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Engineering in Eastlandia

This case deals with issues that arise when undertaking overseas contracts

IN PREPARING a corporate appraisal of the company, the strengths, weaknesses, opportunities and threats of the company should be analysed so that both the internal and external factors are taken into account in the development of C's strategic plan.

Strengths: C is an established company that has a strong financial track record. It is, therefore, likely that it has an experienced team of managers and also resources that will enable it to grow. C has successfully survived a major recession and this s hould give its stakeholders greater confidence. It is likely that C's success has resulted from the resources that it has developed and retained. Also, C has a strong reputation as the company that has undertaken major contracts and it is acknowledged to be a company that produces work of high quality.

Weaknesses: C has specialised in only one activity, namely building roads. The company has been engaged as a sub-contractor to construct a road on behalf of an Eastlandian development company. However, another development company, D, has gone into receiv ership recently. If this were to happen to the company, that is, using C as a sub-contractor, it could create major problems for C. It is, therefore, essential that C monitor the financial position of any businesses with which it is associated.

At present, there is the possibility that C will lose significant amounts on the current contract to construct a major road in Eastlandia. The losses could arise through either the foreign exchange position or possibly penalty payments being incurred as a result of the later completion of the project. The failure of the supplier to provide high quality materials will have damaged C's reputation in Eastlandia. As 40 per cent of C's order book could relate to Eastlandia, the problems in that country could have a significant impact on C.

Opportunities: The lack of confidence in civil engineering contractors benefits C, which has a good reputation in Eastlandia. This means that C has a competitive advantage as it is reputed to produce work that is of a high quality of workmanship. This is particularly important, as some of the other contractors have been responsible for constructions that have collapsed. The invitation to tender received by C is a confirmation of the good reputation that C has established in Eastlandia. C could use its g ood reputation to diversify into other related areas of civil engineering.

Threats

C, as a sub-contractor to the Eastlandian development company, faces a number of different threats as a result of its involvement in the road-building project in Eastlandia. The economic recession, particularly in Eastlandia, may pose serious problems fo r C.

The government is likely to reduce the levels of spending on the country's infrastructure and so the number of building contracts available will be reduced. This will probably result in the postponement of civil engineering projects in Eastlandia. Howeve r, as Eastlandia could represent 40 per cent of C's order book, the effect of the recession could be a major setback for C. The problem is compounded by the decline in economic activity in C's overseas markets and this is likely to reduce the company's g rowth and profitability. Although C is established as a high quality contractor in Eastlandia, it is important that other markets be developed in order to diversify the risks of recession in any one country.

As a foreign contractor, C may face a problem if preference is given to local companies. This situation could be remedied by entering into a strategic alliance that would ensure that C was not excluded on the basis of being a foreign contractor. There wo uld, however, be other problems in the management of strategic alliances.

At present, C is a sub-contractor to an Eastlandian development company. It is possible that this organisation could get into financial trouble and this could have serious repercussions for C. Another company has already failed and so it is important tha t C's management takes steps to safeguard its position in the event of the development company experiencing difficulties. In future, C must ensure the financial viability of all companies with which it becomes associated. The delay in the progress paymen ts should be investigated immediately.

It is possible that the development company is in difficulties already and assistance should be offered to ensure that the contract does not continue if the position is already impossible to save. At a relatively early stage, it may be possible to resche dule the payments and institute a plan that can be managed effectively. It is imperative that action be taken immediately to make sure that the position is not allowed to drift until it is beyond rescue.

The contract work in Eastlandia represents 10 per cent of C's turnover, which is a high proportion of their total business. Any difficulties there could create problems for C worldwide. It is, therefore, important that C takes steps to ensure that it is not associated with problem companies as this could create financial difficulties for C and also affect its reputation worldwide. It is important that C's management review the other contracts that they have in the region to ensure that the problems expe rienced with this contract are not repeated.

As it is now expected that the contract will be completed three months late, it is likely that C will be liable to pay penalties. It is essential that C's management undertakes a thorough investigation of the causes of the delays and take steps to ensure that the project is completed as soon as possible. It would seem to be sensible to inform the other parties involved in the contract that it could be completed three months late. Once this information is disclosed to the public, it is possible that the share price will be affected as a result of the increased possibility of losses on the Eastlandia contract.

The use of faulty materials has necessitated remedial work already. If acceptable materials are not available, additional costs will be incurred and C's profit will be reduced and its reputation damaged. At present, C has a good reputation and the Eastla ndian government is likely to use contractors who it can trust. The loss of confidence could have a major effect on the orders received, especially as the government funds most civil engineering contracts. It is also possible that faulty workmanship coul d result in accidents and C could be linked to the poor quality that has been produced by other Eastlandian companies. C's management must try to obtain materials that will not make it necessary to repair the roads soon after completion. A system of qual ity control of both the raw materials and the completed work should be put in place.

The weakness of the Eastlandian currency will adversely affect the financial performance of companies operating there. Also, as C is a sub-contractor to an Eastlandian development company, this could cause major problems if the development company were t o ``get into difficulties''. The expected fall in the value of Eastlands will have an impact on C's profitability. It was expected that the rate of exchange would be 7.26 to the pound in the current year and 7.54 to the pound next year. However, the rate of exchange is now 7.74 to the pound and the forward rate being quoted is 8.56 to the pound. This represents a decrease of 6.6 per cent in the current year and 13.5 per cent next year. These reductions in the value of the local currency represent a thre at to C's future profitability. A detailed investigation of C's foreign currency exposures should be prepared and hedging techniques used to minimise the effects of devaluation of Eastlands.

The growing importance of Eastlandia as an area in which C has major contracts must be taken into consideration in developing its strategic plan. The country is facing an economic downturn and it may be wise for C's management to identify other markets t hat may offer better opportunities. The most important strategic decision is the extent to which C should commit itself to working in Eastlandia. It is possible that more business should be obtained in other countries. This may ensure C's long-term survi val even if it reduces its profitability in the immediate future.

c) The demand for C's services will depend on many factors. Both external and internal sources of information should be used to assist in predicting future demand.

External information: The external sources should provide indicators of the general economic climate and particularly the amount to be spent by the government on infrastructure projects. This information should be monitored and data could be obtained fro m a variety of different sources. These include the publications of trade associations and professional bodies that publish economic surveys to assist businesses that operate overseas.

In addition, many banks and the IMF publish reports that provide information about the economic conditions in different countries. These reports may provide the management of C with useful information, about the likely level of investment in capital proj ects in different countries. Also, there are external databases and local and national government statistics that may include relevant information. Finally, it is possible that benchmarking with competitors may be a useful method of obtaining external in formation.

Particular areas that should be monitored are:

* The monetary policies to be adopted by the government, especially in respect of interest rates, will have an effect on the number of civil engineering projects that will be undertaken especially by C's non-government customers. It is likely that govern ment statistics will be published so that it will be possible to forecast the level of economic activity within Eastlandia. In particular, the budgeted spending by the government on capital projects would be very significant.

* The building plans passed would enable C's management to assess their success in gaining contracts against the competitors. This information could be used to predict the number of contracts that C might obtain in the future. This information may be ava ilable in economic surveys that are produced for both trade and economic journals.

* The political stability of the countries should be considered before any decision is made regarding an expansion into a foreign country. The political risk faced by a company that is involved in business overseas can range from excessive bureaucracy to the extreme situation of confiscated assets within the country. This is a matter that is very difficult to assess, but information should be obtained to include an assessment of the political risks into the decision.

* It is important that C monitors the activities of its competitors both in Eastlandia and in other parts of the world. This will indicate their success and also give an indication of the overall demand for the type of work in which they specialise.

Internal information: The internal sources of information that could be used are the previous histories of clients, including customer account profitability, the past records of their preferences and also their record of payment. The trends in terms of t he order book, size of orders and sales volume is another area that would provide useful information. Also, the analysis of the competitors' turnover and profitability, especially in respect of their activities in foreign environments would be a useful a rea to investigate.

The experiences of suppliers overseas is another area that should be investigated as it may provide an insight into the problems that are faced in foreign countries. Finally, the effectiveness of the tender process and procedures should be researched and the success rate in the foreign environment reviewed.

The information regarding both clients and trends within the industry should be studied continuously. This will provide information regarding the trends within the market and the degree of competition that C is facing, particularly in Eastlandia, one of C's present major markets.

At a different level, it is important that information is gathered regarding the payment records of organisations that are likely to place orders with C. In future, it is essential that C exercises good credit control. Also, the reputation and performanc e of major suppliers should be monitored to ensure that C can be certain that only quality suppliers are used.

d) By entering into a strategic alliance with an Eastlandian civil engineering contractor, C will acquire local knowledge and experience. The strategic alliance will enable C to obtain benefits relatively quickly and this will place the expanded company in a position to benefit when the economy improves. It is possible that the benefits arising from the strategic alliance will be obtained at a lower cost than if either company had to obtain the knowledge and experience alone.

It is important that C choose its partner carefully. Ideally, the local company should have a good reputation especially in respect of quality. Also, the management should understand the customs and protocols of operating in Eastlandia. A sound knowledge of current developments in Eastlandia and local legislation, especially in respect of civil engineering, would be a major benefit to C. Also a good relationship with the government would be useful as many of the contracts will be initiated by government agencies.

As a result of the depressed economic conditions in Eastlandia, some of the existing developers have failed to survive. However, if C establishes a strategic alliance at the present time, it will be in a better position when the economy recovers. By comb ining with a local company, both parties will benefit from the arrangement.

By obtaining local knowledge, it is possible that C will be able to reduce the risks of default by a developer. The failure of a developer could cause considerable financial losses to C and so any means of preventing this could be very worthwhile. Altern atively, the local company could gain from being able to obtain advice and technology from C. This might be in a number of areas, but C's reputation as a quality contractor might be in an area that would prove very useful to the local developers. There a re currently problems with accidents as a result of poor quality construction and this could be an area where the advice from C's management might benefit the local developer.

In seeking a strategic alliance, C's management must be creative and find a partner that will complement C's strengths or reduce its weaknesses. However, it is important that the arrangements of the alliance are studied carefully. C's management must con sider some practical issues. These include the financing arrangements to be used to ensure that the resources needed by the alliance are available. It is also necessary to discuss how the alliance will be managed especially in terms of the decisions and control of the alliance. In particular, the procedures should be agreed to deal with the problems that would arise if the local company experiences financial difficulties. These are all issues that must be discussed and agreed before the strategic allian ce is finalised.

This is the solution to the case study that appeared on November 6.

(Source: Q&A for the Strategic Management Accountancy & Marketing paper (May 2000, Stage 4) of CIMA, London.)