Practise analysing working capital, its cycle and the causes of working capital problems using IB Business Management HL questions.
Valdemar Holstein (the son of RDB founder Henrik Holstein) started working at the company in 1951, when he was only twenty-one. He spent his entire career at RDB, including several years as a machinist. In 1965, he replaced Henrik as Chief Executive Officer (CEO). Under his leadership, RDB kept thriving, as he successfully implemented several changes. Although the company maintained a tall organizational structure, Valdemar empowered his middle managers. He also adopted management techniques that were fashionable at the time, such as total quality management (TQM), benchmarking and Kaizen. RDB remained profitable and maintained brand loyalty. However, financially, gross and net profit margins were lower than previously, which Valdemar thought was unavoidable. Internally, some maintenance and technological upgrades were being delayed - but Valdemar did not pay attention to this. Externally, some environmental campaigners started to put pressure on RDB because of the high pollution levels in the vicinity of RDB factories - but Valdemar ignored their claims.
Anna had big ideas for RDB. A scientific and analytical thinker, she had carefully studied the external environment in which RDB operates. She knew that demand for ball bearings was slowing down in Europe, whereas it was growing substantially in countries such as Brazil, China and India that were going through a phase of strong industrialization. From her research, she also concluded that manufacturing in the twenty-first century would be accomplished in smaller, more flexible factories, instead of the huge modernist structures typical of the late nineteenth and twentieth centuries. Time would be the critical factor; having factories close to customers' locations would reduce response time and improve logistics, including distribution and delivery. This would also shorten the working capital cycle - an important benefit for RDB. Given her international experience, working at RDB made Anna realize that her colleagues in the Engineering Department, and even the entire RDB workforce, needed a better cultural understanding of their customers. The best way to achieve this, she thought, would be through a workforce that resembled RDB 's customers, and increasingly they would be from Asia, India and South America.
She was also convinced that RDB had to focus on "green" technologies and its corporate social responsibility. The company would have to significantly increase its spending on research and development (R&D) and also examine its impact on the environment and on its customers' carbon footprint. The two are linked, Anna reasoned: the ultimate aim of innovation in the ball bearing industry is to save energy, which is fundamentally what ball bearings do by reducing friction. For users, better ball bearings mean less friction and, in turn, less friction means that less energy is wasted. Thus, less energy is needed. Anna's vision for RDB was to make the world's most technologically advanced, energy-efficient ball bearings in small "green" factories located near its customers. This would require selling the two megafactories in northern Germany and Sweden, and significantly downsizing the one in Denmark. RDB's production would be offshored to 12 small factories to be opened around the world, mainly in Brazil, China and India. In terms of workforce planning, each of those new RDB factories would be jointly managed by one experienced RDB senior manager from Europe and one local manager familiar with the language and culture. Some machinists from RDB 's European factories would be offered key positions. Most of the existing jobs in Europe would be made redundant, as most of the new workers would be recruited locally on lower wages.
Northern European countries have generous redundancy payments, largely funded by the employers, and these costs would be significant in the short term. In the long term, however, RDB would lower labour costs. Marketing would also play a major role in the new RDB that Anna imagined. RDB 's marketing department had always been "sleepy", with a small budget and unchallenging objectives.
Advertising and promotion were limited to some trade journals and trade shows. Anna thought that this should change. She believed that RDB should advertise in a wider range of publications, including e-zines (online magazines) and professional web sites for industrial design and architectural robotics. She wanted to use information and communication technology (ICT) to communicate to a wider range of external stakeholders. That way, RDB would create brand awareness in the design community, and not just in the manufacturing community. The marketing department should start carrying out market research, both primary and secondary. Anna also pictured groups of RDB "engineers-turned-salesmen" calling on major manufacturers to generate orders, whilst other staff would pressure politicians for more legislation and incentives to support environmentally-friendly products.
Anna wrote all the details of her ideas in a strategic plan that she named "RDB 2020". She calculated that the transition costs for such a large-scale restructuring would be enormous. In order to generate 50% of the funds required, RDB would need to sell the two megafactories in northern Germany and Sweden. For the rest of the funds, Anna would list RDB on the Frankfurt Stock Exchange: RDB would become a public limited company, with funds generated from the sale of newly issued shares. Anna was very pleased with her overall strategy for RDB; she found it coherent, consistent and forward-looking.
Valdemar's counterproposals Valdemar was stunned when Anna explained her "RDB 2020" strategic plan to him. Although he recognized that manufacturing was shifting away from Europe, and that RDB had to become more environmentally conscious, he had major objections. "RDB is a Danish company", he insisted, "we managed to expand significantly after the first world war thanks to a major contract from the Danish government". He felt a moral obligation to provide jobs in Denmark. At times, RDB had also formed public-private partnerships with the Swedish and German governments for various projects. The workforce was local and loyal; Valdemar felt like a father to them; a major retrenchment would be a violation of the "social contract" he implicitly had with them. He also despised the idea of RDB going public. Despite Anna's assurances that the Holstein family would still be the major shareholder, he did not want to answer to shareholders who were not family members and had no sense of the company's history or traditions. He had a bad feeling about this. He also did not like the idea of the relocation of the factories. A lifelong industrialist, he loved to see his three megafactories in northern Europe. Their scale of operation was so vast that expansions had been coordinated with the local urban planning authorities; the Swedish factory was so large that railroad lines had been installed in order to deliver supplies and to transport finished products.
It was beyond his imagination that small factories operating in industrial parks on the outskirts of Mumbai or São Paulo could accomplish the same as the European ones. Despite Valdemar's objections, Anna told him that she would speak to other shareholders in the family and could collectively force the company to change. He asked her for time to come up with an alternative proposal that would incorporate "some" of her ideas. A month later he suggested the following to her: - Rebrand the company, changing its name from "Royal Danish Bearings" to "Green Bearings, an RDB Company" and adopt Anna's marketing strategy. Green Bearings would be "green" in name only. - Remain in northern Europe, but divide each of the three megafactories into autonomous cells, each assigned to serve a region of the world and each with its own strategic and tactical/ operational objectives. Local salesmen would be hired, paid low salaries, but with high commissions as an incentive. This would make the company look more international, but the current workforce in Europe would not change. - Form strategic alliances with ball bearing companies in Brazil, China and India.
Valdemar admitted that he had thought about finding a major investor whose financial assistance RDB could use to modernize the current factories and make them environmentally-friendly. The Holstein family could sell a portion of their shares to the major investor. However, Valdemar rejected this idea. Though being "green" was good practice and was socially responsible, he hated the idea of having a shareholder who was not a member of the Holstein family.
Explain why shortening the working capital cycle would be "an important benefit for RDB".
Working capital is that portion of (long-term) capital invested in current assets. The working capital cycle can be defined as "money tied up in the business and used to finance its day-to-day needs, such as buying raw materials" (Clark, P. et al., 2009, Business and Management Course Companion, page 149, Glasgow, U.K., Oxford University Press). In the case of RDB, the working capital cycle includes money spent to buy raw materials (eg steel) which then becomes (unsold) stock (eg ball bearings);
when the stock is sold, consumers (debtors) pay for it (sometimes after a slight delay expressed in debtors days) and cash is returned into the business (to pay for new raw materials from suppliers as well as workers' salaries etc). Having factories in Brazil, China and India would mean that the customers based there would receive the goods more quickly (without delays due to distribution and delivery). This could ensure prompter payment which, in turn, could result in a faster purchase of new raw materials to produce more ball bearings (a sort of virtuous circle). Utilizing working capital more effectively is actually an internal source of finance that also enables the company ( RDB in this case) to manage its stock better. Just as the Japanese companies adopting just-in-time (JIT) production in the 1970s (as mentioned in the case study), RDB could also consider that approach in order to further shorten the working capital cycle in its new, flexible factories.
A full definition of working capital is not necessary to explain the importance of the working capital cycle, though some candidates may offer a definition. What is important is that candidates convey an understanding that, with factories around the world, both inventory turnover and debtor turnover may contract. When that occurs, RDB will be able to divert some of its long-term capital away from short
term needs and, possibly, use it more productively (use funds generated by the contraction of working capital as an internal source of finance).
Accept any other relevant explanation. Candidates are not expected to incorporate all of the above points in their response.
Award [1 mark] for a basic answer showing some limited knowledge of the working capital cycle (for example, a definition of "working capital", but no reference to the cycle that includes raw materials, stock and payment).
Award [2 marks] for an answer which shows some knowledge and understanding of the working capital cycle (yet without application to RDB ).
Award [3 marks] for an answer which correctly applies the working capital cycle to RDB.
Award [4 marks] for an answer which correctly applies the working capital cycle to RDB and explains why shortening it would be an important benefit for the company.