Background of undertaking the project
Describe about the Case Study on management of the NEXT Plc.
The aim of this report is to provide the management of the NEXT Plc with information about financial aspects of the investment project, calculations of key quantitative indicators, its analysis and finally an advice on the organizational structure and financing arrangements which the company should adopt it were to undertake such a project.
This report is intended to be discussed the investment opportunities for Next Plc, a UK based Company, which is planning to build on its well established UK operations to access customers on a much broader global stage.
Next plc. is UK based company with limited international operations. This company is engaged in trading of stylish clothes, shoes, accessories for men, women and children. First retail chain was launched in 1982 and today company trades through three channels. These are NEXT Retail, NEXT Directory and NEXT International Retail. Next retail is a chain of over more than 500 stores in the UK and Eire. NEXT Directory is online shopping division with over 4 million active customers in the whole world; a NEXT International Retail with 200 franchised stores.
The company always maintains strategy of focusing on products, profitability and returning cash to shareholders through dividends and buyback of shares. Company has objectives like developing NEXT brand, investment in online growth, investment in profitable new space, improve service and control costs so that price of product may be fixed at right price.
Next AR& A (2015) reported that in 2014 and up to January 2015, company earned revenue of 4 Billion GBP with growth in profit of 12.5% to 782m GBP and in EPS of 15% to 420p which is remarkable in such retailing industry. Our share price rose by 14% during the year. Company has employed approx 50,000 employees according to latest data of year 2015. During this year company increased trading space by 330,000 square feet to 7.4 million square feet. For future company is expecting to increase space up to 350,000 square feet of net trading space in each of these two years.
Now company is planning to accelerate the BOD approved strategic plan to grow overseas. The company has indentified many territories for overseas investment. Till January 2015, company has very limited overseas trading. Major trading is only with china which is 50% and rest is in UK. We have indentified US, Japan, Australia, Germany, France, Canada, Italy and Switzerland as overseas investment opportunities.
Background of country of investment “USA”
Next AR&A, (2015) reported that Company is planning to expand its business by investing capital in overseas market. Company is intended to generate more profits and brand value at global level for longer term. This project is taken into consideration company’s investment and expansion proposal in USA by setting up approx 100 shops in USA, considering effecting investment decisions on the basis of which decision shall be taken. This investment will double overseas profit of company with long term benefit.
According to Focus Economics, after facing many challenges still U.S. economy is the largest and most important in the world. According to International Money Fund (IMF), the U.S. has the 6th highest per capita GDP in the world. In year 2014 per capita GDP of U.S. was USD 54,597. The U.S. is typically regarded as the home of free- market economic policy. (Focuseconomics.com, 2016)
U.S. government regulates many rules and regulations over economical, financing, trading activities. In USA it’s not so easy to do business because of its rules and regulations.
Market Entry Alternatives
Company has many ways to enter in overseas market like establishing a new wholly subsidiary, acquisition of local market or establishing a Franchised store in other country. Each alternative has its own benefits and drawbacks.
Company may expand its business in US by establishing a wholly owned subsidiary in USA. In this alternative company has to start from bottom. Company has not any background. It will start from scratch.
Secondly, company may acquire business of any local trader of USA. This is already established in USA and has planned to be merged with any company.
Last option with company is that company may provide its franchise to a local trader. This is suitable for a company which has a established brand. In this case local trader will always be ready to take franchise. In such option without any huge investment profits may be earned.
It is recommended to opt for Franchise option as company is not going well so a huge investment by company is not seems to be good. Hence we advise company to go for franchise option.
We have decided to take option of Franchise option. For this option we will have to study market position in United States. All commercial registration will be taken and legal advice will be taken timely. For this we are planning to appoint a lawyer who will suggest us on United States commercial laws and regulations so that any future conflict may be resolved time to time.
Market Entry Alternatives
Market Entry considerations
In franchise option, there will be many risks like political risk, economic risk, FDI rules, strategy of competitors. We took a research on these aspects and result is as under.If company establishes its subsidiary company in USA, first of all company needs huge amount for investment to set up a new project. By establishing a company, company may gain brand value in new company.
Economic and political risk is that USA is one of those countries in which doing business is not easy. Recently company has strictly changed rules and regulations of economy, financial position. Company will have to consider these rules and regulations while establishing business.
Political risk means risk that a company will take political decisions that will have adverse effect on the multinational company’s profits and goals. This risk should also be considered by company. In USA elections have been announced and political parties may be changed in this case t is possible that permitting authority may deny giving permission for personal benefits.
If company acquires business of local trader main benefit is that company may estimate outcome very easily and can be established quickly.
Zejan, Mario C. (1990) suggested that economically merger of two companies will not be feasible. Company has past results that company is not gaining any advantage of acquiring business in a foreign company (Zejan, Mario C. 1990) so this option is not feasible company should drop this idea.
If company provides its franchise in USA economically it is more feasible in comparison of above two plans because investment is not so required.
Politically political parties may not give permission as they can impose any rule on such person interested in taking franchise of NEXT Plc. government may impose any irrelevant clause on both parties on the name of safety of country.
Foreign Direct Investment in the United States increased by 35494 USD Million in the fourth quarter of 2015. Broadly United States is open economy with low barriers for FDI. Foreign direct investment may attract many incentives like low corporate tax, tax holidays, free land or land subsidy, R&D support etc.
Since company is opting for franchise business, company is not required to invest so much money in form of FDI. But for future expansion United States is better option for investment.
Company is doing business in very competitive market. Company’s major competitors are Marks and Spencer group p.l.c., Arcadia group limited and Debenhams plc. All the competitors are doing well and planning to expand their business in foreign territories.
It is stated that company made a full analysis on the following competitive factors (Baker, 2000):
Advise and Appropriate recommendation on Market entry
The threat of new entrants to the industry
The threat of substitute products or services
The bargaining power of customers
The bargaining power of suppliers
The rivalry among current competitors
This is one of the important factors which should be considered while taking investment decisions. As finance is blood of a business without finance any business cannot run. Financial feasibility should be properly measured in all aspects.
Due to present scenario, prevailing in European economy it is recommended to Next Plc. to invest in foreign countries. U.S. is being considered best alternative for overseas investment.
If investment is made in USA, on the financial projection it is estimated that in the financial year company will suffer a loss of approx USD 3 Million and in from second year company will start to recover its investment and will earn sufficient profit.
Company’s long term objective is to provide better return to its shareholders as well as continuous improvement in product quality and service. So it is required that any expansion should prove itself for betterment of company and its brand value so that this investment becomes successful and company make more investment in other countries.
Investment appraisal which is also known as capital budgeting is a planning process in which decision for acceptance or rejection of an investment is taken. There are 10 techniques on the basis of which decisions are being taken like net present value method. Accounting rate of return, profitability index, payback period, discounted payback period etc.
Whether project should be accepted or rejected, following methods are to be used:
Net Present Value Method
Under this method acceptance or rejection decision should be taken on the basis of net present value of project. Net present value is difference between present value of cash inflow from project and present value of cash outflow from project.
If Net present value is positive then project is accepted if it is negative project is rejected.
Net Present Value = Present Value of Cash Inflow – Present Value of Cash Outflow
Net present value of this proposal is GBP 2583230.528 which is positive hence company may accept this proposal. (Appendix -1)
Payback period Method
In this method it is derived that in how much time company will recover its investment. Next plc will recover its investment in 3 years and 10 months approx. which is not so far hence company my accept this proposal. (Appendix- 2)
Commercial and legal consideration of selected option
In starting year company will have to suffer loss of GBP 12,53,600. From second year and onwards it is expected that company will earn sufficient profits. It will increase financial position of company in terms of profits.(Appendix – 3)
Company requires finance to make investment in USA in such a way that finance position remains sound. There are many alternatives available for company. Company needs to invest USD 500 million in opening 100 stores in U.S.
Following are options available for company:
Next plc company may borrow from its home country i.e. U.K. benefit from borrowing loan in home country is that in home country company has its own goodwill and reputation. Bank and financial institutions will give loan easily. Drawbacks of borrowing local us that there will be exchange rate fluctuations problem as company will establish its business in U.S. and if it take loan in U.K. it will remit back money from U.K. to U.S.
Company may take long term debt loan from foreign bank. It is more recommendable and beneficial as company will not suffer any loss or gain due to exchange rate fluctuations. As company will earn in foreign currency and company will pay principal and interest also in foreign currency. Thus this will reduce risk due to exchange rate movement.
Company may utilize its retained earnings. By doing this company will safe itself from paying higher rate of interest. Drawback of using retained earnings is that company will not be able to pay returns to its shareholders. Company has its main objectives to provide better return to its shareholders. Currently, Company is not doing well so utilization of retained earnings is not feasible option.
Company may issue new shares in market to take money for its project. By availing this option value of share will get reduced and ownership of shareholders will be diluted. Company will have to suffer an additional cost of capital.
Capital structuring is required if company makes investment by acquiring another company or company is expanding by establishing new company in foreign country. As such company has not any plan because company has selected franchise option.
Company will earn profit in U.S. and at any point of time it will repatriate its profit and cash of business in local business. For repatriation, rules, regulations, economic scenario of foreign company will be considered. If we overview economy, geography, rules for repatriation then it is concluded that there is no obligation on repatriation of profits or cash from U.S. to U.K. but company will have to considered all rules, regulations, time limit of repatriation, monetary limit of repatriation.
Market Entry considerations
In some countries there is restriction on repatriation of profit and cash from foreign company to local country. Some countries demand that earned profit and cash should be reinvested. But this is not acceptable because company earns profit for itself, for its stakeholders and for its country if it reinvests profit and cash in foreign company then it will not be able to contribute in economy of its home country.
An article in Wikipedia of Taxation in the United States of America (Wikipedia,2010) A tax on net taxable income is imposed in the united states by the federal, local governments, most state.
In U.S. for individual there is slab rate for levying tax from 10% to 39.6%. for companies tax will be levied between 15% and 35% depending upon income and deduction of company. U.S. government levied tax on nonresident at the flat rate of 30%.
U.S. Government levies income tax on worldwide income of its resident. For nonresident it levies income tax on that income which in earned in U.S. Next Plc will start business as franchise so in case franchise business main source of income is royalty or income through profit sharing. Company will pay tax on such income in foreign country. When it withholds its profit from foreign company it will have to pay withhold tax. It may be possible to pay franchise tax because some countries impose franchise tax.
After remitting income in local country, it will pay tax on the same income in U.K. this will amount to double taxation. In case of double taxation, foreign tax credit on tax on foreign country may be given by local country. U.K. government has signed many tax treaties with many countries. If it has signed tax treaty with U.S. then tax paid on income earned in U.S. will not be double taxed because U.K. government will not levy tax on such income again due to tax treaties.
Specifics risk associated with overseas investments
When a company invests in local country as well as foreign country it considers all aspects whether it is small or big. Every aspect effects working of country. So we consider many aspects relating to investment in U.S.
Company may have to face risk of foreign exchange rates fluctuations. Next plc. decided to select franchise option for market entry into U.S. market. In this option, Next Plc. will get amount from franchise depends upon agreement between both parties.
Political and Economic Risk
Company may get money in two ways from its U.S. franchise. First it may get money in form of royalty and second is that company may get share in profits. If it decides to take money as royalty it will fix amount in its local currency i.e. GBP. In this case franchise will pay a fix amount in GBP so risk of foreign exchange will be totally ignored.
If company gets share in profits, since profits are not fixed at any point of time and franchise will earn profit in local currency that is dollar. When franchise will transfer share of company due to foreign exchange rate fluctuations it may suffer profit or loss.
So to avoid this exchange rate fluctuations risk, company will have to enter into hedging contract so that company will avoid this risk. In such contract, a contract is entered by company with market or exchange banks and a fix rate is decided on which contract is settled whether exchange rate is increased or decreased.
There are various hedging strategies which the company can use in order to reduce the impact of foreign exchange risk. Although hedging strategies have some cost but they save the firm from the huge losses due to the unexpected movement of in the exchange rate of the currency. At the same time there are some losses in some of the hedging strategies that the firm cannot take advantage of the favorable movement in currency.
Suggested that Company can enter into short forward contract where they can fix upon an exchange rate at the current date which is valid for a future date. By doing that company can ensure that they can sell their foreign currency inflows at the rate that is fixed in the forward contract irrespective of the spot exchange rate at the time of executing the contract. (Barton, Shenkir, and Walker, 2002) This strategy is useful when the exchange rate movement is unfavorable for the company. But when the exchange rate movement is favorable i.e. the local currency is depreciating with respect to the foreign currency, then also the company has to sell its foreign currency reserves at the agreed upon rate of the forward contract.
Stated that Company can enter into swap agreements through a investment banker. Company can decide upon a fixed amount to enter the agreement by predicting the cash flows of the coming. (Bodnar, Gebhardt, 1998) They can enter into swap with some minimum fixed amount and any amount they earn above the swap amount they can exchange it on the exchange rate.
Suggested that Company can take put options of the foreign currency, by doing this they can ensure that if the exchange rate foes down below the expected level they can still sell it at the strike price of the put contract. (Hakala, J., and U. Wystup, 2002) In buying the put option they have to pay a premium for buying the option. But in buying the put option they do not necessarily have to exercise it. If the exchange rate (POUND/USD) is above the strike price of the put contract, company will let their put contract to expire and will change the currency at the spot rate in the market. If the spot exchange rate is below the strike price of the put contract, company will exercise its right to sell (put option) and will sell their dollars at the strike price of the put option irrespective of how much lower the spot rate is below strike price.
Company will have to face many management risks due to opening a franchise in foreign country. It will not be possible to manage day to day operations of franchise business. Company will have to suffer additional operating cost to manage operations outside the local country. Company will have to recruit an expert who will review operations of franchise business on periodically basis. This period may be forth nightly or monthly basis. Company will incur additional conveyance cost for this expert for review.
In future many situations may be changed; government may change any law, rule, compliance of which is not so easy because company is not in foreign country.
Company should take decisions considering all the factors of day to day management risks.
Strategic management is most important to operate a business successfully. Strategic management is future oriented management.
While expanding business in foreign country major risk for a business is foreign exchange rate fluctuations risk. Company should opt for a proper strategy to avoid this risk. To avoid this risk, company should enter into hedging contract. If company opts for hedging strategy, company may go ahead with expansion plan in U.S.
Company should go for opening a office in U.S. in future to manage day to day operations and problems arising in business.
If company can manage these risks company may go for more expansion in foreign country U.S. as well as countries like Japan, Australia, Germany, France, Canada, Italy and Switzerland.
Operational matters like managing day to day functions, taking operational decisions, employment of personnel, managing personnel from a distance, managing cultural differences are also important factors that should be considered while taking investment decisions.
While a company takes decision to operate business in a foreign country it is important for a company to employ an expert who knows very well business of company in local country and another person also who knows the business methods and strategy of foreign country. By this both persons will effectively utilize their expertise to grow a business. One person will take decision on the basis of company’s strategic objectives and then correlate with another expert having expertise in business matters in foreign country then decisions will be taken effectively and in a right and timely manner.
While operating business from foreign country a company will have to consider culture of foreign country. Company will have to make adjustment in its business so that sentiments of persons of foreign country are not adversely affected. It will be very difficult to be adjusted according to foreign country culture because it is not possible to be changed quickly.
To be established for long term franchise will have to adjust itself according to culture of foreign country. Franchise will have to do business according to foreign country’s holidays, festivals, style of persons, thought of persons etc.
Practically, it is very difficult to maintain regular communication with person residing in foreign country. In absence of proper communication, Company may bear heavily loss because employed person will take decision on their own and it may be harmful for company.
We are planning to conduct meeting on periodical basis. In this meeting we will discuss new ideas, updated report, risks, and problems and will make decisions and strategic plan. Simultaneously franchise will send us report of operations of business so that business can be reviewed and decisions may be taken promptly.
Next PLC has identified few of the potential markets for their overseas expansion of which one identified market is US market. US market is very large compared to all other potential market; one problem with US market is that it has so many competitors with international operations. There players not only operate internationally but they also have a stronghold in the local market. Having decided to expand operations in US, company has to make 2 critical decisions, one of them is to decide the source of financing and the other critical decision is about how to manage the exchange rate risk arising due to increased exposure in foreign currency.
It is advisable for the company to finance its expansion through a local financial institution. In doing this company would negate the risk of exchange rate fluctuation as they would be borrowing and paying back the borrowed funds in the same currency. Company needs to do some corporate restructuring as well, they will have to move few local employees to US to support in operations. As the financial projections show that the net present value of the project is positive so there is no harm in going ahead with the project. Company’s income statement will show a negative income for the first year. Company’s income statement will show a positive figure for income from year 1 onwards.
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