclusions and recommendations Although not concluding decisively on York, the candidate does do so in relation to the specific topics of tanning; proximity to Marie; and Indigo

Recommendations include the need for more market research but overlook some other areas where information is lacking, such as in relation to Sullivan’s intentions and the Indigo contract

Overall paper: Appendices

The candidate has included two Appendices, one each relating to Requirements 1 and 2

Unusually, these appear at the end of the sections to which they relate rather than right at the back of the report

Appendix 1 tabulates the key figures used for Requirement 1, covering all three salons and both revenue streams, indicating changes both in absolute terms and as percentages It also

provides some good analysis of the KPD, extending the case data to produce useful ratios such

as average number of products per appointment and average revenue per appointment (which can then easily be incorporated at Requirement 2) This is followed by a clear calculation of the

impact of Irina Yu’s issues on Newcastle’s bonus computation (albeit that this adjusts the staff numbers by 2 for a full year each rather than for a half year)

Appendix 2 sets out clearly the calculation for the loss of gross profit This would have been almost perfect were it not marred by two careless errors: use of 25% rather than 75% (ie 100% – 25%) and an incorrect decimal place (31.8 rather than 318) The candidate has split the five-month period into two and three five-months, in the process making sure to apply the right

seasonality factors

Overall paper: Report

The script is generally well written although characterised by some clumsy wording and spelling (eg “gross demotivation”, “recouperate”)

Overall, it has met the requirements, is balanced across the main topics and demonstrates a strong commercial understanding of the case scenario

ILLUSTRATIVE SCRIPT

To The Board of Luvlox Limited

Review of 2012 performance and strategic developments

25 July 2012

Prepared by Baron Young LLP

1 Terms of Reference

This report has been prepared for the directors of Luvlox (“LL”) and deals with the following issues:

 A review of the performance of the three salons for the year ended 30 June 2012

 An evaluation of the shortfall in revenue and discount policy related to the Wallsend fire

 An assessment of the strategic, operational and ethical aspects of the new salon proposal and related product supply arrangement

This report is based solely on the unaudited information provided by the directors of LL It has been prepared solely for the use of the directors of LL and should not be disclosed to other parties without our written consent

No liability can be accepted in such an event

Overall LL has had an outstanding year Revenue grew by £297k, up 5.4% from £5,481k, defying industry expectations of 2.2% The salons have had varying performances

2.1 Performance for June 2012

Gateshead and Newcastle both achieved good growth in both revenue of services and products For Newcastle this reflected better cross-selling and reduced discounts on products Gateshead continued to produce strong revenue growth in services as a reflection of the successful colouring campaign; and parents attending salons with their children

Wallsend has seen a fall in revenue as a result of reduced appointments and continued heavy

discounting

Gross margins have increased from 56.2% to 58.9% demonstrating revenue growth as a result of better margins as well as volume

An adjustment should be made to Newcastle bonus assessment which resulted in an increase of 23.1%

of gross profit to salon numbers – therefore the salon should be awarded the bonus for the year

2.2 Wallsend fire

Based on the assumptions provided to us: the insurance claim for the loss is expected to be £437k for the

5 months to December 2012

There will be a series of staffing issues associated with the transfer as a result of the fire; these include potential loss of key staff due to unwillingness to commute; overcrowded working conditions etc

Capacity to fulfil additional clients at the other two salons will be difficult especially with existing long waiting times at Newcastle

The incentive scheme regarding Wallsend staff is likely to cause gross demotivation as they are unlikely

to receive the bonus for the year due to the fire – however, this will almost automatically enable them to meet the criteria for the following year due to current low gross margins

Retention of clients will be key during the closure of the salon However, consideration also needs to be taken of the view of other clients paying full prices

Consideration should be given to disclosure plans for refurbishment to the insurance company to avoid any instance where this could render the claim void due to non-disclosure

2.3 New salon and product agreement

The plan for a new salon in the new mall appears to be a good opportunity to expand and also diversity into beauty services However, consideration needs to be given to the lack of experience it has with the geographical area and also beauty services

Tanning services are also mentioned which opposes LL’s current reputation and stance Most salons do not offer sunbeds due to its risky nature and harmful UV rays

The mall is 1km away from Marie Duval and may constitute as direct competition

The product agreement requires exclusivity of LL’s salon and despite being a cheap way to finance a fitting of the salon may pose risks to quality and reputation of LL

2.4 Conclusions and recommendations

Performance overall has been promising and good; consideration should be given to emulate results at Gateshead eg roll out colouring

Discounting should be standardised to avoid inconsistency

The incentive scheme should be adjusted to reflect one off items and use average employees during the year

LL should continue to offer incentives to retain clients following the fire as this is key to Wallsend’s

performance after it reopens

Incentives should continue to be offered until full reopening

Incentives should be introduced to offer off-peak services to reduce burden of other two salons during this time

The new salon is a good opportunity and should be considered seriously but contact with Marie is key to ensure that she accepts the distance

Tanning beds should be negotiated out of the proposal due to health risks it proposes and also

reputational damage to LL

The product supplier appears good but research into the quality needs to be assessed

3.1 Revenue

Overall results have been promising for the year for LL with an excellent growth of 5.4% (Appendix 1) in revenue defying industry expectations of 2.2%, up to £5,778k from £5,481k

LL has shown positive growth despite the continued economic downturn which has seen a reduced spend

on non-essentials: this is particularly positive in a week where Mary Porter (dubbed “Queen of the High Street”) was quoted noting that 11% of high street shops are empty due to high rents LL’s reputation for quality has seen it persevere as noted by its improved client feedback

Newcastle has shown growth in both services and revenue Service revenue has grown as a result in increased revenue per appointment from £39.10 to £39.69 which is a small indication of better cross-selling by its staff of other services

The increase in revenue in services is largely attributed to increase in appointments by 4.9%; this is likely

to be an effect of better services offered as reflected by an increase in recurring clients of 100, up from 4,400

Product revenue in Newcastle has soared by 47.5% by £75k from £158k in 2011 This is also an effect of improved cross-selling with the average number of products sold per appointment up to 0.42 from 0.32 Less discounts are also being offered per product pushing up product revenue (2011: £15.96) averaging

£17.26 per product

Gateshead has demonstrated equally strong results Services increased by 12.5% with colouring

package helping to achieve better gross margins The inclusion of a child’s play area may also have induced more appointments with parents coming along as appointments are up 8.7% reflecting the highest feedback satisfaction

Product revenue at Gateshead remains consistently good, although cross-selling has fallen to 0.46 products per appointment from 0.49 in 2011 However, higher priced products or less discounts have improved the revenue per product to £20.34 towards the higher end of product pricing

Wallsend unfortunately has seen a fall in both service and product revenue Revenue has fallen to

£1,679k, down £82k (4.7%) as a reflection of both falling appointment numbers (1.2% decrease) and average revenue per appointment down to £39.79 from £41.24 in 2011 This could be a result of more discounts given and male clients who typically generate less revenue than full price female customers Wallsend is also the only salon to reveal a fall in recurring clients to 6,200 from 6300 in 2011 This could

be a result of more clients transferring to the rival salon nearby and also lower quality products as

Wallsend has the lowest percentage of senior stylists

Products at Wallsend also suffered a £271k fall in revenue down 4.1% – this appears to be a continued pattern of excessive product discount with Wallsend’s average product price at £14.13 (the lowest of all 3 salons) and with less appointments: there has been a reduced cross-selling opportunity reflected in fall in product numbers

3.2 Gross Profit

Gross profit margins have been positive with an increase from 56.2% edging towards the top end of the industry expectation of 50-60% margins

Newcastle has achieved the lowest gross margins for services marginally due to higher staff salary costs

as an indicator of hiring the largest percentage of senior stylists

Salaries as a percentage of revenue currently contribute to 30.8%; less than 2011 of 32.8% – this is significantly lower than the industry expected of 40% This reduction in staff costs protects margins; and although the average staff salary across all 3 salons are higher than the industry average of £10k – it is important to retain key staff who are unlikely to be motivated by wage freezes

Margins for services are the best at Gateshead reflecting more ‘technical’ services such as colouring which has higher margins than typical blow and cut

3.3 Irina Yu & Bonus Incentive Issues

Upon inspection of the gross profit to salon numbers ratio it appears Newcastle achieves a rate of 7.3% increase missing the bonus

Taking into account Irina’s email, it appears that salon staff numbers should be adjusted to 19 stylists This is because numbers at year end should reflect the number of staff “working” – it appears reasonable that these staff are not included

There should be an adjustment for the products but only the net of supplier credit as there are no

adjustments made for one-off items Adjustment for the old people’s home experiment should be made so that figures are comparable to prior year

Taking into account these figures, Newcastle achieves an increase of 23.1% in the return and should be awarded a bonus

3.4 Conclusion

Overall LL is performing well with improvement in the Newcastle salon; and overall revenue growth exceeding expectations and economic turmoil

Revenue has improved largely due to better cross-selling and reduced discounts although Wallsend is the only salon to have shown a contraction due to heavy product discounting and reduced appointments Gross profit margins are higher than industry averages of 50-60%, which is an indicator of LL’s strong reputation and differentiator as a “luxury” supplier Margins have also been protected by lower staff costs (less than 40%)

Taking into account Irina Yu’s email, it appears reasonable to account for the necessary adjustments as proposed by her and so Newcastle should be awarded a bonus

3.5 Recommendations

To improve revenue and margins LL should consider rolling out the “shades of season” campaign

currently at Gateshead to all salons as it has proved successful

Stricter policies regarding product discount will allow better margins as will rationalising suppliers to achieve higher bulk discounts

LL should work to improve occupancy rates which currently stand at 50% to increase revenue – this can

be done by encouraging further initiatives

The bonus incentive scheme should be reconsidered to take into account any matters which are head office related and not controlled by the salon manager and adjustments for any one-off items An average number should be used for the year instead of as at year end

Appendix 1

2012 £

2011 £

Change

£

%

Newcastle (N)

Gateshead (G)

Wallsend (W)

Revenue mix

2012 2011 Change %

Ave no products/appointment

Gross profit to salon staff no

Adjustments per Irina Yu for Newcastle salon

£000

Gross profit per 2012 management accounts 881

Adjustments for:

914 Salon numbers per 2012 management accounts 21

Adjusted for:

two stylists on long-term sick leave (2)

19 Adjusted gross profit to salon staff 2012 £48.12

4.1 Expected loss

According to the insurance policy LL can expect to recouperate £437,250 from the policy based on the assumptions provided to us

However, this figure is based on a series of assumptions, the use of expected seasonality figures may be incorrect and assumes seasonality is consistent year on year

The take-up rate and continued number of recurring clients are based on unverified assumptions

An expected £20 spend on products appears high for Wallsend considering the salon is prone to offering high discounts; it may appear an overestimation of actual spend

The gross profit margin used is based on 2012 rates of 57.7%; this does not incorporate any growth which may have been expected for Wallsend in this period

The numbers also do not incorporate any loss of potential new clients for the period