T4 Nov 2011 Answer

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The Chartered Institute of Management Accountants 2012 Page No: 1

T4- Part B Case Study

Papy Sustainable trading case November 2011

REPORTTo: Chief Executive of Papy

From: Management Accountant

Date: 24 November 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 Evaluation of the proposal to reduce electricity usageAppendix 4 Evaluation of reductions in carbon emissions from the 2 proposals and

comparison to target for 2013Appendix 5 Possible change in the number of supermarkets re-builtAppendix 6 Comparison of capital expenditure of reducing carbon emissions for the 2

proposalsAppendix 7 Presentation and graph on the 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 been

established, headed up by Arif Karp, the newly appointed Corporate Affairs Director, to identifyand 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 if Papywere to implement the proposal to re-build 12 stores and the proposal to reduce electricity

usage, together with a graph showing Papys carbon emissions as measured by carbonemissions in kilograms (kg) per square metre of sales area. This is included in Appendix 7 tothis report.

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3.0 Prioritisation of the issues facing Papy

3.1 Top priority Management of change and carbon emission targets

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. Additionally, Lucas

Meyer, Chief Executive, wants Papys carbon emissions to be reduced to 700 kg per squaremetre for 2013. The company needs to decide whether this target is acceptable and whether itis achievable and what proposals it could undertake to reduce its carbon emissions.

3.2 Second priority - Balanced Scorecard

The second priority is considered to be the recently agreed introduction of the BalancedScorecard from 1 January 2012 both as a way of measuring progress towards the achievementof a wide range of targets and also as a mechanism for rewarding employees with free shares. Itis important that all employees are working towards the achievement of Papy becoming a moresustainable retailer to ensure goal congruence. It is also important that the correct key issuesare identified and measured in the Balanced Scorecard.

3.3 Third priority Proposal to re-build 12 supermarket stores

This is considered to be the third priority as it is a significant proposal to temporarily close andre-build 12 profitable supermarket stores. However, as they are older stores and have high heat-loss, it would be a sensible way to reduce carbon emissions. The proposal is to re-build 12 newsupermarket stores which are more energy efficient and incur lower operating costs andgenerate lower levels of carbon emissions.

3.4 Fourth priority Proposal to reduce electricity usage

In order to meet Lucas Meyers target of 700 kg per square metre by 2013, it will be necessaryto invest in as many projects that reduce carbon emissions as possible. The range of investmentprojects to reduce electricity usage is less urgent than the other issues prioritised above but are

worthy projects.

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% (measured as debtof 870.0 million / debt plus equity of 870.0 million + 2,104.4 million). Tescos gearing was46.0% at the end of February 2010.

Papy has also repaid debt of 150 million in the last financial year. So there is room to increasedebt financing in order to fund the proposals to reduce Papys carbon emissions which are setout in this report. Papys interest cover is 9.5 which is high and demonstrates a good ability topay the interest on its current debt.

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 in

long-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 was

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

4.2 Management of change and carbon emission targets

Lucas Meyer wants the Papy chain of supermarkets to be a more sustainable retailer. For this tohappen there will need to be 2 principal changes:

1. Focus on achieving lower targets in carbon emissions and how to achieve these targets

2. Management of change in order for Papys employees to become focused on targets otherthan financial targets.

There is a need to get all employees involved in Papys proposed 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. There needs to be a full commitment from allmembers of the management team and this must be driven by Lucas Meyer. Many managersand employees consider the subject of climate change not worthy of their attention, especially indifficult trading times where costs are being cut and growth in revenues are difficult to achieve. Itis necessary to brief them and explain what Papys new targets are and why and to explain theneed for them to be involved.

It is suggested that a top down approach to briefing is started with all senior managers briefedby Lucas 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.

Perhaps some of the senior management team do not appreciate the importance of long-termobjectives and are focused too much on the achievement of short-term profitability targets.Therefore, the introduction of the Balanced Scorecard (as discussed below) will help Arif Karpand Lucas Meyer to set a range of meaningful targets. The Balanced Scorecard viewsprofitability as being a lag rather than a lead as an indicator of the businesss performance.

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 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 and

accepted 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 bediscouraged as this could further antagonise store managers. It is important for Papy managersand all other employees to be involved and not to use consultants excessively, except whereexpertise on specific aspects is required.

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.

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Within Arif Karps team, it is suggested that a small team should be exclusively committed tocommunication with managers and all other employees throughout the company.Communications could be face to face, by web cast, email or by posters in the staff areas ofeach 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 the Balanced Scorecard, as discussed below, willhelp to identify and measure a much broader range of performance measures linked tosustainability.

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 with

helping 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 eachcountry 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.

Lucas Meyer has set a target of 700 kg per square metre by 2013.

Papy can only achieve these reduced carbon emission targets if it invests in projects to helpdeliver large volumes of savings in carbon emissions, such as the re-building of the 12supermarkets and the proposal to reduce electricity usage. These proposals could deliver largesavings in carbon emissions as shown in Appendix 4.

In summary these savings are as follows:

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Total carbonemissions

Carbon emissionsper square metre

of sales area

Based on average square metre of 1,457,000for 2013

2013kg millions

2013kg per square

metre

Latest forecast for 2013 1,274 874.4

Re-build 12 supermarket stores (264) (181.2)

Reduced electricity (97) (66.6)

Revised forecast after these 2 proposals 913 626.6

The table above shows that these 2 proposals could bring Papys carbon emissions down to626.6 kg per square metre which is 73.4 kg below Lucas Meyers new target.

4.3 Balanced Scorecard

The Balanced Scorecard is a useful management tool to measure, monitor and set targetsacross a wide range of performance indicators. For Papy, it would represent a move away fromsetting only financial targets as a basis for rewarding its employees. However, this initiativeneeds to be handled with great care. It has already been identified that employee morale is low,and that many are resistant to change. With increased profits over the past 5 years employeeshave been rewarded with free shares, and therefore this raises employees expectations for thefuture should profits continue to grow, which they are expected to.

The use of the Balanced Scorecard as a tool to reward Papys employees with free shares isalso useful as this will help employees to focus and understand the range of measures upon

which they will be rewarded. This will help Papy to achieve goal congruence and also help Papyin its transition to become a more sustainable retailer. This cannot happen overnight andchange in employees attitudes and understanding will take time. Investments in sustainabilityare likely to have an impact on store profitability since inevitably payback periods are relativelylong, although the effect on carbon emissions is beneficial. This point has already been raisedby Arif Karp with store managers, and is a sensible justification in itself for having a broaderspread of performance measures.

Through the introduction of the Balanced Scorecard in January 2012, a range of stated andmeasurable objectives and targets can be set. Then actual results can be monitored andreported. Over a period of several years, this will help employees to understand the importantissues and the strategic direction the company is trying to pursue.

The most important measure of carbon emissions has been omitted from these proposalscompletely. It is suggested that the measure of kg of carbon emissions per square metre ofsales area should be included as an Internal Business Process measure. It is thereforesuggested that the proposed measure of electricity usage is removed and replaced by carbonemissions.

The suitability of the measures proposed by Arif Karp and potential conflicts are as follows:

Financial

The financial measures proposed do seem to be appropriate, since they complement eachother. One is volume based, which is a good measure of marketing success, whilst theoperating profit margin is a key measure of store effectiveness in terms of effective purchasing,control of waste and of store overheads. To some extent however local store managers may beinhibited by central control over suppliers and product range.

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There is a conflict between percentage growth in sales revenue and some carbon reductionproposals which could reduce sales revenue, such as the electricity usage reduction which isforecast to reduce sales revenue by a small amount.

There is also a conflict between operating profit margin (which is after depreciation charges) and

the higher depreciation charges that will arise as a result of capital expenditure for carbonemission reduction projects. The more Papy invests, the higher the depreciation charges, whichwill reduce operating profit margins.

Customer focused:

The customer focused measures again seem to be relevant and can be influenced by goodstore management and a keen workforce. Customer satisfaction surveys are an importantsource of information for store managers to highlight where there may be areas forimprovement. The problem of course is getting sufficient customers to complete the surveys inorder to make the data meaningful.

Customer loyalty card information is very useful information. Supermarkets want regularcustomers, for example Sainsburys regularly mail-shot a months discount vouchers tohouseholds in an attempt to get them to change their purchasing habits.

Customer satisfaction could be adversely affected by the electricity reduction proposal whichwould reduce heating (or reduce air conditioning) and make shopping perhaps a little lesscomfortable for customers.

The innovation and learning measures:

Training days on sustainability issues would seem to be suitable, and would support PapysCSR plans. Training is also a useful TQM approach to continuous improvement. There is also

the conflict between operating profit per store and the cost of training days for sustainabletraining issues. Training however should be viewed as an investment in the future, rather thanas a current cost.

A better measure than the cost of investment in carbon reduction projects should be considered.It would be far better to focus on outcomes, which is the drop in carbon emissions. Focusing oninvestments alone, without considering their impact, could lead to over-investment and damageto both cash flows and profit margins.

Therefore, instead of the measure of the cost of the investment in carbon reductionprogrammes, and as a way to involve all employees in the need o change, then a new measureof the number of new carbon reduction programmes introduced by store employees isproposed.

The internal business processes:

As noted above, the key sustainability measure of carbon emissions per square metre hasbeen omitted. It is suggested that this should replace electricity usage as carbon reduction iscrucial to Papy becoming a more sustainable retailer. This measure is at the heart of hat Papy istrying to change and therefore it is crucial that this should be incorporated in the new BalancedScorecard measures.

The other measure concerning the percentage of packaging and other materials recycled isvalid in principle but is not a realistic measure for the Balanced Scorecard as Papy could notmeasure this. Customers may recycle packaging in many ways or not recycle at all and thiscould not be effectively measured.

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It is suggested that an alternative measure is used which is the reduction (in volume) ofpackaging for all products. Therefore, the reduction in volume of packaging for productsdelivered to stores is a more sensible and realistic measure.

There is also the problem with setting targets for each of the proposed Balance Scorecardmeasures that employees can understand and that are SMART i.e. Specific, Measurable,

Attainable, Relevant and Time-bound. There is a need for the Papy management team toensure that it achieves goal congruence and the Balanced Scorecard is widely used as a tool tofocus all employees and management away from solely financial targets. Tesco uses theBalanced Scorecard to ensure that its performance is measured against a range of relevantbusiness targets.

If Papy can achieve its sustainability targets, then this should lead to improved customer focusand profitability. Papy could usefully follow The Co-operative Group in this respect, which whilstit is an organisation focused on profits was also awarded the Responsible trader of the Year in2009 by the Grocer magazine.

The final 8 measures to be used in the Balanced Scorecard need to be considered and thendiscussed with employee representatives, before being introduced in January 2012.

4.4 Proposal to re-build 12 supermarket stores

This is a risky proposal to close down temporarily (for almost a year) 12 profitable supermarketstores. However, they are older stores and a complete re-build will make them more efficientand the new stores would generate significantly lower levels of carbon emissions, at only 0.4million kg for each new-built store.

Many supermarket chains have plans in place to cut their emissions. Tesco has a goal of beinga zero-carbon business by 2050 and has opened several new stores built to a new low-carbon

blueprint. Tesco has several new stores which are zero-carbon, including some in the UK,Europe and in Asia. If Papy is to remain competitive, it must follow the lead set by Walmart,Carrefour and Tesco, which are the 3 largest supermarket chains in the world.

However, the underlying forecast assumptions for revenues and operating profit are suspectand I, as Management Accountant, will need to resolve all of the questions before the proposalis submitted to the Papy Board. This is also discussed in Ethics below.

The revenue per store after re-building is shown as 28.50 million, an increase of 1.0 millionfrom current levels, despite the sales area remaining the same at 2,800 square metres. Theassumptions behind this increase in sales revenue needs to be resolved before the proposal issubmitted to the Papy Board. The operating profit is forecast to be 2.0 million per store after re-building, which is an operating profit margin of 7.0% which is considerably higher than current

performance at these 12 stores of just 2.0%. However, the newly built stores will have loweroperating costs and this is possible. Papys current average operating profit margin in 2010 was5.1%.

The proposal would reduce carbon emissions from 22.4 million kg per store to 0.4 million kg perstore. This represents a total saving of 22.0 million kg per store with a total of 264 million kg forall 12 stores. This represents an equivalent of 181.2 kg per square metre for 2013, which is asignificant volume. This is shown in Appendix 4.

The re-building of these 12 stores could help Papy to meet Lucas Meyers new target of 700 kgper square metre by 2013. Indeed, together with the proposal to reduce electricity usage, itcould exceed the target by 73 kg per square metre. This is also shown in Appendix 4.

It is necessary for Papys Human Resources department to give all employees at these 12 storere-assurance over their jobs and explain what will happen to them during the 10 month re-

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building process. It may be possible for them to work at nearby stores or to attend trainingsessions. In order to maintain employee loyalty, all of the affected employees will needreassurance that they will continue to receive their salary and that their jobs are secure. Thecost of the proposal should include the cost of these employees on a retainer during the periodof the rebuilding of the 12 supermarket stores.

It would be possible for Papys management team to choose to only re-build only 8 supermarketstores in 2012 and the remaining 4 in 2013 and still meet the target of 700 kg per square metre.

Whether all of the 12 supermarket stores were re-built in 1 year or over 2 years, this would stillenable Papy to meet the proposed target of 630 kg per square metre for 2014. This is shown in

Appendix 5.

There is some concern over the loss of customers and customer loyalty whilst these 12supermarket stores are being re-built. How can Papy try to retain customers? It could issue itsexisting customers at these stores with special vouchers or even provide a bus service to otherPapy stores nearby, assuming there are other stores in the same cities as the stores which willbe re-built.

Furthermore, the marketing budget needs to be agreed in order to launch the opening of the 12newly re-built stores and regain its customer base.

The total capital expenditure is 24 million per store, with a total cost for this proposal of288.0million. This proposal is forecast to save 264 million kg of carbon emissions. Appendix 6 showsthe comparison of capital expenditure for this proposal and compares it to the proposal toreduce electricity usage. The capital investment is 1.09 million per 1 million kg of carbonemissions. This is less expensive than the other proposal to reduce electricity usage, whichcosts an average of 1.34 million per 1 million kg of carbon emissions reduced.

In summary, this proposal can be evaluated using Johnson, Scholes and Whittingtonsframework of suitability, acceptability and feasibility, as follows:

Suitability:

This investment would achieve substantial reductions in carbon emissions as required by LucasMeyer for 2013, and also go a long way towards achieving the even lower target for emissions in2014.

Acceptability:

In terms of acceptability this investment would meet the need for reduced carbon emissions ofsome important stakeholders (using Mendelows framework). In particular it would satisfy LucasMeyer and the Board. Arif Karp of course would also be pleased as he has a performancerelated bonus linked to reductions in carbon emissions from a 2010 base.

Investors should find the investment acceptable as it generates higher levels of operating profitat these stores. However, the Management Accountant is concerned that this is based on whatis perceived to be optimistic forecasts for profit improvements from the re-built stores and it isnot clear what the basis is for the 3.6% increase in sales revenue (i.e. from 27.5 to 28.5million per store) after the re-building, since there is no increase in sales area.

Feasibility:

There would appear to be no feasibility problems with this investment. Papy had a significantcash balance of 603.9 million at the end of 2010 and Lucas Meyer has set a challenging targetfor reductions in carbon emissions which this proposal addresses.

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4.5 Reduction in electricity usage

If Papy is to become a more sustainable retailer it must embrace not just the large investmentprojects such as the re-building of stores but also address the many smaller projects across itsentire property portfolio in order to save electricity costs and to reduce carbon emissions.

Many of Papys competitors have much lower levels of carbon emissions as measured bycarbon emissions persquare metre. The Case Study Pre-seen material shows that Competitor2 has a level of only 243 kg per square metre, so even the new 2013 target of 700 kg persquare metre is still high. Papy has a long way to go and therefore it needs to find a wide rangeof small projects to help it to reduce carbon emissions. It should also get employee involvementfor other suggestions on how electricity usage could be reduced.

The proposal to reduce electricity usage included reducing the outside lighting for signs.However, this needs to be weighed up against possible loss of customers, some of whom maythink that the store is closed. A sensible compromise needs to be taken to reduce wastage ofelectricity.

Reducing levels of heating and air conditioning also needs to be carefully considered and

measured so that the temperature is comfortable for staff and also for customers. If customersare not comfortable, this may affect repeat business and customer satisfaction. Concern hasalso been expressed by store managers over the disruption that could be caused by thisinvestment, and the potential loss of customers arising from the change in store temperatures.However, this would demonstrate to all store managers, employees and customers that Papy istrying its best to reduce its carbon footprint by taking this range of measures to reduce electricityusage.

Reducing lighting at night is sensible but the lighting needs to be at a reasonable level to allowstaff to work effectively and safely during night shifts.

The proposal to reduce electricity usage is forecast to generate savings in carbon emissionstotalling 97 million kg in total as shown in Appendix 4. This is equal to 66.6 kg per square metre

in 2013 and will help Papy to achieve (and even exceed) the target of 700 kg per square metre.

The capital cost is 130.137 million, as shown in Appendix 6. Papy has adequate cash funds atthe end of 2010 to fund this proposal. The investment is to be depreciated over 14 years, whichis also the payback period of the investment (as per Appendix 3). This is quite a long timeperiod. However, the operating cost savings are all on-going so this should not be a majorproblem.

This proposal is forecast to save 97.0 million kg of carbon emissions. Therefore the capitalinvestment is 1.34 million per 1 million kg of carbon emissions. This is higher than theequivalent measure for the proposal to re-build 12 supermarket stores, which is only 1.09million per 1 million kg of carbon emissions.

Appendix 3 shows the effect on Papys profitability for this proposal for 2013 only. This proposalshows that the savings in electricity usage are 11.29 million, but this could be partially offset bya reduction in gross margin as a result of a small fall in sales. After taking into account thedepreciation charge of 9.29 million (130.139 million / 14 years), then there is a small fall inoperating profit of (0.22) million for the entire company. This is very small compared to thesavings in carbon emissions.

Appendix 3 shows that the effect on the operating profit for 2013 will be a small increase of0.29 million for small convenience stores, whereas the effect for supermarket stores is a fall inoperating profit of (0.51) million. Therefore the proposal is financially viable for smallconvenience stores.

The forecast fall in sales, perhaps due to customers not seeing Papy supermarket signs or

customers not spending as much time and money due to less than comfortable store

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temperatures, needs to be carefully monitored to try to reduce or eliminate this potential fall inrevenue.

In respect of Lucas Meyers new target of 700 kg per square metre for 2013, it would bepossible to still meet this target even if this proposal were not to be approved, as the proposal tore-build 12 supermarkets generates sufficient savings in carbon emissions to meet the target.

However, this proposal is to introduce a wide range of electricity saving proposals across Papysentire property portfolio and would encourage all employees to become involved with reducingcarbon emissions.

5.0 Ethical issues and recommendations on ethical issues

5.1 Range of ethical issues facing Papy

There are a range of ethical issues facing Papy including the following:

1. Management Accountants dilemma concerning possible incorrect revenue and

operating cost assumptions in the proposal to re-build 12 supermarket stores

2. Proposal to change packaging

3. The dilemma of whether the Papy Board should accept both proposals or not as thiswould result in the target of 700 kg per square metre being exceeded in 2013.

Alternatively, Papy could cut back on some of the initiatives or even delay the re-building of up to 4 supermarket stores until 2013 or later but this would be unethical.

4. Duty of care to employees and that shelf stacking should not occur in semi darknessconditions

5.2 Management Accountants dilemma concerning incorrect assumptions

5.2.1 Why this is an ethical issue

This is an ethical issue as myself, Management Accountant, have serious concerns about theunderlying assumptions for the revenues and operating profit for the 12 stores after re-building.There is something suspicious going on as I have overheard a conversation between Arif Karpand the Marketing Manager about whether the proposal to re-build the 12 stores would beapproved if it were to be known that a lower level of sales revenue and operating profit werelikely to occur after re-building these stores. Perhaps Arif Karp is trying to make this proposalmore attractive as it reduces Papys carbon emissions and would generate a higherperformance related bonus for him personally. There is a conflict of interests here.

I do not believe the revenue and operating profit assumptions are correct and fear that there is

some sort of cover up to make the proposal appear to be more financially attractive. Havingbeen appointed as a member of the project team headed up by Arif Karp, I am unsure as to whoI should raise my concerns with.

5.2.2 Recommendations for this ethical issue

It is recommended that the Management Accountants concerns about the integrity of thesefigures should not remain unanswered.

The Management Accountant needs to consider both h is/her own integrity and CIMAs code ofethics. In particular the Management Accountant needs to consider the fundamental principlesof objectivity (i.e. not to allow the undue influence of others to override business judgements),and also professional competence and due care.

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It is recommended on ethical grounds therefore that he/she raises the concerns with theFinance Director. It is important that business decisions are made based on realistic figures,particularly high profile and high capital expenditure projects such as this one. They should beaccurately and honestly prepared and presented to the Papy Board.

It is further recommended that Arif Karps performance related pay is changed or re-negotiated

(if possible) and that it is linked to the new Balanced Scorecard and not just Papys reduction incarbon emissions. Perhaps his 3 year contract cannot be changed during his first 3 years butthis is a specific clause that should be changed when the contract comes up for renewal.

5.3 Proposal to change packaging


The general idea to reduce the volume of packaging is good, but this is an ethical issue for 2separate reasons, which are:

1. The proposal to change from recyclable glass to plastic which is not easily recycled, is not inthe spirit of Papy becoming a more sustainable retailer

2. The change would reduce Papys carbon emissions by a small amount but would actuallyincrease its suppliers carbon emissions

Supermarkets have a large power over its suppliers, and Papy could force this change through.Customers could also view this initiative in a positive light because of inadequate local recyclingfacilities for glass. The ethical issue this raises therefore is whether Papy should just consideritself or the impact it has on the whole supply chain?


It is recommended that the change to plastic containers is not pursued as the use of plastics

should be discouraged. Glass is a recyclable material and therefore this is a good material for asustainable retailer to use.

Furthermore, it is recommended that Papy should actively promote and encourage the recyclingof glass containers. If local recycling facilities are not available then Papy should establish itsown or raise this concern with local authorities.

It is recommended that a large container for glass recycling is set up within the car parkingareas of as many Papy stores as possible. This could be a new measure for encouragingrecycling in the communities in which it operates.

It is stated that only 20% of customers recycle their glass bottles. As part of being a sustainableretailer, Papy should encourage its customers to recycle glass. Regular customer surveys

should be held to see whether the level of glass recycling is increasing.

5.4 Accept carbon reduction proposals and exceed targets or delay or cancel some


There is an ethical dilemma as to whether Papy should approve both proposals and exceed thetarget of 700 kg per square metre in 2013.

The proposals would reduce carbon emissions to 626.6 kg per square metre. This is 73.4 kg persquare metre lower than Lucas Meyers new target.

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Each of the 12 supermarkets saves 22 million kg which equals 15 kg per square metre.Therefore the Papy Board could decide to delay the re-building of 4 supermarket stores (60 kgper square metre) as shown in Appendix 5.

Alternatively, Papys management team could choose not to undertake the electricity reductionproposal (66.6 kg per square metre) and still meet the target of 700.

Should Papy consider delaying or cancelling the re-building of 4 stores until 2013 or not toundertake the electricity reduction proposal? Is this an ethical stance for a company trying toprove that it is committed to reducing its carbon emissions?


It is recommended that both proposals are approved in full and are undertaken without delay.

This will result in Papy exceeding the target of 700 kg per square metre and the forecast is toachieve 626.6 kg per square metre for 2013. Papy must show its commitment to reducingcarbon emissions and not be distracted by short-term loss of profitability.

5.5 Duty of care to employees and that shelf stacking should not occur in semi darknessconditions


As an employer, Papy owe a duty of care to its employees to provide a safe workingenvironment. Therefore, the store managers who are trying to save electricity costs byinstructing employees to fill the supermarket shelves during night shifts in semi-darkness arebreaching this duty of care.


It is recommended that this unsafe and unethical treatment of employees should stop

immediately. Arif Karp should send a message to all store managers telling them that adequatelighting for night shift employees should be provided.

Furthermore, it is recommended that the operations department investigate installing motionsensors and low energy lighting, so that lighting is provided only in the areas of supermarketstores where employees are actually working, rather than for the whole store.

6.0 Recommendations

6.1 Management of change and carbon emission targets

6.1.1 Recommendation

Lucas Meyers wish to see Papy become a more sustainable retailer is a sound one and it isimportant to set challenging targets to reduce carbon emissions. It is recommended that thetarget of 700 kg per square metre is agreed and that both of the proposals (see below) areaccepted. This would result in Papy exceeding this target for 2013 with forecast carbonemissions of only 626.6 kg per square metre.

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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It is important to get all of Papys employees on board with the need to become moresustainable. It is also clear that many employees are confused by the apparent change of focusaway from cost control to carbon emissions. There is also a significant change proposed to themethod of calculating performance related pay, which if not handled carefully would furtheraffect employee morale. Recommendations on the Balance Scorecard are shown below inparagraph 6.2.

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 (Case Study Pre-seen materialpage 5).

At some stage in the next 5 to 10 years it is expected that the European Union (EU) will tax orimpose fines on any company that do not make substantial reductions in its carbon footprint. Itwill be better for Papy to change voluntarily now, rather than have changes, or substantial fines,imposed on the company.

6.1.3 Actions to be taken

1. Lucas Meyer should be the senior Champion for change, and to work with Arif Karp andstore managers to get the message on sustainability across to all employees.

2. Simona Papy, the HR Director, could also work with small groups of store managers,possibly on a regional basis, to help drive the Boards messages through the organisation.

3. Because many employees do not understand what the company is trying to do then Papyshould train a number of store employees to be Energy Champions who are tasked toreduce energy and to encourage colleagues to do the same. This would also support one ofthe proposed Balance Scorecard performance measures under Innovation and Learning.

4. 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.

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

6. Arif Karp should seek advice from his previous consultancy company, and appoint it ifnecessary, to advise him on other practical ways in which Kurt Lewins ChangeManagement Model of unfreeze, change and re-freeze could be used to changeorganisational culture within Papy.

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

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

6.2 Balanced Scorecard


The Board has already given its approval for this initiative. It should help Papys sustainabilityagenda because 4 of the 8 proposed performance measures are clearly linked to sustainability.

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However, as noted in paragraph 4.3 above, the crucial measure of carbon emissions in kg persquare metre should replace the electricity usage measure in Internal business processes .

Additionally, it is recommended that the internal business process measure concerningpackaging is re-worded as shown below.

These new performance measures should have a significant influence on employee

performance related pay, but because of the current low morale of store employees, thesemeasures should be fully discussed and explained to all employees.

It is recommended that there should be some changes to the performance measures in theproposed Balanced Scorecard due to conflicts and the omission of the important target ofcarbon emission reductions. The new measures should be:

1. Financial percentage growth in sales revenue per store (no change from proposedmeasure)

2. New measure: Financial growth in operating profit margin excluding depreciation chargesas capital projects approved by Arif Karps team will increase depreciation charges whichare outside the control of store managers

3. Customer focused customer satisfaction survey including comfort in stores (no changefrom proposed measure)

4. Customer focused - number of customer shopping visits each year (using data fromcustomer loyalty card information) - (no change from proposed measure)

5. Innovation and learning - training days specifically on sustainable trading issues (no changefrom proposed measure)

6. New measure: Innovation and learning number of new carbon reduction programmesintroduced by store employees

7. New measure: Internal business processes Reduction in volume of packaging

8. Internal business processes recommend removal of electricity usage and replace with:New measure: Internal business processes: carbon emissions - as measured by kg persquare metre of sales area, for each store.

6.2.2 Justification

Performance related pay (free shares) should be linked to the achievement of long-termobjectives. As Papy realigns its objectives to become a more sustainable retailer, it is correct forthe reward mechanism for free shares for employees to also change. Therefore the BalancedScorecard is an appropriate tool for Papy to use.

As the focus should be on Papy becoming a more sustainable retailer and reducing carbonemissions, then the performance measure of carbon emissions must be included within theBalanced Scorecard.


Then it will be necessary to set targets for the new measures by store and for the Papy group.

Arif Karp and his team should set up meetings with Simona Papy and representatives from bothstore managers and other store employees to discuss the implications for performance relatedpay based on the Balanced Scorecard.

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Actions:

measure actual progress for each of the agreed measures

to communicate progress to all store managers and other store employees

to monitor progress and take appropriate corrective actions

to try to exceed targets set to speed up Papys progress towards becoming moresustainable

6.3 - Proposal to re-build 12 supermarket stores


It is recommended that these 12 old stores are temporarily closed and re-built. The new storeswill generate higher levels of profit and substantially lower levels of carbon emissions.

It is also recommended that myself, as Management Accountant, resolves my concerns over theunderlying assumptions for forecast sales revenues and operating profit figures after the re-building of the 12 stores before the proposal goes to the Papy Board for approval. It isrecommended that I refer this concern to Papys Finance Director.

6.3.2 Justification

If Papy is to become a more sustainable retailer it must reduce its carbon emissions and these12 stores generate very high levels of carbon emissions at 22.4 million kg per store. This is over7 times greater than an average store with only 3 million kg of carbon emissions.

The newly re-built stores are forecast to generate only 0.4 million kg which will generate good

publicity for Papy and will demonstrate to key stakeholders that Papy is serious about reducingits carbon emissions.

It will enable Papy to meet, or even exceed, Lucas Meyers target of 700 kg persquare metre for2013.

The rationale for the referral of the financial aspects of this proposal to the Finance Director isbecause I have overheard a conversation concerning the accuracy of the financial aspects ofthe proposal. Irrespective of this referral concerning the financials, my recommendation is thatthe proposal should proceed as it will reduce Papys carbon emissions and allow Papy to meetLucas Meyers target of 700 kg per square metre by 2013. Therefore, whilst I recommend thatthe proposal should proceed, it is subject to clarification of the financial data.


The Papy Board should invite tenders from a number of construction companies, and prepare ashort-list of companies for the Board to choose the contractor.

It is further recommended that there should be local marketing initiatives undertaken explainingto the local community why Papy is causing short-term disruptions in these 12 supermarkets,emphasising the environmental benefits.

It is recommended that the Human Resources department gives reassurance to all of theemployees at these 12 stores and confirmation that they will continue to receive their salary andthat their jobs are secure.

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Myself, as Management Accountant, need to resolve the questions concerning the forecast levelof revenues and operating profit after re-building of these stores.

6.4 Reduction in electricity usage


It is recommended that Papy does invest in these projects at a total cost of 130.137 million asthey will lead to a fall in operating costs (due to lower electricity usage) and also lead tosubstantial reductions in Papys carbon emissions across all of its stores. The forecast reductionin carbon emission is 97 million kg from this proposal.

6.4.2 Justification

This proposal will help to contribute towards Papy reaching and even exceeding its target of 700kg per square metre by 2013. This proposal will save a total of 97 million kg of carbonemissions, which is equal to a saving of 66.6 kg per square metre for 2013.

The capital cost for this proposal, as expressed as the cost per 1 million kg of carbon emissions,is 1.34 million on average. This is almost 23% higher than the other proposal to re-build 12stores, which is only1.09 per 1 million kg of carbon emissions.

The forecast small loss of operating profit of (0.22) million for 2013 is due to forecast lowerlevels of revenues. Revenue forecasts needs to be monitored closely to see if this reduction canbe reduced or eliminated.


The Papy Board to approve this proposal.

All store managers to be briefed on the range of proposals and the target savings in electricityusage by store. Actual usage should be measured against these targets after the measureshave been taken.

Contractors need to be selected and a timetable for the work on all 1,215 stores planned.

Employees suggestions for other ways to reduce electricity usage should be gathered.

Store managers to plan when and how work can be carried out to minimise the disruption tostores.

7.0 Conclusions

Papy needs to change in order to achieve its plans to become a more sustainable retailer.Lucas Meyer has set a challenging target of 700 kg per square metre. This target could even beexceeded if both of the proposals to re-build 12 supermarket stores and undertake theproposals to reduce electricity usage were both 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 company

New Chief Executive with determination tobring about change

Environmental expertise and experience ofArif Karp

Strong CSR objectives

Good IT systems

Increase in customer numbers

Growing market share in its home country

High operating profit margin compared to2 of its competitors

Reduction in long-term debt in lastfinancial year

Increase in cash balance over the lastfinancial year

Weaknesses

Employee resistance to change anddifficulty in bringing about changeEmployee morale and scepticism aboutchanging the focus from profit targets toreduction in carbon emissionsSome employees are frustrated and areconsidering resigningPapy has the highest carbon emissionsper square metre in comparison with 3 ofits competitorsDependent on store managers to achievetargets setHow to measure CSR targetsPerformance related targets are currentlyonly financial targetsPapy does not offer Internet shopping

Opportunities

To change to become a more sustainableretailer and reduce carbon emissions

To achieve a target for carbon emissionsof 700 kg per square metre for 2013To re-build 12 supermarket stores toreduce carbon emissionsTo reduce carbon emissions throughreduced electricity usage at all storesTo engage all employees in a wide rangeof targets through the introduction of theBalanced ScorecardTo 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

Poor employee commitment to sustainabletrading focus

Risk that capital expenditure may notachieve the planned savings in electricitycosts or not achieving planned reduction incarbon emissions

Loss of customers following the temporaryclosure of 12 stores whilst they are beingre-built

Losing key staff whilst Papy undergoes aperiod of change

The effective management of change inthe face of the highly competitive foodretailing industry

Possible employee opposition to

performance related pay (free shares)linked to the Balanced Scorecard startingin January 2012

Long-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 the

unseen material, is expected.

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Appendix 2PEST analysis

Political/Legal

Possible future fines or taxes based on levels of carbon emissions

Pressure from different EU governments to reduce carbon emissions to meet EU targets

Possible subsidies from EU governments for investment in low carbon technologies

Economic

Pressure from competitors and the need to maintain market share

Shareholders demands

Will finance be available for the proposed investment opportunities due to bank lendingrestrictions?

Shareholder reaction to investment in low carbon emissions stores (both the re-building

of 12 supermarket stores and the reduction in electricity usage at all stores)

Social

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

Customer reaction to the temporary closure of 12 supermarket stores whilst they are re-built

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 ways to reduce electricity usage

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Appendix 3

Evaluation of the proposal to reduce electricity usage

Evaluation on operating profit for 2013 only:

Forecastrevenue

reduction

Forecastreductionin GrossMargin*

Annualsavings inelectricity

costs

Sub totalbefore

Depreciation

Depreciationcharge(over 14years)

Forecasteffect onoperatingprofit for

2013

million million million million million million

Supermarkets (4.81) (1.92) 7.87 5.95 (6.46) (0.51)

Small convenience

stores

(0.74) (0.30) 3.42 3.12 (2.83) 0.29

Total stores (5.55) (2.22) 11.29 9.07 9.29 (0.22)

*Note: Forecast reduction in Gross Margin is based on 40% of forecast revenue reduction ascost of good sold is 60%

Depreciation charges are calculated as follows:

Supermarkets: 437 stores x 207,000 = 90.459 million / 14 years =6.46 million per year

Small stores: 778 stores x 51,000 =39.678 million / 14 years =2.83 million per year

Total capital cost = 130.137 million

Payback period:

The payback for this investment = capital expenditure of 130.137 / annual cash flows (sub totalabove before depreciation charge) of 9.07 = 14.3 years.

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Appendix 4

Evaluation of reductions in carbon emissionsfrom the 2 proposals and comparison to target for 2013

Savings in carbon emissions from the proposal to reduce electricity usage:

Averagenumber ofstores for

2013

Savings incarbon emissions

per store

Total savings incarbon emissions

Kg per storeFor 2013 Kg million

Supermarkets 437 157,400 68.8

Small convenience stores 778 36,300 28.2

Total 97.0

Evaluation of reductions in carbon emissions from the 2 proposals

2013 is based on 1,457,000 square metres 2013Carbon

emissions

2013Carbon emissions

kg millionkg per square

metre of sales area

Latest forecast 1,274 874.4

Reduction from:Re-building of 12 supermarket stores* (264) (181.2)Reduction in Electricity usage (97) (66.6)

Updated forecast including the 2 proposals 913 626.6

Lucas Meyers target 1,020 700.0

Exceeded target for 2013 by: 107 73.4

*Note: Reduction in carbon emissions from re-building 12 supermarket stores is 22.4 kg millionless 0.4 kg million = 22.0 kg million x 12 stores = 264 kg million. This is equal to 181 kg persquare metre.

The reduction in carbon emissions that could be achieved by implementing these 2proposals would result in a lower level of carbon emissions for Papy overall that thetarget of 700 kg per square metre. The carbon emissions would exceed target by 73.4 kgper square metre for 2013.

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Appendix 5

Possible change in the number of supermarkets re-built

Each supermarket that is re-built saves 22.0 kg million = 15.1 kg per square metre in 2013.

If Papy were to only re-build 8 of the proposed 12 supermarkets then Papy can still achieve thetarget of 700 kg per square metre, as follows:

2013

TotalKg millions

2013

Kg persquare metre

Updated forecast carbon emissions including the 2proposals (as shown in Appendix 4) 913 626.6

Reduction of 4 supermarkets at 22.0 kg m each(i.e. To re-build only 8 supermarkets for 2013)

88 60.4

Revised total carbon emissions 1,001 687.0

2014 targets:

The re-building of these 4 supermarkets could be deferred by 1 year. Irrespective of when theywere to be re-built, they would help Papy to achieve the target of 630 kg per square metre for2014.

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Appendix 6

Comparison of capital expenditure of reducing carbon emissionsfor the 2 proposals

Savings incarbon

emissions

Capitalcost

Capital costper 1 million kg

of carbonemissions

saved

Kg million million million

Re-build 12 supermarket stores- 12 stores 264.0 288.0 1.09

Reduction in electricity usage:Supermarket stores 437 stores 68.8 90.459 1.31Small stores 778 stores 28.2 39.678 1.41

Overall for reduction in electricity usage 97.0 130.137 1.34

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Appendix 7

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

The savings in carbon emissions from the re-building of 12 supermarket stores is 264.0

million kg. This is equivalent to 181 kg per square metre in 2013

The savings in carbon emissions from the proposals to reduce electricity usage is 97.0million kg by 2013. This is equivalent to 67 kg per square metre in 2013

Together these 2 proposals could bring Papys carbon emissions down to 627 kg persquare metre by 2013. This is 73 kg per square metre below the target of 700.

Total investment required for both proposals is 418.1 million.

It is recommended that both proposals are accepted, assuming the funding can besecured, so that Papy can reduce its carbon emissions down to 627 kg per square

metre and beat its target for 2013.

End of answer

Carbon emissions (kg)

per square metre of sales area

1,077 1,042 1,022948

627

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1,1001,200

2009 2010 2011 2012 2013

Carbonemissions(kg)

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squaremetreofsalesarea

T4 Nov 2011 Answer

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