To give a better understanding of the information in the analysis of the company data available, keywords are defined and explained as follows:
The net margin is a measure of profitability that is calculated by finding the net profit as a percentage of the revenue. The formula of net margin is: [(net profit ÷ revenue) × 100 = net profit margin].
The Return on Capital Employed (ROCE) is an accounting ratio used in finance, valuation, and accounting. It is the sum of shareholder’s equity and debt liabilities, and a useful measure for comparing the relative profitability of companies after taking into account the amount of capital used in the quest for profitability (Fernandes, 2014). It is calculated as: [(Earnings Before Interest and Tax (EBIT)/Capital Employed) × 100], Furthermore, Earnings Before Interest and Tax (EBIT), also known as operating income, shows how much a company earns from its operations alone without regard to interest or taxes, and it is calculated by subtracting cost of goods sold and operating expenses from revenues.
The Price Elasticity of Demand PED denotes the variation in demand for products which coincides with changes in price. As Ivan stated, it is the ratio of the percentage change in demand to the percentage change in the price of a particular commodity (Bibliography, p. 57)). The formula for figuring it out is (PED = % Change in Quantity Demanded/ % Change in Price), and it usually yields a negative value, due to the inverse nature of the relationship between price and quantity demanded, as described by the “law of demand” (Gillespie, 2010).
The average hourly wage rate represents the hourly cost of employing production workers for the company. The figure is obtained by dividing the total annual wage cost by the average number of employees, the number of weeks, and weekly working hours.
Analysis of Company Data
ETCO Engineering had a net margin that slightly exceeded the industry average in 2014, staying at 37.4%, this progressively reduced to below the industry average both in 2015 (22.7%), and 2016 (18.75%). In most instances, net margin is used for internal comparison since differences in competitive strategy and product mix can cause it to vary among different companies so that comparison of one with the other can have little meaning. However, net margin is essentially an indicator of a company’s pricing strategies and how well it controls its costs, therefore, the company’s diminishing profit margin indicates a low margin of safety and a further decline in sales could result in a net loss.
The company’s ROCE for the years 2014 and 2015 were above the industry average standing at 13.14% and 9.6% respectively, eventually falling to 8.2% in 2016 which was below the industry average for that year. The gradual decline in ROCE over the three years denotes a fading efficiency in the company’s use of capital and a subsequent struggle to generate shareholder value. This does not bode well for an engineering company such as ETCO in a traditionally capital-intensive sector. Investors, in general, tend to lean towards companies with stable and rising ROCE numbers over companies where it is volatile and bounces from one year to the next.
ETCO’s average Price Elasticity for its products has remained at a respectable -1.6 in absolute value, and this should generally be indicative of a relatively “inelastic” demand for the goods. It bodes well for the business that changes in the price of its products don’t have a relatively large effect on the number of products purchased, though more can still be done to maximize revenue.
Analysis of the wage cost reveals that the average hourly wage rate for ETCO, based on a 52 week year and a 40 hour work week, has remained at a consistent £8.25 for the three years under review, i.e. 2014, 2015, and 2016. This pales in comparison to the industry average in the year 2016 of £9.10 and could be contributing to the persistently growing absenteeism percentage and voluntary employee turnover that is noted in the consultant’s report.
Cause and Effect of Company Results
The analysis of data identified two causes for the decline in ETCO’s profits over the three years in review; the most significant being the development of a leadership vacuum caused by the retirement of the long-standing figurehead, Harry Clarke. Effective leadership is the fuel that keeps the organization’s fire burning amid consumer and competitor demands (Blohowiak, 2003). According to Ungar (n.d.), leadership vacuum can have effects that last a long time and should, therefore, be addressed in infancy.
The vacuum in question is exemplified in the report where it is evident that the leadership has failed to understand and interpret the environment in which the business operates by not developing and adjusting strategies to counter the industry variables. Case in point; despite the reduced revenues, the company increased the amount of capital employed from £10.5M in 2015 to £11.0M in 2015/2016. Additionally, the dividends given out to the shareholder’s has also remained constant at £0.25M over the three years. Both actions have invariably contributed to the declining amount of retained earnings, consequentially leading to a drop in shareholder value.
The second cause that can be attributed to declining profits is the decline in employee morale. Production workers at ETCO are paid lower wage rates compared to the industry average and this is bound to put a constraint on their motivation for work. It is evidenced by the ever-increasing absenteeism, voluntary employee turnover, and defective product output rates over the three years in review. The deficiency in products output has a negative effect on the amount of revenue that can be collected and thereby leading to a reduction in net profits.
Possible Solutions to Company Problems
Most employers in the modern corporate sector will agree that putting more resources into boosting employee morale keeps them happier, and is cost effective in the longer-term. This, however depends on how management views their employees, that is, as the backbones that ensure growth in company revenue and not just costs that hamper profitability. A study by Casio (2006) into two competing warehouse companies; Costco and Sam’s Club, revealed that the former pays its employees up to 40% more in wages compared to the latter. Despite this, Costco still manages to remain healthily profitable.
In terms of the leadership crisis prevalent at ETCO, it should involve a concerted effort by the management involved to lift the company from relative obscurity. This will include effecting certain measures, such as; understanding and interpreting the industry environment in which the business operates, developing both proactive and reactive strategies to improve productivity while executing them efficiently, and finally, measure the impact of these strategies progressively to develop departmental and personal capabilities of those involved in running the company.
References
Fernandes, N. (2014). Finance for Executives: A Practical Guide for Managers. NPV Publishing, chapter 3.
Bouckaert, B. and de Geest, G. (2013). Bibliography of Law and Economics. Springer Science " Business Media, p. 57.
Gillespie, A. (2010). Business economics. OUP Oxford.
Blohowiak, D. (2003). Who's Guiding Your Corporate Destiny? Business, (pp. 216-217). Perseus Publishing.
Ungar, L. G. (n.d.). Nothing Good Happens in a Vacuum of Leadership: 5 Steps to Lead through Presence. [Online]. Available at: <http://www.electricimpulse.com/resources/nothing-goodhappens-in-a-vacuum-of-leadership.php> [Accessed May 24, 2018]
Fernandes, O. (n.d.). Leadership Vacuum: A self-made Crisis in Organizations. Bratislava, Comenius University. [Online]. Available at: <http://www.cutn.sk/Library/proceedings/mch_2015/editovane_prispevky/4.%20Fernandes_Leadership.pdf> [Accessed May 24, 2018]
William, C. (2017). How Positive Employee Morale Benefits Your Business. [Online]. Available at: <https://www.forbes.com/sites/williamcraig/2017/08/29/how-positive-employee-morale-benefits-your-business/2/#378881774a1d> [Accessed 24 May, 2018]
Cascio, W. F. (2006). Decency Means More than “Always Low Prices”: A Comparison of Costco to Wal-Mart’s Sam’s Club. Academy of Management Perspectives. [Online] Available at: <http://www.ou.edu/russell/UGcomp/Cascio.pdf> [Accessed May 24, 2018]
Weisul, K. (2014). How Paying Employees More Can Make You More Profitable. [Online]. Available at: <https://www.inc.com/kimberly-weisul/four-strategies-to-raise-profits-by-paying-employees-more.html> [Accessed May 24, 2018]
Gandz, J. (2005). The Leadership Role. [Online]. Available at: <https://iveybusinessjournal.com/publication/the-leadership-role/> [Accessed May 24, 2018]
