Toy Story - analysis of the Jot case study
Adrian Sims of BPP Professional Education provides some initial analysis of the pre-seen material for the TOPCIMA Part B – Case Study exams on February 28th and May 24th 2012. I’m writing this article in late December 2011 to help candidates prepare for the March and May 2012 T4 (TOPCIMA) exams based on the pre-seen material for Jot- toy case. Some previous T4 cases have lacked fun, but toys are fun. I’m sorry, but I decided to combine this article with quotes from the three Toy Story movies (Disney/Pixar). The Toy Story quotes are in italics, a bit contrived, and probably of no use for the exam. They made me smile and gave me (and you) an excuse to watch the Toy Story movies again. But my newspaper today rather kills the joyful mood. It has the headline ‘Sales boom may not save High Street big names: analysts predict failures within days’. It reports that the December sales boom has been insufficient and has left many stores with unsold stocks and unable to pay their outgoings. This has afflicted markets as diverse as camping equipment and lingerie. This brings us to the heart of the Jot pre-seen material. Jot makes toys and is part of an industry for which November and December sales are critical. It depends on retailers to sell its products, but retail in Europe is facing terrible times as a consequence of the recession caused by the sharp reductions in government spending and collapse of bank lending. It has a perilous cash flow position such that at December 2011 it is owed €4.065m by retailers – representing 76% of its capital base (€4,065k/€5,378k) with a further €542k in unsold inventory (10% of total assets). You will be taking the examination in March or May. You are a specialist in financial management. You will be expected to give advice to management to ensure that it survives beyond December 2012. Remember what the T4 exam seeks to assess Buzz Lightyear’s cry of ‘To infinity and beyond’ led him to crash to the floor because he was trying to do too much. He couldn’t fly. Reading the CIMAsphere posts during 2011 it looks as if a lot of candidates are still being encouraged to try to fly, by approaching the T4 exam with a strategic mindset rather than a management accounting mindset. Let’s not try to fly to infinity in our speculations otherwise your examiner might conclude ‘that wasn't flying! That was falling...with style!’ and fail you. The T4 – Part B Case Study exam is a Test of Professional Competence in Management Accounting. It is a management accounting examination, not a second Business Strategy exam. Your role in the exam room will be that of a management accountant reporting to Tani Grun, the Finance and IT Director. The examiner will instruct you to conduct management accounting tasks for Tani Grun and/or the Board of Jot. The four exams in 2011 did not involve complex questions on acquisitions, overseas expansion, or changes to mission. They involved dealing with late-running projects, meeting emissions targets, assessing investment proposals from financial and non-financial viewpoints and providing recommendations, and the short-term financial and non-financial impacts of other business choices. The balance you have to strike is to deal with these management accounting and financial management problems in a robust, technical way, drawing on the knowledge you have gained from throughout your CIMA studies. There will be numbers to do, and formal management accounting concepts to deal with. But put them in their broader context by referring to their implications for the management of Jot and for its strategic position. I do anticipate that there may be a slightly more strategic element to the Jot exams than there was in the exams in 2011. Jot is a small firm, and this means that management accountants will be expected to make a bigger contribution to the decisions of the business than would be the case where the management accountant works as a team leader dealing with month ends in a large firm like the ones featured in the preseen material for the 2011 exams. Also we are told that Tani Grun ‘is finding the role more challenging’ (page 11) and so may be willing to delegate more to you, a member of her finance team. This article will stay rooted in the management accounting/financial management aspects of the pre-seen material for Jot, and bring in the strategic issues towards the end. I think this is the right way to see this case. The T4 assessment matrix and passing the exam The case study material is provided in two documents. The pre-seen material has already been posted on the CIMA website and is relevant to both the March and May exams (please note, the ‘March exam’ is actually on th February 28 this year). The second part is the unseen material and it progresses the story from the pre-seen. It will be given to you on your exam day as the second half of a booklet that contains the pre-seen, the exam

requirement, and also mathematical tables and key formulae. This unseen material is different between the March and May exam and the May exam does not use any of the information from the March unseen material. Passing the exam requires you to deal professionally with the issues in the unseen material. In recent exams the unseen has contained 6 issues. Most candidates attempt to deal with 4 of them in detail. This article suggests some potential sorts of issues you may face concerning Jot. Your script is marked against the Assessment Matrix on page 16 of the pre-seen material (and also in the exam booklet on exam day). Here is a quick guide to what each assessment criteria means and what marks are awarded for. Technical: this means application of relevant technical theory, mainly from the Enterprise pillar papers in the CIMA qualification. A good SWOT analysis is always rewarded, but it must contain the issues from the unseen material and not just some pre-learned points from the pre-seen material. Also valuable are the Ansoff matrix, stakeholder map, model of motivation and so on if they are relevant to the issues you are analysing or discussing. Application: marks here are mainly for number work. It is vital that you do the numbers competently, understand what your results mean, and employ them in your discussion of the issue and to support your recommendations. Your competence as a management accountant is being assessed so you must do numbers. A small number of the marks, say about 3, are available for applying the SWOT and other Technical models to the issues. Diversity: this means employing relevant toy industry and other real-world business examples to illustrate the issues and support your recommendations Focus: this mean ensuring you discuss the things that matter in the unseen, and that you do provide a full analysis of each, rather than writing a report that skates around and doesn’t give sufficient detailed attention to the key issues Prioritisation: sifting through the 6 or so issues in the unseen to select the 4 you want to write about, and then putting these in a rank order of importance to Jot. A good guide here is to recognise that problems are things that must be dealt with, they are threats. Proposals are things that can be dealt with, they are opportunities. Big threats should be given a higher priority than bit opportunities. Judgement: assessing the weight of the issues and commenting on them. If they are threats describe their impact and then outline alternative ways to resolve them. If they are opportunities assess their suitability, acceptability, and feasibility. The key to good marks here is the depth of the points you make. Rather than say ‘this is a bad thing’ say ‘this is a bad thing because..’, and if you are considering an investment don’t just say ‘it has a positive NPV ‘ instead say ‘it has a positive NPV but also it is consistent with the goals of Jot and it carries limited risks…’ Ethics: this is about noticing things that have a moral dimension, pointing this out, and recommending ways that management can deal with the issue to best balance the moral and commercial considerations. This may involve treatment of staff, infringement of legal rights, unsafe products and practices and so on. Having a separate section in your report headed ‘Ethical Issues’ is a good idea. Usually 1 of the 6 issues in the unseen is purely ethical and you can deal with this as a 5th issue in addition to the 4 commercial issues you have discussed. 1 or 2 ethical issues may be included as aspects of commercial opportunities, such as outsourcing to a factory that is cheap but which exploits its workforce. Discuss the ethical aspect in the Ethics section of your report, and the commercial aspects in another section. Logic: up to 20 marks are awarded for recommendations on what to do about the 4 commercial issues. A good approach is to tell management what they should do in a clear sentence or two. Then justify the recommendation by telling them why you recommend this. Finally tell them how to set about doing it. The key to good marks here is to ensure that your recommendations do follow from the analysis you made of the issue in Judgement, but also that your recommendations are well-justified and supported with practical steps. Rather than say ‘ the firm should change behaviour by using Lewin’s three step approach’ be practical and say ‘ the first step in changing behaviour would be to make staff aware of the intentions of management. This should be done by briefing team leaders and then commanding them to hold work place meetings’. A further 10 marks under Logic is for a small requirement, called Section (b). This is to assess your ability to communicate with non-accountants by taking one particular issue and summarising your analysis and recommendations into a presentation, email, or short briefing document.

Integration: these marks are awarded on the basis of the overall helpfulness and professionalism of your report. If you say nothing, or it doesn’t make much sense, you will be awarded only 0 or 1 mark under Integration. But a report that flows has good number work, and that comes to sensible and clear recommendations will get 4 or 5 marks. I hope it’s clear that the bulk of the marks are given for the heart of the report – the numerical work and the analysis of issues and the quality of recommendations. This is where Application marks (15), Judgement marks (20), Logic marks (20) and marks for Focus and Integration (5+5) are awarded – 65 marks from a total of 100. You cannot pass this exam without making a good attempt at the issues. Some candidates spend too long trying to pick up Technical, Diversity and Ethics marks. But to pass people for doing just these things well would be like awarding a restaurant Michelin stars based on the quality of the salt and pepper and the view outside the window! Michelin stars are awarded for the food. T4 marks are awarded for the discussion of the issues and the use of properly calculated numbers to support the discussion. The need for industry knowledge Candidates complain that the T4 pre-seen is never about their industry, and that if it were then they would have more chance of passing. One such lady worked for a logistics firm and her role was accounting for the containers loaned to supermarkets. I was delighted when ‘pallet woman’, as she became known, emailed me to say she passed in November in a case involving…supermarkets. But unless you work in toy manufacture already you will need to do some adjusting. ‘But we are not on my planet – are we?’ Jot is not a real world firm, but the industry it exists in is real enough and you need to do some research and understand it to the same level as you understand the industry your employer is a part of. Between now and the exam it’s a good idea to assume that you also work in the toy industry. It may not be your home planet, but you will need to live there until the exam. Even if Jot was a real firm it wouldn’t have appeared in the Toy Story movie. The toys in those movies were ‘placed’ by large global firms like Mattel (Barbie and Ken and Rex), Hasbro/Playskool (Mr Potato Head), James Industries (Slinky Dog), Texas Instruments (Mr Spell), and Ohio Art Company (Etch). Once the first Toy Story film had been successful these established toys enjoyed renewed popularity. As for the toys created specifically for the film, such as Buzz Lightyear, Woody, and Hamm – they were licensed out for other firms to make, notably by Thinkway Toys who secured the worldwide rights in 1995. The real world toy industry is dominated by a few large players, but in fact nearly 60% of European toy sales are the products of firms that employ less than 50 people. These smaller firms, like Jot, survive by being distinctive. As Rex explains ‘I'm from Mattel. Well, I'm not really from Mattel, I'm actually from a smaller company that was purchased by Mattel in a leveraged buyout’. But a green plastic dinosaur (with issues) is hardly innovative so it and the firm that made it were swallowed up in one of the lovely in-jokes in Toy Story (dinosaur…survival….get it?). But another reason Jot would not be in the film is that, despite its being a landmark film in the history of computer animated graphics, the toys in Toy Story are generally un-animated. The film was made in 1995 when Nintendo hand helds were the main games consoles. But there are no video games in the film outside of Pizza Planet. The toys are mainly plastic figures and push-along toys and they are quickly swept aside by Andy when Buzz Lightyear comes on the scene because he has electronic circuits and he does stuff! Jot makes toys that are electronic, animatronic, and, in many cases, educational (page 3). It is a focus differentiated player in the market (Porter’s 3 generic strategies). Real world producers in Jot’s market segment include VTech and Lexibook, although some mainstream toy firms like Chad Valley have ranges of animatronic toys too. The range of toys includes hand held game boxes with educational and gaming content which seems to have something in common with Nintendo DS. But the list does not seem to include additional software for the game boxes, nor does it design and manufacture more ambitious gaming solutions like Nintendo Wii, Play Station, and X-Box 360. These are real-world examples and references of the sort you will need to research before you take the exam. Getting to grips with the pre-seen material The Strategic level exams use a common pre-seen case study to set the scene. Your experience in passing those exams is a helpful introduction to T4. But the pre-seen for T4 is much more focused and must be used more intensively as part of your pre-exam preparation. But ‘Sheriff, this is no time to panic!’ The pre-seen for Jot is reasonably straight-forward.

Jot’s operational position is described as follows:      Jot is a small business with €9.9m turnover in 2011 (page 12), but which grew by almost 18% in the year to December 31st 2011 (page 4); It produces for two market segments: 3-5 year olds and 5-8 year olds; Its product portfolio is a mixture of in-house designed electronic toys, and toys produced under license from other firms (page 3); At 31st December 2011 Jot has significant capital shortages. It has only €540k left of its line of credit from its bank (€1,500k-€960k – page 4); Jot is expecting a replenishment of its cash position by March. It made €5,008k of sales in Quarter 4 of 2011 (page 14) and this has led to it holding €4,065k of trade receivables at year end (page 12). Given that it takes customers between 30 and, for some more than 60 days, to pay (page 7) it should receive this money by March 2012. This assumes that none of its retail customers have gone, or will go into, administration during the poor sales season of Christmas 2011 referred to at the start of this article; It launches 5 ‘totally new’ products per year and spends €1.2m on design and development (page 5). New products are essential to its profitability and growth; The design for its 2012 range has been finalised and prototypes will be shown at trade fairs between January and March 2012 (page 5). Final production decisions and orders are due to be placed by the end of May 2012 (page 6) for manufacture between June and early November 2012; All its products are made in China by 20 different outsourced manufacturing companies (pages 5 and 6); It maintains its own warehouses (page 7) but does do some direct sales from factory to large retailers too (page 6); Jot seems to have significant foreign exchange exposure. The pre-seen does not state the currencies it prices its toys in, nor the currency in which it pays its Chinese manufacturers and shippers. However page 7 shows it sells to Eurozone countries (40% of total), non-Eurozone (29%), USA (23%) and the remaining 8% from various other countries. Changes in exchange rates will affect the Euro value of its sales revenue, the gross margin it achieves on sales and, in extreme cases, its ability to pay its overseas suppliers for the toys and license rights.

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Jot’s strategic position is described in the following terms:       ‘Jot is a young, growing company which is dependent on loan finance’(page 4) Jon Grun was inspired to start Jot 13 years ago to exploit ‘a gap in the market for innovative, educational toys’ (page 11) ‘The Jot brand name is synonymous with quality electronic toys’ (page 9) and the inclusion of electronics in its toys is seen as one of its strengths (page 3) ‘Jot’s sales are heavily dependent on seven large retailers…for over 68% of sales...[these are] based in Europe and the USA’ (page 8) Jot would like to expand its sales by specifically targeting other areas of the world, including the Russian and Asian markets (page 10) Jot has aspirations to improve its Corporate Social Responsibility (CSR) credentials during 2012 (page 10) which implies concerns will extend beyond product safety to include also working conditions in

Chinese factories, the materials from which toys and packaging are made, carbon emissions, and the social impact of the toys themselves   There is ‘a current trend in toy sales...towards electronic toys and computer assisted learning’ (page 2) Jot has ambitious growth plans that seek to increase revenues by 95% over 5 years (1€19,260k/€9,866k), sales volumes by 99% (1- 1,405.0k/706.3k) and operating profits by 145% (1€1,348k/€551k). This is to be achieved by increasing the number of countries it sells to, and doubling the number of new products it launches each year from 5 to 10 a year by 2016 (page 15)

The timing of the exams The plastic aliens in Toy Story thought the random grabbing of the mechanical claw of an arcade machine was actually divine selection ‘The claw chooses who will go and who will stay’. I’m not sure how you see the T4 exam. But it is not random, and some clues on what you will need to do can be derived from the content of the pre-seen and the timing of the two exams. There will be two exams based on this Jot pre-seen: February 28th (the so-called March exam) and May 24th. The exams are sat in real time. This means that the pre-seen information takes the story up to 31st December 2011, and then 2 months will have elapsed by the time of the first exam, and 5 months will have elapsed by the time of the May exam. Consider where Jot will be in its annual cycle on February 28th 2012 and the issues and decisions it will face. It will know the outcome of many of the trade fairs ‘held in several locations in the January to March period of each year’– i.e. the first 2 months of the year – and the ‘make or break reaction’ to its products (page 9) in an industry where ‘the level of sales achieved by many toy companies will often depend on orders generated from buyers attending these international toy fairs’ (page 2). This suggests that you might be asked to provide a financial forecast for the year, or perhaps update the 2012 column of the 5 year plan in Appendix 5. By February 28th management would also be aware of any default in payments from struggling retailers, any write-down to inventory values (page 8), and the outcome of the auditing of its accounts. As a management accountant you might be asked to deal with these. It will also be budgeting for the research and development work due to commence from May 2012 (page 5) and which, this year, is supposed to create 6 new toys rather than 5 (page 15). By May 24th the issues facing Jot, and therefore you in the exam room, will be different. We are told ‘key customers place their main orders in May or June each year and sometimes earlier’ (page 8) and this leads Jot to select suppliers and place orders with them. This again may lead to a requirement to update 2012 forecasts in the May exam. Also May candidates might be asked to advise on the ‘difficult decision to when placing orders with outsourced manufacturers, between ordering too much inventory and not selling it and the opposite of losing sales because of lack of inventory’ (page 8 – this is mentioned twice on the same page which suggests the examiner wants you to notice it). This would also be the point at which supplier selection takes place. We are told that Michael Werner uses a tender process and appoints them ‘by the end of May’ (page 6) and is mainly guided by price. But there may be other issues to consider such as whether a supplier can offer Just In Time production to help Jot manage its inventory risks, potential Corporate Social Responsibility (CSR) considerations, and perhaps the benefits of ‘near-shoring’ (page 6). Operational issues facing Jot You now you have a taste of the sorts of ways the examiner may ‘spin’ the pre-seen into a final exam. I don’t have any inside line that tells me what the real questions will be. I have explained the thinking of the T4 exam and you know what you are likely to be up against. ‘Great! Now I have guilt!’ But here are a few of my speculations with some ideas on how they might be examined and how I would approach them. Issue 1 – improving working capital management My reading of this pre-seen is that Jot has working capital management issues that, if not addressed, will harm its short term performance, even its ability to survive, and will make it impossible for it to achieve its 5 year plan targets.

Page 4 tells us that its bank will not provide additional long-term finance to Jot and that at December 31st 2011 Jot had used €960k of its maximum €1,500k overdraft facility. This means that it has €540k spare. According to its 5 year plan Jot’s working capital needs will increase during 2012 due to three factors:  The planned increase in sales. Between 2010 and 2011 sales rose by €1,495m, from €8,371k to €9,866k. The Statement of Cash Flows on page 13 shows that during 2011 Jot increased its overdraft by €170k to help finance the €421k rise in working capital its needed to sustain its rise in revenues. Page 15 shows that Jot plans to increase revenues by €1,702k (€11,568k -€9,866k). Given that it took €421k extra working capital to finance €1,495k of sales this implies a ratio of 28% so, by extension, a rise in revenues in 2012 of €1,702k could require €477k extra working capital to support it (€1,702 x 28%). However these calculations assume that Jot’s customers continue to pay within the same timescales as they currently do;; Potential extension in the time retailers take to pay. In the present credit crunch banks won’t lend more to Jot. They will be unwilling to lend more to retailers too. This means that in 2012 some retailers may try to extend the credit they take from Jot even further than they did in 2011. This will cause more strain on Jot’s working capital position; The planned increase in new products. The five year plan states that 6 new products will be launched in 2012, and 7 in 2013. Page 5 explains that Jot has paid all the research and development costs of its new products for 2012 during 2011. It also states that development costs are ‘between €0.1m and €0.25m for each’. Therefore the need to research 7 rather than 6 new products during 2012 will require additional capital up to €250k, nearly half of the €540k remaining from its overdraft limit.

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This suggests that working capital may be a constraint during 2012. It will certainly become an issue if Jot tries to achieve the growth in revenues, new products, and geographical markets set out in its 5 year plan. Be prepared to make recommendations on how Jot could improve its management of working capital and, thereby, finance its planned growth. You might consider:    Better debtor control which, according to page 7, Jot does not ‘chase …too aggressively’; Extend the credit taken from suppliers. However it may be difficult for a small firm like Jot to exert power over the Chinese manufacturers to demand this; Better inventory management. Although at year end Jot holds relatively little inventory this is just a snapshot following its busiest sales period. From June to early November it would be building inventory as deliveries come from manufacturers (page 6). This will absorb working capital. A shift to shorter supply lead times, such as by near-shoring, or favouring suppliers with flexible manufacturing systems (FMS) able to produce small batches in a swift and cost-effective manner would help reduce this problem as well as limiting the amount of unsold inventory that needs to be disposed of at ‘substantially reduced prices’ each January (page 8).

Jot really needs to have business in the first half of the year because during the months from January to June it will have warehouses with little stock, and very little business activity (page 14). In the same way as, allegedly, the producers of refrigerated meat products sought to diversify into soft drinks and ice cream to get use from their depots and trucks during the summer months. It could consider taking on garden furniture products or, as real world Hong Kong toy firm Kader Holdings did, washing up bowls and household plastic wear. Jot is a private company with just 5 close shareholders (page 4). It raised, at most, only €130k from the sale of its shares (€40k + €90k) and as a consequence has been depending on bank lending and retained earnings to finance its growth. The bank is refusing to lend it more. We are also told that the shareholders have not received any dividend from their holdings ‘to date’ (page 4) and will not be able to receive any over the coming 5 years due to the need for Jot to conserve cash to finance its growth. Several of the Directors purchased their shares and so will be expecting a return. An alternative approach would be to attract additional finance from different sources.

One source might be debt factoring. This is a type of financing method in which Jot would sell its accounts receivable at a discount. The company purchasing the accounts receivable, usually a division of a bank or other finance house, is known as a factor. The factor then collects the outstanding amounts from the businesses customers. This has the benefit of releasing cash quickly for Jot and improving cash flow generally. It also spares itself the costs of debt chasing, legal actions for recovery and so on. The discount, say €3 per €100 of debts, represents the profit to the factor and the cost of the finance to Jot (€3/€100 = 3%). This could be compared to the interest it pays on overdraft finance (12% page 4), however it should be remembered that Jot would not expect to be owed the money for an entire year. So if debts are normally paid within 90 days, say, then the overdraft interest rate would be 2.95% (90/365 x 12%) which is more favourable than 3% from the factor in this example. However with no further overdraft available beyond €1,500k Jot may have no choice but to turn to debt factoring. The problem is that this might reduce the operating margins of Jot, which are presently 5.6% (Appendix 5) and Jot may not be able to increase them as forecast in the 5 year plan. You might advise Jot to seek venture capital backing. It has a successful track record and its 5 year plan seeks to increase operating profits by 145% in 5 years. If it can buy shares at the right price, this is likely to be very attractive to a venture capitalist. And it would provide a way for some shareholders to get some of their investment back now, by selling shares to the venture capitalist, as well as an eventual exit route for all shareholders if Jot were to become quoted after 2016, or sold on to another firm. If the examiner sets a task for you to advise the Board of Jot on venture capital financing you would need to assess whether the price the venture capitalist was offering was adequate, and also warn them of the potential for loss of control over their business if the venture capitalist puts a representative on the Board, and the risk that the venture capitalist will ratchet up their shareholding to compensate for any underperformance against the targets in the 5 year plan. You should also note that three Directors do not have shares in Jot (page 11). Any issue of new shares could provoke jealousy and disagreement from those left out or, if they are included, from existing shareholders who fear dilution of earnings. Issue 2 – deciding how much to make ‘And this is the Buzz Lightyear aisle. Back in 1995, short-sighted retailers did not order enough dolls to meet demand.’ (This line is from Toy Story 2 and another in-joke given that Toy Story 1 was released in 1995. Also the line is spoken by Barbie whose makers, Mattel, had refused to endorse her appearance in Toy Story 1). The pre-seen repeats the point that sales are seasonal and uncertain, but that Jot needs to decide in May the quantities of each product line it requires for its 4th quarter sales. This is likely to be a very difficult thing for Jot to get right. It will involve balancing considerations such as:    Getting a low unit price by ordering one large run versus the risk of being left with unsold stock at the end of the season; Saving working capital by ordering periodically in small amounts versus the higher total costs involved in buying numerous smaller runs; The extra costs of over ordering and holding excess inventory versus the revenue lost from not having sufficient supplies of a popular toy.

Until firm orders arrive in May it will only have indicative expressions of interest from enquiries at the trade shows in Quarter 1. This will particularly affect the 6 new products it is launching. Where it is licensing in products ties to films and entertainment, such as plastic figures and vehicles based on the most recently re-launched Marvel Comics character, it takes a risk on the film being a box office hit. In 2000 real world publisher Dorling Kindersley had to be rescued, at a bargain price, by Pearson group after it sold only 3m of the 13m Star Wars books it had printed to tie-in with the first of the prequel Star Wars films which had disappointing box office sales. Jot may have some ‘cash cow’ toys that have sold well for many years. But the trend that is favouring interactive electronic toys may be reducing the sales of these earlier toys. Also the films or characters they are based on may be in the decline stage of their own life cycle. Firms like Lego freshen up its 1949 building block toys by tying them into popular films like Harry Potter and Star Wars, and have diversified by taking its brand into video games like Lego Star Wars.

The examiner has used probability-based forecasts in past T4 exams, and has featured calculations that ask you to extrapolate trends across several years, such as a 5% annual reduction in sales volumes or prices. In the March or May exam you could be presented with data on potential sales and be asked to recommend a production volume, or forecast sales revenue. Be prepared to do the calculation requested using the data provided, but then be ready to discuss the difficulties in relying on probabilities for one-off strategic decisions, the fact that the expected value is not the value that will actually occur, the limitations of hunches and guesses, and the possibility that a given product may lead to spin-off revenues from cross selling. Issue 3 – supplier selection At present all 20 of Jot’s suppliers are based in China. They tender to produce the toys and their packaging each May/June and, from page 6, it seems that they assemble the products from components of known cost. They are selected on unit price to achieve a target gross margin with some regard also given to meeting timescales and product quality. A number of issues come to mind that Jot might wish to consider:  Differences in non-production costs caused by suppliers. The pre-seen specifies gross margin as the key factor in supplier selection. This is defined in a way that ignores the costs of transporting and storing the product, the working capital used, and the flexibility to cope with changes in order quantity. A supplier that quotes a low price but produces all the units in July would gain preference over one that charged a higher price but offered a flexible solution that meant stock didn’t arrive until October, was delivered straight to the retailers thus by-passing the warehouses, and allowed orders to be increased or reduced to avoid stock-outs or unsold inventory. This recalls your earlier studies on Direct Product Profitability as a basis for supplier selection.  Near-shoring versus China. China is no longer the dominant production location it once was. Studies have shown rising labour costs, increased congestion in getting product through the ports, much higher transport costs, and growing concern over ‘toxic toys’ where the paint used contains carcinogens or lead. China also has a poor reputation for respecting the intellectual property rights of outside firms. Nearshoring to North Africa, Mexico, Estonia, Hungary and other places would help Jot to develop a more flexible, just-in-time, supply chain. Orders can be fulfilled and supplied in 4-6 weeks rather than 3 months with consequent benefits for adjusting supply to demand and reducing inventory and transport costs. Corporate Social Responsibility. ‘Idiots! Children destroy toys. You'll be ruined, forgotten, spending eternity rotting on some landfill.’ Page 10 refers to Jot becoming concerned about CSR, although its traditional focus has been on product safety. Real world firms like Hasbro have policies on product safety (of materials used as well as how they perform in play), but also on manufacturing ethics (wages and conditions in factories, life chances for workers, hiring practices), sustainability (such as carbon emissions, packaging, inks used, materials used in manufacture of toys, end of life cycle salvage, and transport footprint), and on the content and impact of the toys and games they sell (such as violence or discriminatory stereotypes). If Michael Werner and Alana Lotz do develop a CSR policy for Jot in early 2012 then some of these could affect supplier selection decisions made in May/June 2012. The T4 examiner has examined sustainability extensively in recent exams.

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Issue 4 – adding a product to the 2012 range In the exam there could be a requirement to comment on whether to add a product to the range. The pre-seen makes clear that although the toys for 2012 have been decided, there are probably no production models available for the 6 new toys. They are prototypes (page 5). They will have to await the tenders from manufacturers in May in order to know what the final cost of the production version will be. According to page 6 they will ‘have already decided on an indicative selling price’ and have a ‘planned gross margin’, and they rely on the manufacturers to come in at a production price that will give this margin at the indicative selling price. This looks a little like target costing, where instead of basing prices on costs, the firm bases costs on price. Management estimates what the product must to sell for in order to achieve a target level of sales, sets a gross margin, and then relies on cost accounting and production know-how to find a way to make the product at the target cost. This often involves value engineering of the original design to find ways of reducing the production cost without detracting from the desirability, quality, and selling price, of the product.

An exam requirement involving target costing could require you to deduct the mark-up of the retailer (stated on page 4 as between 50% and 100%), from the final market sale price, then deducting the gross margin required by Jot (presently 31.9% overall according to page 15) to get to the maximum price from the manufacturer. So if the final selling price of a toy is €100 and the retailer has a 50% mark-up then Jot sells the product to the retailer at €66.67 (100%/150% x €100) of which the price charged by the manufacturer can be no more than €45.40 (1-0.319 x66.67). If this target production cost is unlikely to be achieved then the product should not be made unless either the price can be increased and/or the manufacturing cost reduced. You may be asked to advise on this. You might also advance a criticism of the exclusion of the management accounting function at Jot from the new product development (NPD) process described on page 5. This exclusion of cost considerations might lead to products being displayed at trade shows that are later found to be uneconomic to make. Issue 5 – protection of IPR’s The pre-seen makes clear that IPR’s are valuable. It buys some of these in from licensees at a cost (page 3) but in the main it relies on its annual research and development budget of €1.2m to develop ideas that can be registered as IPR’s belonging to Jot. A particular invention requiring IPR protection seems to be the ASIC components referred to on page 6. IPR’s are the source of differentiation in the toy market. Jot’s toys are special because they have a particular set of features, or are associated with particular benefits or popular characters and shows. Without the IPR the toy is just a piece of plastic and its sales revenue and margins will be much lower. Jot needs to control and defend its IPR’s. We can assume that Anna Veld, the Licensing Director, has some knowledge of the law around IPR’s, but several procedures seem to invite loss of IPR’s:  The prototypes are made and shown to target consumers, perhaps in family focus groups, before the IPR’s are registered (page 5). We can assume these prototypes are being evaluated by families rather than retailers who might tip-off competitors;    Prototypes are made and tested by a European manufacturer outside of Jot and therefore this manufacturer is given the plans; Designs are given to several manufacturers (page 5) of whom one will be given the contract to make the toy, whilst the others can set about finding ways to make a similar toy without infringing the IPR’s; Plans for the ASIC components are also given to the manufacturer who then passes them to its suppliers without reference to Jot.

Past T4 exams have featured questions involving infringements to IPR’s framed as a decision making question where the costs of legal action, the potential award, and the probabilities of success in court, are set out as a decision-making problem. Although not a technical management accounting issue with numbers, the protection of assets and the avoidance of risk was a key part of your P3 studies. You should be ready to recommend improvements to the control of IPR’s. Some strategic issues facing Jot ‘Buzz, the monkeys aren't working! We're formulating another plan, so stay calm! ‘ The T4 exam is a management accounting exam and the issues you will be ask to advise on are likely to be similar to the financial management issues described above. You will need to keep your eye on the present problems of Jot, as they appear in the unseen material on exam day. But you need to consider and explain the strategic context of decisions. Individual business decisions are like laying flagstones to build a path. Each decision is a single step, but each step takes the firm in a direction. Before laying down more flagstones Jot’s management needs to glance up and consider where the path is leading, and where they want it to lead. The following are some of the strategic issues facing Jot. Issue 6 – focusing the Jot product portfolio The pre-seen describes a firm with limited capital which it needs to use carefully to meet its growth plans. According to its 5 year plan its gross margin will rise between 2011 and 2016 despite the average price of its product falling from €13.97 (€9,866k/706.3k units) to €13.71 (€19,260k/1,405k units). This suggests that it may be relying on cost reductions as the way to improve its margins. So would increasing sales volumes and prices...

The product portfolio described on page 3 is not wholly consistent with Jot’s positioning and reputation for innovative, educational, electronic toys. For example toy vehicles, soft play toys, plastic figures, and dolls and action figures. Page 4 tells us that ‘80% of [its] products are sold to retailers for €20 or less’. This recalls the Pareto rule, that 20% of items often deliver 80% of value. There is a possibility that these are suffering greater market competition and are less profitable. Also where products are licensed in there is little opportunity for Jot to add value because they are actually just acting as a manufacture and distribution partner for the licensor. To conserve its capital and to achieve better margins Jot may need to focus more closely on what it can do that is unique. It’s distinctive competence. This would probably lie in educational products. Product Profitability Analysis (PPA) would assist this decision. At the moment Jot is focused on the gross margins of its products, defined as ‘sales revenue less the outsourced manufacturing cost of units sold’ (page 6). However 80% of its products are sold for less than €20, and the average price of its products is just less than €14 per unit (page 4). There are many costs involved in designing, prototyping, testing, licensing, ordering, marketing, and supplying toys that must be deducted from each product’s net profitability. These costs are independent of product selling price and sales volume. It is possible that proper PPA, using sensitive Activity Based cost drivers, might reveal that some of Jot’s products are actually being sold at a loss. Issue 7 – warehousing and licensing Jot is a network organisation sitting in the middle of web of relations with retailers, manufacturers, testers, and license owners. It would seem to add value to the network through the designs and market knowledge it has. This opens the question of why it remains involved in warehousing when operating them could be outsourced easily, and at lower cost perhaps, to specialists. Continuing on the same theme, why does it not simply license out its designs and escape the risks and uncertainties of manufacturing, marketing and logistics altogether? Tying up capital in inventory and debtors is a poor use of money when it could be adding more value if spent on research and development. Issue 8 – focusing the client portfolio ‘Welcome to Al's Toy Barn. We've got the lowest prices in town. Everything for a buck-buck-buck.’ Jot has 350 customers (page 8) consisting of retailers and distributors (page 7). Of these 7 large customers account for over 68% of Jot’s total sales (page 8). From our knowledge of the real world we could surmise that these are likely to be catalogue selling operations, like Argos, on-line operators, like Amazon, category killers, like Toys R’ Us, and some of the larger supermarket and store chains such as Tesco and Wal-Mart. These firms are pan-European and several have operations in the USA. The remainder will be smaller toy stores, department stores, and on-off operations like Al Mc Wiggin’s Toy Barn in Toy Story. Consider this from the perspective of Customer Profitability Analysis (CPA). Smaller stores will be expensive to serve because they buy in small and unpredictable quantities. This requires Jot to have a warehousing operation. Where Jot supplies through a distributor then the prices must be very keen because both the distributor and the final retailer need to get a mark-up, but they will also want the final selling price to be competitive with the prices of the larger players. Given that Jot is seeking to enter new territories as well as expand its sales in its present 22 countries it might be well advised to begin targeting and attracting the most profitable customers. We are not told in the pre-seen how Jot tracks and attributes its costs to clients. To analyse them for CPA purposes would need sophisticated assessment of the margins from the mix and quantities of products bought by each customer, and a comparison if these against the unit costs of the items plus the other activity-driven costs of order taking, order handling, inventory holding, credit control, logistics, returns and so on. There may be problems in Jot doing this because ‘some of the systems are not ideal and do not provide Jot’s management team with all the data that it requires’ (page 9). This might affect its ability to conduct Product Profitability Analysis too. There is also no IT expert at Director level because Tani Grun combines this with her finance role (page 11). Establishing a better system that can analyse the history of purchases by customer, and which can track numbers of orders, sales visits and so on is likely to be expensive to set up and we remember that Jot has limited capital. Ethical considerations will be examined in the T4 exam. Consideration to protect the margins of smaller stores, and its own margins, may have been behind the illegal cartel operated by Hasbro for large catalogue operations to charge the recommended retail prices for its toys that resulted in it receiving a £15m fine in 2003

which was waived when it turned evidence against two of its largest customers who instead received fines totalling £23m. There are quite a number of ethical issues here, including abuse of monopoly position to exploit the customer, breaking competition law, and the questionable tactic of escaping punishment by blowing the whistle on their former partners in a cartel that they themselves instigated. Issue 9 – strategic IT As mentioned above, Jot has IT systems that are less than ideal (page 9). These systems seem to comprise the accounting system, an inventory control system (also called a database system), and its CAD/CAM system. Jot also accesses, via an extranet presumably, the tracking and logistics systems of its logistics partner, and the systems of its outsourced manufacturers. There does not seem to be any Customer Relationship Management (CRM) system in place and it is unclear how orders are entered. There is also no external intelligence in the system despite Jot recognising that its costs are ‘subject to price fluctuations’ (page 6) and that is works in a competitive market. The systems are not integrated, and this means that error and waste will creep in and that data analysis will be held back. The accounting systems ‘do not accept data directly from any of Jot’s other IT systems’ and there is replication of data between systems. The systems were developed ‘some years ago’ by an external consultant and there is no expertise at board level able to take the systems forward. Jot lacks an end-to-end view of its business. The exam may ask for suggestions on improvements and instead of simply saying ‘Enterprise Resource Planning system (ERP)’ you could make the following specific recommendations:  Interface the CAD/CAM system with the database of costs for the components (referred to on page 6) to help value engineer toys from the start and ensure their profitability;  Give the manufacturers and logistics firms access to the customer orders to make fulfilment quicker, especially if Jot decides to move to near-shoring and more flexible manufacturing arrangements. This would reduce costs along the supply chain such as from rush orders and inventory carrying; Give customers access to the tracking systems of the logistics firm. This would help them advise staff on delivery dates and manage their own inventories better. This will build loyalty and help build sales volumes and margins; Import data from the point of sales systems of the main retailers. This will automate replenishment orders and also provide intelligence on which toys are ‘going viral’ for Christmas and becoming the ones which need to be produced in greater quantities quickly. This will boost sales. Track customer profitability by assigning costs to all the activities, and sales, recorded in the CRM. This can help manage costs and profitability, perhaps by ceasing to supply them directly and migrating them to a different solution such as distributors or purchase from a web page; Reduce costs and improve working capital management by instituting electronic invoicing and settlement using standard times agreed with clients and suppliers Introduce e-procurement systems, such as a purchasing portal, to attract tenders rather than just ‘asking the same outsourced manufacturing companies which it has used previously’ (page 6). This would enable cost savings on tender process, lower prices for products, and access to a wider range of manufacturers giving greater flexibility; Introduce an e-commerce solution to cut the costs of selling and customer support. Smaller clients could open an account and place orders on-line (thus allowing cybermediation through bypassing the distributor and allowing Jot to capture the distributor mark-up), or interfacing with the portals of on-line stores to provide product information, prices and availability; Develop websites to support the product such as technical questions, additional content, player-to- player interaction and so on. Consider how Nintendo uses the Internet to involve users more in Wii and DS and so enhance sales, acceptance of upgrades and ad-ons, and loyalty.

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But recall that Jot reported profits of €246k in 2011. It cannot afford significant IT systems improvements, and it cannot borrow significant capital from banks. Also consider how this new system could be managed. Tani Grun is ‘considering recruiting a new person to take responsibility for IT’ (page 11) but you might suggest that the range of solutions needed, the limited time available, and the global nature of the what you are proposing would be better provided by an outsource partner (and if so it’s a good idea to have a few real world names of such partners ready for the exam). Also in the age of ‘the Cloud’ would better systems necessitate huge capital expenditure on equipment and software? According to a Comp TIA survey in July 2011 the ‘sweet spot’ for cloud adoption is the Small and Medium Sized Business (SMB) with turnover between £10m and £100m which is the range that Jot will be in soon. Jot has limited capital. It also has peak demands for 3 months and outside of that it is limited. The expensive systems would be idle for much of the year. You might suggest instead employing Infrastructure as a Service (IaaS) to give the hardware, Platform as a Service (PaaS) to provide the maintenance and development, and Software as a Service (SaaS) to make it work. It could enter partnership contracts to lease capacity from an established provider of end-to-end solutions. Inevitably performance measures might be involved in the evaluation of new IT systems and the improvements they bring to the business. Consider what Critical Success Factors (CSF’s) there are in the toy business (e.g. right toys, stock availability, reliable delivery. quality, competitive pricing, margin). Evaluating the suitability of an IT solution involves considering how far it can improve these. KPIs are used to ensure the system is delivering the benefits it promised, and to permit management control. Consider what possible KPIs there are for each CSF, and recommend that the new systems monitor and report on these too. Issue 10 – New products and earnings The pre-seen states that Jot does not produce toys for the under 3’s nor for the over 8’s (page 3). It is doubtful that the under 3’s is an attractive market for Jot because its distinctive competence in electronic educational toys is unlikely to be exploited there. Under 3’s are toddlers and they are still learning motor skills. These require physical toys for them to manipulate, not toys that move by themselves and which also talkback. The over 8’s is much more promising. The real world Nintendo DS is marketed as a games consol suitable for over 3’s up to adults. The consoles are the same, but age differentiation is achieved by the application. The 6 year old will play Super Mario and Pokémon, whilst their parents will be buying ‘brain training’ and ‘maths tuition’ packages for the teenagers, and possibly using their own Nintendo DS for puzzles and to keep their neural pathways open. They can also read books on them. If your are asked to evaluate new products aimed at these older segments be ready to cite the examples of Nintendo and PS4, and the way they are marketed, as examples of what Jot could do. The other advantage of the Nintendo approach is that it enables the firm to lock in the user and perhaps exclude the retailer. Once the user has the hand-held consol they will depend on Jot for upgrades, new games and access to peer users. These consoles feature connectivity via Bluetooth and wi-fi and therefore it is possible for them to download the new software (and promotional messages) straight from Jot. This is high margin business because the variable costs to Jot of a download of software are zero (or the license fee if the IPRs in the software belong to someone else). Issue 11 – risk management Jot runs a number of significant risks:  Risks to IPR’s: these were discussed earlier under Issue 5;  Foreign exchange risk: it contracts sales in numerous currencies but contracts its manufacturing in China. It also has the costs of warehouse operations in Europe and USA. This creates potential for risks in translation (affecting the value of assets) and transactions (the value of money received from sales versus the value of debts owed to suppliers); Credit risks: it is owned substantial amounts by retailers at year end and during the year. Default or delay by a retailer could seriously harm its cash flows;

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Product risks: Jot could be held responsible for injury or trauma to a child caused by its toys. It is significant that page 10 of the pre-seen details this aspect and, in the final sentence, states ‘Jot cannot delegate this responsibility’. This spotlighting of product risk (or perhaps compliance risk) suggests that the examiner wants you to notice it; Personnel risks: it is a small firm and the loss of a Director would make it difficult for it to operate and grow. In addition these staff know about products and contacts and could commercially damage Jot if they defected to a rival. Two Directors hold no equity in Jot and this will loosen their loyalty; IT systems risk: the systems are possibly inadequate, but more importantly the person overseeing them is not a specialist and is overloaded. They are crucial to its operations and to its strategic development.

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There is no information in the pre-seen material on how these risks are managed. Small firms like Jot do not have to comply with the codes on corporate governance and have audit or risk committees. But for a small firm like Jot a crystallisation of any of these risks could easily destroy it. Issue 12 – new countries Page 9 tells us that Sonja Rosik ‘has been working on the establishment of links and promotion of the Jot brand in new geographical markets’. Page 10 identifies these as the Russian and Asian markets and tells us that Jot wishes to ‘establish distribution links...and arrange for delivery of toys direct to customers based in Asia’. This is followed by the lessons from its American experience, ‘to ensure its products are available if demand exceeds expected supply levels’. The 5 year plans shows that Jot intends to add a further country during 2012, and 2 more in 2013, 3 more in 2014, and then 4 more each year until 2016. Entering new countries will have the following implications for Jot:  There will be logistics issues. Even if they supply the Asian markets from the Chinese factories it would be unrealistic to supply the whole of Russia from the European warehouses. Empires have fallen from underestimating the size of Russia, given that Russia extends from middle Europe across to further East than China (although the majority of its population is concentrated in its European western cities and in a band along its southern borders);    It will demand increases in working capital to stock up to supply the market; There will be a need for changes to languages and cultural references in the games and learning products; There will be additional foreign exchange risks due to exposure to the Russian rouble, and the specific currencies of the Asian countries (anywhere from Pakistan to Japan and in the real world Asian trade groups often include Australia); There will be political risks in several of the countries that are quite different from the risks in Europe and USA. Consider recent political developments in Pakistan, China and Russia which seem to reflect a lack of genuine popular support for leaders which will spiral into increasing political and civil instability and repression;

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You might consider the most appropriate entry strategies for Jot. Should it reduce its risks, and capital needs, by licensing the rights to local manufacturers and marketing firms? Or form a joint venture with local firms. What risks to IPR’s, do you see, and how would Jot maintain financial control? I doubt you would be expected to suggest these as ideas. They might be proposals given in the unseen on exam day and you would be called on to evaluate them.

Preparing for exam day ‘Buzz, you could have defeated Zurg all along! You just got to believe in yourself!’ Many students find the T4 exam emotionally taxing. You will find passing it emotionally elating. There are several resources on the CIMA website providing information on what the exam will be like, and the skills it tests. There are study texts and toolkits available that can tell you too. And there are tuition courses both face to face and online. This article is not going to cover that again. But to finish, please be aware that, unlike all your previous CIMA exams, T4 cannot be passed by learning a syllabus, text book, and what a tutor tells you and then writing down what you remember in the exam room. You cannot prepare to run a marathon just by reading a map of the route. You have to take practice runs and become physically and emotionally prepared. It’s the same for T4. The way to pass T4 is:  Understand the pre-seen material. I hope this article has helped you to begin doing that;  Understand what the T4 exam wants from you and understanding how your script will be marked using the assessment matrix. Looking at past T4 exams and the examiner’s Post Exam Guides on the CIMA website are the best way to do this; Practice exams against the clock to hone your exam day approach and time management. These could be the commercially produced mocks, based on Jot, or otherwise use the real exams from 2011 to help you; Try to get feedback on your script by having it marked professionally by a tutor, or show it to someone who has passed T4 and ask them for their comments.

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To finish off with my two favourite quotes from Toy Story: ‘I just don't think I can take that kind of rejection!’ There may be points in your preparation when you will wonder whether you can pass this final exam ‘I have been chosen. Farewell, my friends. I go to a better place’ And when you do pass it you feel a real sense of achievement. It’s the last CIMA paper you have to sit, you have achieved your ambition, and you have proven that you are competent as a management accountant to the standards set by the World’s leading professional body for management accounting. Good luck! adriansims@bpp.com Adrian Sims is Publishing Director of BPP Learning Media Ltd and is responsible for the T4 materials it produces. He teaches T4 for BPP Dublin.