F
82
C H At' rER 2 / ~TRATH~ I C J\ t AN AG~ME)JT A:--J D PRO JECT S EU'.<T IO),J
The foll owing case co nc~rn !'i i.l Europea n finn try in g ro chooi.e between alinos [ a dOLen <:ilpi ta l in ves tment proj ects bei ng
ch amploncJ by different ex:e c llli\i e.~ in lhe firm. Howeve r, [here are m,lll Ymore projech <lvail<lhl c for funding: [han there (Ire
fllnd.~ av ailabl e 10 implem ent tl1enl. so the set lTIlI .')'! be narrowed dO'W11 10 the 1Il0~1 valu able "Hid important 10 Ihe firlll .
Finan Cial. ~ lra L e gic, and olher data arc gi ven concerni ng til<: projects in order 10 faeililale the an;ll y... i!:o needed to make a
fin ,1! in ve stment re( omlllcndation 10 the Bourd o f DireCWf\ .
,
!
!
•
j
I
i
"
It w a!-. ead y January, and th e se nior-l11anagement <':0111 ­
millee or Pan- Europa Foods wa ~ [0 mee t to draw up the
linn',.., capital budge t for the new yea r. Up for conside r·
Jtion wert' II i1liljor projects tha l totaled over €lOS million
(euroq. U nforlunately, the board of d irec t o l ~ had imposed
il spending limit of onl y R
€ O million: even so. in ve!'tmen t
<II that rate would re pre~ ent a major ilH.:rease in the rirm '"
asse t base or E656 million. Thu s the ch<tllenge for the
se nior managers o f Pan-Europa was to allocate fUlld ,
among a range of co mpelling proj ec ts: new-product
introduction. acq uh.ilion, mark et expa nsion, efti ciency
improve men ts. preve llli ve m<tinlenancc. safe ty, <.Ind pol­
lutiun cu nt ro l.
The Compan y
P<tll-Europa Foods. headquartered in Brll sscl.<.,. Belg ium.
was a mllitinalionnl producer o f hi gh-qui:l lity ice cream,
yogUrI, bouled W<:Itcr. and fruit jui ce ~ . Its products were
so ld throu ghout Scandinavia, Britai n, Belgium. th e
Netherlands, Luxembourg. we'>tern Gefll1a ny. and north ­
ern Fn111ce. (S ee Ex hihit I for a milp of the cumpany":-­
marketing region.)
T he co mpan y wa s rounded in 1924 by Theo Ve rdin ,
a Belgian farmer, as an off'ihoOI of hi s dairy bu s in c~~.
Through kee n ,\llention to produ ct developme nt, and
shrewd marketing, th t: busine~" grew steadily over th e
year.'> . The company went public in 1979 ancl by 1993
was li.'>led for tradi n,g on the L ondon . Frankfurt, lind
Brlls~eb ex changes. Last year P::l Il-Europa htld sales of
almo... 1€ I . I billiu n.
Ice cream aceouliled for 60 percent of the compa ­
ny's revenues: yogu l1. whi ch wa, introduced in 1982.
>l" RepriIlH.?d wilh
pt" rllli .,~io n.
Copyri J;hl Durden Gradua(e
Sdwol FOllnd .lI mn. Chnrlolh;;"\· III(!. Vi rgin ia .
Bu ~i n(! ' "'
co ntribulecl ahout 20 percent. Th e remaining 20 per­
cenl of .~ale:-; WilS di vided cquall y helwee n bOlllcd water
and fruit juices. Pan-Europa' " flag:--hip brand name wa s
·'Roll y." whi('h was reprc:-.c nted by a fat, dancing bear
in rLlnners' clothing. lee cream , Ihe co mpany ' s lead in g
product, had a loyal base or eu s tL)l11 e r~ who ~ou g ht oul
its high bULlCrfat content. large cl1unkc; or ch ocolate.
fruit. nuts, and wide range or ori ginal Rtl vors.
Recentl y. Pn n· Europa ... ale.. . hnd been '> (atie (see
Ex hibit 2). which management ~ltlribU(ed 10 low popu ­
bli on growth i n northern Europe and market s.Hura­
lio n in sume ~lrt":as. O llt~ide ulN:.:rvc r.,>, however, faulted
recent failures in new-product Intruduc lions. Most mem­
ber.':> uf man agement wanted (0 expa nd lhe comp.ulY'.<;
market pre~e n ce and imrodllce n10re ne w products to
boos t :-. alc ~. These manager:-- hoped th ar inc rea~e J mar­
ket pre.. .ence and ~ :lle<; would improve the co mp allY'~
market value. P;'.II1-Europa·s ~tock W<l~ cu rrently at eight
times earnin g... , ju'>1 beluw book va luc. This price/earn­
ings ratio was be low the tr;:1d ing mu ltiple.,> of compara·
ble compani es. but it gave little va lue to t.he co mpan y 's
brands.
Resou rce A11 oc;)tion
T he capital budgel al Pan-Europ,l W(l.'> prepared annuall y
by a cOlllmitt ee of senior manager... who then presented
it for appruva l by the board of director';. The co mmit­
tee co n s i ~ te d o f fi ve managing directors, the p/"(!si.dcJIII
direcleur-gell(;ral ( PDG ). and the finance director. Typi ­
call y. the PDG solici ted illvc.~!Jnenl proposab from the
managing direc tors. The propo.'>a l<.; included a brief proj ­
ecl descripti on. a ti nancial anaI Y''' i:--. and a discuss ion o f
.'>I rategic or other qualitative con . . idcrati on:--.
A " a matter u f policy. in ver.; rlllelli propo<;ab at Pan­
Europa were <,uhjecteu 10 two linancial test" . pa yback
83
CASE
EXHIBIT 1
P;lIl -Europa Foods S. A. N ations \Vh ere Pan -Europa Co mpe ted
NOle: The shaded area in thi s map re vea ls the princ ipal diSlribution region o f Pa n-EurQP:' 's produclS. lmpon ant faciliti es Me indicated by the
follo w ing fi g ufe~:
!. Headqu arters, Bl1lssel s, Be lgium
2. Plant , Ant werp, BelE ium
3. Plam, Slrasbollrg. Frauce
4. Plant, Nuremberg , Germa ny
S. Planl, Hamburg. German y
6. Plan l, Copenhage n. Denmark
7. Plant . Svald , Sweden
8. Plan t. NeJly-on-Mersey. England
10. Pl an!, Melun, France
and inte rn . 1 rate of return (lRR). The test s, or hurd les,
had been es tabli shed by the management comm ittee anti
valied accordin g to the type of projec t:
MiHimum
Acuptable
Type ofProject
J. New prod uct or new markets
2. Product o r market extensi on
3. Efficiency improvements
4. Safety or environmental
(
9. PI<l nl , Caen. Frauce
IRR
12%
10%
8%
No tesl
MnxinU4;m
Acceptable
Payback
Yean
6 yenrs
5 yea"
4 years
No rest
The most recent estim ated weighted· average cost of cap­
ital (WACC) for Pan -Europa was 10.5 percent. In desclib­
ing (he capital-budgetiog process, the finan ce director,
EXHIBIT 2
SUlllln <lry ofF in~HH.: ia l RC~Ll lt s (.\11 va lues in
€ millio ns except per-shan.: amounts)
Fiscal Yea,.,. Ending December 31
PrerWus
Last
Year
Year
Gross saLes
Net income
Earnings per share
Dividends
Total assets
Share holders ' equit y
(book value)
Share holders' equit y
(market value)
This
Year
477
182
20
580
206
1,074
37
0.54
20
656
235
453
400
229
t,076
51
0.75
20
t,072
49
0.72
Trudi Lauf. sa id. <'We use the s liding scali! of JRR tests as
a way of recog nizin g differe nces in risk among the vnriOlls
.,
84
CH .'.PTEI\ 2 / STRATFGI C MAI'AGcMFNT A)lL> PROJECT Sf.LFCTION
types of projecfs . Where (he company takes more risk, we
should eam more relUm. The payback test signals that
we are not prepared to wa il for long to achie ve that retum."
Ownership and th e Sentiment of
Creditors and Investors
Pan-Europa's 12-me mber board of directors included
three members
the Verdin family, four members of
management. and five outside directors who were prom­
inent man(lgers or public figures in nonhern Europe.
or
Member!', of the Ve rdin family combined owned 20 per­
cenl of Pan - Europ~ 's shares Qu{"tanciing. and company
executives owned I 0 perce nt of the ~ hare s. Venus A sset
M<magement, <1 mUlual-fund management company in
London, held 12 percen!. Banque du Bruges el des Pay\)
Ba<, held 9 percenl and had o ne representative on the
board of directur". The remaining 49 percent of th e nnn 's
shares were widely held. The nnn's shares lraded in
London, Bn.l~.r.;el s . and Frankfurt.
At a debl-to -equiry rati o of 125 percent. Pan· Europa
was leve raged lIllich more highl y than its peers in (he
Europe3n consllmer·foods industry. Management had
relied on debl finan cing significantly in lhe past few
years to sllstain th e firm 's c<.lpital spending and dividends
during a period ot' price wars initiated by Pan-Europa.
Now. with the price wars hnished, Pan-Europa 's bank­
ers (led by Banque du Bruge~) s(rongly urged an aggres­
sive program of debt reducti on. In any event, (hey were
nOI prepared 10 ~l1an ce increase~ in leverage beyond the
current leve l. The presiJen! of B<.IIlql.le du Bruges had
remarked at CJ recent board meeting,
Restoring .\ome strength to the right-hand side of
th e b<.llance sheet should now be a hrst priority.
Any expansion of a s~e ts should be financed from
the cash ftow afte r debt amortizaiion until the debt
ratio returns to a more prudent level. If there are
crucial inve:-..tments that cannot be funded thi s way.
then we shou ld cut the dividend!
Al a price-to-ea rnin gs ralio of eight times, shares
of Pan- Europ a common stock were priced below the
av erage multiples of peer companie!=. and the average
multiples of all companies on the exchanges where
Pan-Europa W<l,\ traded . Thi s was attributable 10 the
rec ent price war~, which had suppressed the co mpa­
ny's profitability, and to the we ll -kno wn re cen t fai lure
of the co mpany to seize significant market share with
a new produt: l line of flavored mineral water. Since
las t yea r, all of the major securities houses had been
issuing "se ll" recol1lmendafion ~ to in vestors in Pall­
Europa shares. Ve nus Asset Management in London
had qui etl y ac cumulated shares during this period ,
however. in the expec tation of a lurn<.lround in the
firm 's performance. Al the mos t recent board meeting..
th e senior managing direc tor of Ven u.<., ga ve a presenta­
tion in which he said ,
Cutting Ihe di vidend is unthinkable. as it would
signal a lack of faith in your own future . Selling
new shares of stock at this depressed price level
is also unthinkab le, as it would illlpose un accepr·
able dilution on your curre nt shareholders. Your
equity investors ex.pect an impro veme nl in perfo r­
mance. If that improvement i.-. not forrhcoming, or
worse, if in vc",tors' hopes are das hed , your shares
might fall into the hands of raider.'. like Carlo de
Benedetti or th e Flit:k brothers. l
At th e conclusion of the most rece nt Ineeting of (he
directors. the boa rd voted unanimously to limil capital
spending in the nex t year to €80 millioll.
Members of the Senior Mallagetnent Committee
The capital budget would be prepared by seven se nior
managers of Pan-Europa. For co nsideration. each proj·
ec t had [Q be sponsored by one o r the managers present.
Usually the decision process included a period of discus­
sion followed by a vote on two (0 four alternati ve capi·
raj budget". The various exec utiv e" were well known to
each other:
Wilhclrnino Verdi n ( Belgian) , POGo <lge 57. Grand·
dau ghter of lhe founder and ~ pok esp er so n on the
board or directors for th e Verd in family' s inter­
ests . Wo rked for the co mp any he r entire C':Heer.
wi(h significant experience in brand management.
Elected "Europea n Marketer o f the Year" in 1982
for sll ccess fully introducing lo w· fal yogurt and
ice c ream , the first maj or roll · out of thi s type of
product. Eager 10 position the co mpany for long·
term growth but cautious in rh e wake of recent
difficulties .
Trudi Lauf (S wi ss). finance direc tor. age 5J . Hired
from Nestle to moderniI,e financial conu·ols and
syMems. Had been a vocal proponent of reducing
iDe Be neue lli of Milan and the Fhc-k h rolh t: r~ of Munich were
01 promine nt hO "l ile-wkeover aUelllpl ~ 10 rC t.-e nl ye a r ~.
leader~
CASE
leverage on th e balance sheet. A Iso had voiced the
concerns and frustra tion s of stockholders.
Heinz Klink (Ge nTIan), managing direcLOr for Distri­
bution, age 49. Oversaw the transporta tion, warehous­
in g. and orde r-fulfillment ac tiviti es in the company.
Spoilage, transport costs. stock- ollts. and contro l sys­
(em s were perennial challenges.
Maa.nen Leyden. (Dutch) , managing director for Pro­
duction and Purchasing, age 59. M:waged production
operations at the company's 14 p lants_ Engineer by
training. Tou gh negotiator, especiall y with uni o ns ancl
suppliers. A fanatic about production-cos[ control.
Had vo iced doubts about the si ncerity of credito rs'
and investor~ ' comm itm ent to the firm.
Marco Ponti (halian), managing director for Sales,
e
II
,.
j-
l­
o
I-
e
age 45. O versaw the field sa les force of 250 repre­
se ma(ives and planned changes in geographical sales
coverage. The most vocal proponent of rapid expa n­
sion on the senior-management comm ittee. Saw sev­
era l opportunities fo r ways to improve geographical
pos itioning. Hired from Unilevcr to revitalize r.he sales
organ iza tion, which he successfuJl y acco mpli shed.
Fabiellne Morin (French), Inanagi ng direc[Qr for Mar­
keting , age 4 J. Respon sible for marketing re search,
new-product development, advertising, and , in gen ­
eral , brand management. The primary advocate of the
recent price war, whic h, a ltho ugh financially difficu lt,
reali zed solid gains in market share. Perceived a "win­
dow of opportunity" for product and market expan­
sion and tended to support grow th-o rie nted projects.
Nigel Humbolt (British), managing director for Strate­
gic Plan ning, age 47. Hired two years prev iously from
a well-kn ow n consulting firm to se t up a s trategic­
planning Slaff for Pan-Europa. Known for aSking
difficult and challenging qu esrions about Pa n-Europa's
core business. its maturity, and profitability. Sup­
pOtted initiatives aimed at grow th and market share.
Had presen.ed .he mos. aggressive proposals in 1992.
none of which were accept ed. Becoming frustrated
with what he perceived to be hi s lack of inHue nce in
the organi za tion .
The Expenditure Proposals
The forthcoming meeting would enterLain the following
proposal s (see summary table al so):
1. Replacement and expan.sion of the truck fleet.
Heinz Klink proposed to purchase 100 new refrigerated
tractor-trailer trucks. 50 this year and an othe r 50 next
year. By doing so. the compan y could se H 60 o ld, full y
depreciated tr ucks ove r the two years for a total of € 1.2
million. Th e p urchase would expand 'he fleet by 40 tnl cks
with in two years. Each of t.he new trailers would be larger
than the old trai lers and afford a 15 percent inc rease in
c ubi c me ters of goods hauled on each trip. The new trac­
tors would also be more fuel and mainten ance efficient.
The increase in number of trucks would permir more fl ex ­
ible sched uling and more e ffic ien t routing and servicing
of the Heel (ha ll at present and would cut delivery times
and. therefore, possibly inventOlies . It would also allow
more frequenl deliveries to the compa ny's major markets,
which would reduce the loss of sales caused by stock-out s.
Fina ll y. expanding the Heet would SUppOlt geographica l
expansion over the long term. As shown in Ex hibit 3,
the total ne[ investment in trucks of f20 million and the
Bxpenditu~
Project
I. Replacement and expansion of the truc k Heel
2. A new plam
3. Expansion of a plant
4. Development and i ntroduct.ion of new artificially sweetened yogurt and ice cream 5. Plant autom alion and conveyor systems
6. Effluent wa ter treatment at fou r planLs
7. Market ex pansion eastward
8. Market expansio n southward 9_ Deve lopment and roil-oul of snack food s 10. Nelworked, compurer-based inventory-control
system for warehouses and fie ld representat ives
II. Acqui sition of iI leading sc hnapps brand and associaled facilities 85
(€miUum..)
22
30
10
15
14 4
20
20
18
t5
40 Spou.sori"'tl Mn.naget'
Klink. Distributi on
Leyden, Producti on
Leyden. Production
Morin. Marketing
Leyden, Producti on
Leyden, Produclion
Ponti , Sales
Ponti. Salcs
Morin , Marketing
Klink. Di.<;;tribution
Humholt. Strategic
Planning
C<>
0.
free Ca~h HO\'-5 ,llld A1Ul~'sis of Propose:d Projects 1 (all value::, in € millions)
EXHIBIT 3
1
E-x;pand
Truck
Fleet
Investmenl
Property
Worklllg Capllal
3
4
2
3
4
5
6
7
8
.l\liniOlum Accepled ROR
Spread
NPV <'It Corp. '''ACC (10.5%)
NPY at I\'Iinimum ROR
EqnivalentAnnuily (noLe 2)
aud
EastlVal'd
Southward
Expallsioll
(note 5)
Expansiol1
SlVcetClIC1'
C011veyer
SysteluS
20.00
2.00
:!5.00
10.00
IS.OO
14.0()
(I lAO)
(7.90)
3.00
3.50
("HIO)
2.00
5.00
5.50
4.()O
6.()O
4.10
5.00
7.00
0.25
6.50
6.75
5.00
5.25
5.50
"
IRR
8
Artifi:cinl
10
Undiscounled Sum
Payback (~'e8rs)
Maximnlll Payhack Accepted
7
Expnndcd
Plant
7.70
6
4
7.S'/(·
8.0'll:
-O.2lk
-1.92
-0.13
-0.02
23.75
6
5
II.YX
10.09(,
I . ,9,.
0.9\}
un
0.30
(10,(10)
1.25
1.50
1.75
2.00
2.25
2.50
1.50
1.50
].50
1.50
7.25
6
.\
1l.2(,;;:
10.0'/(,
1.2Y"
0.28
0.55
OJ)\}
(.'i.eX))
)l4.1~»
(S.OO)
2.75
2.75
2.75
2.75
2.75
2.75
2.75
(5.00)
3.00
:'1.00
4.00
4.50
5.00
5.50
6.00
6.50
22.50
7
6
17.J'n
12.09(
5.3V"
5.21
:'1.88
0.69
10
11
11l1lflltOf,),-
Strategic
Snack
Foods
Control
System
Acqui.,ition
15.00
3.00
IS.OO
30.00
10.00
(18.00)
3.00
4.00
4.50
5.00
5.00
5.00
5.00
5.00
5J)()
5.W
( 12.(0)
5.50
550
S.OO
9
I
)­
(note 5)
20.00
20.00
EXPECTED FREE CASH FLOWS (note 4)
5.00
Ye8f
0
5
Automation
New
Plaut
(note 3)
Project
2
120.00)
3.00
(20'()())
3.50
4.00
4.50
5.00
5.50
6.00
6.50
7.00
7.50
.'1,.')0
4.00
4.50
5.00
5.50
6.00
6.S0
7.00
7.50
tWO
5.25
6
4
8.7S}
8.0'k
O.7tl,;
-087
0 ..12
0.06
37.50
.I
6
21.4?;
12.(Yk
32.50
6
6
18.87r
12.09(
6.8%
9.00
7.08
1.25
9A1I,­
11.99
9.90
1.75
(l1ote 6)
AnnUITY
corn:Cl~
lor dlUerence'i III dtlrJLlOn JIllOllg
\anoll.~ proJCCl~.
FOl IfhLJIICC. projecI5 I,bls onl) 7 }'ear., ,LIld h,h
,til
Jt
28.50
S
6
20.Ylr,
12.0'n·
8.y;r
8.95
7.3 I
1.2\}
5.00
".00
I LOO
13.00
15.00
IHX)
]\}.OO
21.00
59.00
,
4.00
134.00
5
6
28 77r,
12.0'n
10.71.!'­
47.97
41A3
7.:'13
4
16.29(
8.0o/r
8.2%
1.16
US
0.69
the 111111il11UI11 rcquircd rale 01 relurn tor Ihar prOjeCI
NPV 010.]2 lIlilholl. J 10-yc<lr \Lrc<tm or UllllUdl
cd~h
flo\\, or
0.051111111011. UhcoLlilLed ,ll j) 0 [J'<01'cenL (rhe l'eCj\llred I'alt' or 1""TUrn) abo;. [eleb <111 NPV or 0.3'2 Illlllwil 111 r;ln),,jllg. PWll'Cl~ on l.ilt: baq~ (,I ~q\li\;\lclll allllUlly. big.gn dllnLJllll.> cr<':'l.l~ 1I\0n:
ill\C~101
,,"calLh lhJIl \Ilwlkr
JlmuiLIL·~.
'Thl\ rdku., Ell million ,pcnl bOlh Inlllall) and Jlllll' end or )CJr I.
IFree cd~h no,," = (Jlcremt'lllJI prolil or CO,I ~d\'lIlg.' Ji"ler la.\e~ -+- depreciJllon - Illve~lmeul ill Il\eu U"er~ dud \~orklllg caplla}
'F ranchlsees would gradually rahe over the burden of carrylllg reeel' abies and I1lvenlory.
''€15 millIOn would be \pelll in lhe IlN yeal. 20 million inlhe \eConu. Jnd 5 million in the third.
-,~~
..
,~
'l>
--l
~
0­
( J5JXl)
(20.00)
IThe dfluenL LrealinenL program b 1I0L lllcluucu in Lhi~ eAhiblL.
cThe Cqllil ,Iienl u11nlllLy or:J. pn)llTll'\ lhatic\'cl :ll1l1ll<l1 pdYl11enl over 10 year, thal Y1ekh a llL't rrC~l'nt \dlue ~quallo lh~ NPV
'"
c:
~
!:
)..
L
c:
'"
rr
!:
rr
Z
>­
7.
:;
~
~
;.:
:.r
,,­
T
"
o
7.
CASE
increase in working ca pitaJ to SUpP011 added maintenance,
fuel. payroll, and in ve nto ri es of €2 millio n was expected
10 yie ld total cost savi ngs and added sales potential of
€7.7 millio n over the next seven years. The resulting IRR
was estimated to be 7.8 percent, marginally below the
minimum 8 percent required re lLllll on effic iency projects.
Some of the managers wondered if thi s project would be
more properly classified as "efficiency" than "ex pansio n."
2. A I1.eH.! plant. Mam1en Leyden noted that Pan­
Europa's yogu rt and ice-cream sales in the southeaste rn
region of the co mpan y's market were about ( 0 exceed the
ca pacity of its Mellin, France. manufac turin g and pack­
aging plant. A t present. so me of the de mand was bein g
met by shipme nts frolll the co mpany' s newest, most
efficie nt fac ility, located in Strasbourg, Fran ce. Shipping
costs over thm distance were hi gh, however, and some
sa les were undoubtedly being lost when the marketing
effort co uld not be supported by de li very. Leyden pro­
posed that a new manufacturing and pac kaging plant be
built in Dijon, France, just at the c urre nt southern edge
of Pan-Europa 's marke tin g regio n, to ta ke the burden o ff
the Me lun and S trasbourg plants.
The cost o f thi s plant would be E25 million and would
entail €5 millio n for workin g capita l. The EI4 million
worth of equipment wou ld be amortized over seven years.
and the plan t over 10 years. Through an increase in sales
find depreciation, and the decrease in delivery costs, the
plant was expected to yield after-tax cas h flows totaling
€23. 75 million and an IRR of 11.3 percent over the next
10 years. This project would be classified as a market
extension.
3. Expcmsion of C/ plant. In add itio n 10 the need fo r
grea ter producti on ca pac ily in Pan-Europa's southeastern
regio n, its Nure mberg, German y, plant had reached full
capacity. This s ilUatio n made the sched uling of routine
eq uipme nl maintenance difficult. which, in turn, created
production-sched uling and deadlin e problems. This plant
was o ne of two highly automat ed facilities that produced
Pan-Europa's entire line of bottled water, mineral water,
and fruit juices. The Nurembe rg plant supplied central
and wes tern Europe. (The other plant, near Copenhagen,
Denmark, supplied Pan-Europa's no nhern European
ma rkets)
The Nu re mberg plant's capac it y could be expanded by
20 perce nt for € tO million . The eq uip ment (E7 mittion)
would be depreciated o ver seven years. and the plant over
10 years. The increased capacity was expec red to result in
additional product ion of up to EI.5 million per year. yield­
ing an IRR of 11.2 percent. Thi s project would be classi­
Aed as a market extension.
87
4. Development and imroducfion. of nell.! artificial!.}!
sweeTen.ed yog u!"' and ice cream. Fabienne Morin noted
th at recent developments in th e sy nthes is of artificial
sweet eners were showing promj ~e of significant cost
savings 1O food and beverage producers as well as stimu­
lat.ing growi ng demand for low-c a lorie products. The
cha ll e nge was 10 creale lIle rig ht fla vor to co mpl e ment or
e nha nce the o the r ing redient s. For ice-crea m manufac­
lUre rs, the diffi c ulty lay in creatin g a ba lance (hat would
res ult in the sa me Ravor as was obta ined when using nat­
ura l sweete ne rs; artificial sweeteners migh t. of course,
c reate a superior taste.
€15 mi lli on would be needed to com mercialize a
yogurt lin e that had received promising res ults in labo­
rato ry tests. This cost included acquiring specialized
product ion facilities, workin g capital, and the cost of the
initial product introduction. The overa ll IRR was esti­
mated to be 17.3 percent.
M o rin s tressed that the proposa l, alth o ugh highl y
uncertai n in len'llS of actual res ull!>. could be viewed as a
means o f protectin g present market share, because other
hi gh-qu ality ice-c ream producers carrying ou t lIle same
research mighl introduce th ese produc ts: if the Rolly
brand did not carry an artifi ciall y sweetened line and
its competitors did, the Rolly brand might suffer. Morin
al.so 110[ed the parallels between inn ova ting with artifi­
cia l swee teners and the compan y's past s lIccess in intro­
ducing low-fat products. This project would be classed
in the new -p rod uct ca tegory o f in ves tment s.
S. PLanl automation anti convey or systems. Maarte n
Leyde n a lso req ues led € 14 millio n 10 increase auto­
m,uio n of the produ c tio n lines at six of the company's
o lder plants. The result would be improv ed through­
put speed and reduced accid e nt ~, spi ll age, and pro­
duction lie-u ps. The last two plants the co mpany had
built included co nveyer sy ~ lem s that e limin ated the
need for any heavy lifting by emp loyees. The systems
reduc ed the c hance of injury to e mpl oyees; at the six
older pl an [s, the company had ~ u s t<:lined an average o f
7S mi ssed worke r-d ays per year per plam in the 1asl two
years beC<1 use of muscle injuries sustained in heavy Ii[t­
ing. At an average ho url y wage of €14 .00 per hOLlr, over
E150.000 per year was lhus lost. and the possibility
a lways ex isted of more serious injuries a nd lawsuits.
Overall cos t sav ings and depreciatio n [o laling €2.75
milli on per yea r for the project were expec ted to yield
an IRR of 8.7 percent. This project would be c lasse d in
th e efficiency ca tegory.
6. ElfluCJ1/ ~valer lreatment (It four plants. Pan­
Europa preprocessed a variety o f fresh fr uits at its Melun
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88
CHArTEI\ 1
I
STRAT<c:GI C MANAGF.ME~T AND I'RO)ECT SELECTION
and Strashu urg pla nts. One o f the h~t stages of pro­
cess ing in vo lved clea ning the fruit to re mo ve di rt a nd
p e~lic ide s. The dirt y water was simpl y sent down the
drain and into the Seine or Rhine rivers. Re\;ent European
Comml1nity directi ves called for any waste wil ter contain­
ing e ve n s li ght {races of poisonous chemicals to be treated
af the sources and g.ave companies four years to com ply.
As an en vironmenrn ll y oriented project, thi~ proposa l fell
outside the normal tinanc ial tests of project auracti ve­
nes:-.. Leyden Ilmed , however, that the water- treatment
equipme nt could be purc hased today for €4 milli on; he
,"' peculate d th at the same equipm ent would Cosi €IO mil­
lion in four years when immediate conversion became
mandatory. In the intervening time, the com pany would
I'll!) the ri sks that European Comm unit y regu lators woul d
sho nen the co mpliance lime or that {he company's pol­
lutio n record would become pub li c and im pair the image
of th e company in the eyes of the consu mer. This project
would be cla~s ed in (he envi ronment'al ca legory.
7. an d 8. Market expansions ea'll\vu rd and soufh­
ward. Marco Ponti recommended that the com pany
expa nd irs markel eastward to include eastern German y,
Po land. Czechoslovakia, and Au stri a and/or sou thwa rd to
incl ude :'.oulhern France, Switzerla nd , li aly, and Spain.
He believed th e time wa~ righ t to expa nd sales of ice
I: ream, c1 nd perhaps yogurt , geographicall y. ln theory,
rhe company cou ld sustai n ex pan~i o n s in bOlh directions
. . imullaneous ly. but prnclica ll y, Pont i doubted that th e
sales and d istributi o n organi zatio ns co uld susta in hoth
expans io ns at once.
Each altern cl tive geog raphi ca l expa nsio n had il s ben­
efi ts and ri sks. H the co mpany e xpanded eastward , it
co ul d reach a large pnput ation with a grea t appetite for
frozen dairy produc ts, but ie would also face more com­
pe tition fro m loca l and regiona l ice cream manu fac tur­
ers. Moreove r, cons umers in eas tern Germ<ln y, Poland ,
and Czec hoslovakia did not have the purc hasi ng power
that co nsumers did {Q th e south. The ea ~ tward expans ion
would ha ve to be supplied from plants in Nuremberg,
Srrll shollrg, and Hamburg.
Looking south wa rd, th e t a hle~ were turned : more pur­
chasing power an d less competition but al so <I smaller
consumer appetite fo r ice cream and yog urt. A so uthward
expans ion would requi re building conSllllle r dema nd for
premiu m-qu ality yogurt and ice cream. If ne ither of the
plan( proposa ls (i.e., propos als 2 and 3) we re ac cepted ,
the n the SO lllhw::lrd ex pans ion would need to he supplied
fr o m plants in Melun. Strasbourg, and Rou en.
T he initial cost of eith er proposal W <JS €20 milli on
of working cap iw l. The bulk o f thi s project's cos ts was
expected to involve the hnan cing of di stributorships. I
over t.he IO- year foreCilsl period. the di stributors wo
gradu all y tak e over the burden o f cany in g receivah
and inventory. BUlh expansion propo<;al s ass umed
rental of suit ab le warehou:-.e and dis tribut ion faciliti
The after-tax cash flo ws were expec ted to total €3
mtllion for eas twC:lrd ex pan sio n and €32 .S million
south ward expansion .
Ma rco Ponti pointed out {hat eas lw;J rd expans
meant ,I hi gher pos ~ibte IRR but th at moving sou thw
wa~ a less ri sky propos·llion. The projected lRRs W
2 J.4 perce nt and 18.8 perce nt for e<ls te rn and sOL
e rn e xp an~io ll . res pect ivel y. These projects wou ld
classed in the new market ca tegory.
9. Del'elopmCl11 aud ro/l -ou l (~/ snack foods . F;:
enne Morin suggested that the co mpany use th e exc
capacity at its An twerp spice- and nut-processing fa.
iry to prod uce a line of ll ried fruits to be tes t-marke
in Belgium , Brilain, an d th e Nelhe rl flllds. She noted
strength of the Rolly br<lnd in th ose co untrie s ,
the success o f other food and he vemge co mpanies t
had ex panded inl o . . . nac k-food produc ti o n. She argl
that Pan-Europa's reputa tio n for wh o leso me, qua
producl s would be e nh;mced by a line o f dried fruits:
that nam e assoc iat ion with the new prod uct would pr
ably e ven lead 10 il1L:rea!>ed sa les of th e compan y\ ot
prod ucts amo ng hea lth -conscio us consumers.
Eq uipment and wo rking-cnpital inves tments \.I;
expec ted 10 tOlal €1 5 milli o n and €3 mill io n, res~
li ve ly, for thi s project. T hc equipment would he def
L:i<l led over seve n ye ars. A~sumin g the lest market '
successful. cash Hows fro m the project wou ld be (
to sup port furth er plant e xpa nsi on~ in other strate
loca tions. The IR R was expec ted 10 be 20.5 pem
well above th e requi red re turn of 12 percent fo r n,
product proj ects.
10. Networked, cOll1pule r-ba.ted inventory-coil
SYSTem for wlirelwu.tes (/nd field represenlUlives. H(
Klink had pressed fo r [hree years uns uccess fully
i:I
state-of- the -art co mpu ter-based inve ntory-cor
~yste m lhal wo uld link fie ld sales re presentati ves ,
trihutors, drive r.',> , wa rehouses, and even possibly re
ers. The benefits of :-:.uch a sys le m would be shonel
delay s in ordering and order processin g. bette r cor
of in ve nro ry. redllclion of spoil age, and fas ter reco
ti on of changes in de mand at the cus lomer level. K
was relu cla nt to quantify these benefits. because
could range betwee n modest and quite large amOl
Thi s year, for Ihe firsl time , he presen ted a cas h­
forecast, howe\;e r, th ,lI re Rec!ed an initial o utl a~
QUESTIONS
but
old
)Ies
the
lies.
\15
for
sian
,ard
~ere
luth­
~ be
1€ 2 millio n for the syste m, followed by 3€ milli o n in the
nex t year for anc illary equipme nt. The inflows reflec ted
depreciatio n tax shields, lax credi ts, cost red uctions in
warehousing, and reduced inventory. He forecasted
these benefits to las t for o nly three years. Even S0 , the
projec t's IRR was estimated to be 16 .2 percent. Thi s
project would be classed in th e efficiency ca tegory of
proposal s.
11. Acquisition of a leading schnapps brand and
associated facilities. N igel Humbo lt had ad vocated
makin g d iversifyin g acqui sition s in an effort to move
beyond the company' s mature core business but doing
so in a way that exp lo ited the company's skill s in brand
management. He had ex plo red six possible re lated
industries. in the general fi eld of con sumer pack­
aged goods, and determ ined that cordials and liqueurs
offered unusual oppo rtunities for real growth and, at
the same time , market protectio n through branding. He
had ide ntified fo ur s ma ll producers of well- es",blis hed
brand s of liq ueurs as acq ui sition ca ndidates. Following
89
e xplo ratory talks with each, he had determined that on ly
one com pany could be purchased in the near future,
namely, the leadin g private European manufacture r o f
sc hnapps, locate d in Muni ch.
The proposal was expe nsive: € 15 millio n [0 buy the
co mpany and € 2 5 milli o n to ren ovate the com pany 's
fac ilities co mpletely wh ile silnultaneously expanding
distribution to new geographi cal market s. 2 The ex pected
re turn s were hi g h: afte r· tax cas h Hows were projected to
be £134 million, yielding an IRR of 28.7 percent. T his
project would be classed in the new-produc t category of
proposals.
Conclusio n
Each member of th e manageme nt co mmittee was
expected to co me to the mee tin g prepared to prese nt a nd
defend a proposal for the allocatio n of Pan-E"ro pa's
ca pital b"dget of € 8 0 milli o n. Exhibi t 3 s"mmarizes the
var ious projects in term s of their free cash flow s an d
the investmen t-perform ance criteria.
QUESTIONS
1. Strategica lly. what mlls t Pan· Euro pa do 1.0 keep froUl
becoming the vi ctim of a hos tile takeover? Wh at rows/
caregories in Exhibi t 2 will thus become critically
importa nt thi s com ing yea r? What should Pan· Europa do
now th at they have wo n the pr ice war'? Who should lead
the way for Pan-Europa?
2. Using NPY. conducr a strai ght financial analysis of the
in vestmen t alternati ves and rank the projects. Which
NPV of [he three should be used? Why? Suggest a way
to eva luate the effluent project.
3. Wh at nspects of the projects might invalidate the rank­
ing you just deriv ed? How should we correct (o r each
investmem's time va lue of mo ney, unequal lifetimes,
ri skiness, and size?
4. Reconsider the projec ts in terms of:
• are any "must do" projects of rbe nonn umeri c type?
• whJI elements of the projects mi ght impl y greater or
lesser liskiness?
• might there be any sy nergies or co nflicts between the
projec ts'?
• do an y of (he projects have JJonquantitative benefi ts
or cOSts that should be co nsidered in an evaluation?
5. Considering all the above, what scree ll sffac t or~ might
YOll sugges t to narrow down the sel of most des irab le
projects? Whal criteri a would you use to evaluat.e the
projects on these variou s fnc tors? Do any of the projec ts
fail to pass these screens due to th eir ex treme values on
some of the fac lors?
6. Divide the projects into the four Project Profile Process
eategories of incremental , platform. breakthrou gh. Jild
R&D. Draw an aggrega te projec[ pl an and alTay th e
projects on the chart.
7. Based On a ll the above. whi ch projec ts should the
manageme nt commiuee recommend 10 the Board of
Di rectors?
Th e following reading describes the approac h Hewlett· Packard lIses to select a nd monitor its projeclc;; for reJe ·
vance to the firm 's s trategic goals. The alticie describes the be haviora l as pects o f the process as well as many
of tbe techni ca l tools, suc h as the agg regate project plan. the plan of reco rd, an d the softwa re aid s tbey
e mpl oyed. In addition, th e aut.hors give t.ips and identify pitfalls in the process so anyon e else impleme ntin g
th eir ap proach wi ll know what. problems to watch o ut (or.
2E.xhibi l 3 show:-. negalive eash fl ows ,lInouniing lo only 8 5 mill ion. The difference !.>e lwee n th i~ amOUIlI a nd the E4(J rnillion requesled is a
posilive operal ing ca:-.h fl ow of 5€ mi ll ion in ycar J expecl cd from the norl11al eourse of bus iness.
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