You have recently been appointed as assistant financial advisor of company of your own choice operating in the travel and tourism industry. The objective of the company is to expand its operations and to acquire a greater market share in the industry.
You are required to prepare a draft report to be presented to the Board of Directors. The report should also demonstrate your ability to research on relevant theories.
Your report should include:
i. A discussion on appropriate sources of finance in context of the expansion plan. Provide a recommendation of the most appropriate sources of finance to fund the expansion of the operations.
i) An explanation of behaviour of costs (using graphs and examples) and the importance of cost volume and profit (CVP) analysis as a decision-making tool.
ii) A discussion of various pricing strategies available within the context of a travel and tourism industry. Recommend management about an appropriate pricing strategy to achieve its objectives.
Plan of Expansion- Appropriate Sources of Financing
The company was founded 175 years ago by Thomas Cook with a vision to be a holiday company that is best loved, delighting its customers, shareholders and its people. The company still stands true to its vision formed years ago (Thomas Cook Group 2016).
It is one of the world’s leading groups in leisure travel. But the aim is not to be one among others but to lead others; expansion plans would aid the company to accomplish its objective of leading the travel industry and increasing its present market size. The report aims to highlight the plans of the company for future expansion. The purpose of the report is to discuss the appropriate sources of finance in the context of the expansion plan and our recommendation on the best suited source for the company. For analyzing the change in costs due to change in organization’s activity level we will be presenting the cost behaviour analysis accentuating cost volume profit analysis as a tool in decision making. We will be also underlining various pricing strategies that are available with the industry and the best pricing strategy for the company based on its financials.
The financing is in the form of new share issues or rights issue to raise money for funding working capital or capital needs for expansion. If the company sells new shares to its existing shareholders proportionate to their shareholding in the company then it is termed rights issue. The company that is already listed may wish issuing additional new shares. Preference shares can be issued which has a fixed percentage of dividend and is paid before payment to ordinary shareholders, however it is only paid if profits that are sufficiently distributable available with the company (Fao.org 2017).
Business Angels make investment in expanding or new business which involves their involvement as a mentor or directly. They can contribute their contacts or business skills that can benefit a business or render development capital. The advantage in this source is investment decisions can be made fairly quickly (Business Victoria 2017).
It is a form of high risk capital mainly directed towards young or existing business having prospects of growing rapidly and earning high returns. There major investment lies in research and development of a given business idea, later stage expansion, early stage business and financing management buy in and buy out of established business.
Billion dollar entrepreneurs more often find a way in growing without being externally financed so that financiers are not in a position to control their destinies or grabbing a disproportionate slice in their wealth pie. This is preferred as this allows creative freedom, higher stakes and less outside influence (Young Entrepreneur Council 2013).
Banks are debt financing’s supermarket as they provide long term, midterm and short term financing simultaneously financing the asset needs. Of course this is to be assumed that there must be enough cash flow generation which will be enough for covering interest payment and returning the principal.
Banks require repayment assurance in form of personal guarantees or secured interest like mortgaging personal assets. The advantage of getting financed from banks is that they offer flexibility as compared to Venture capitals and other investors.
This has a direct impact on dividend amounts as the profit earned is not paid by the company but retained to be deployed on its plans. It is preferred as it involves no cash outlay and there is no interference of the shareholders or any of the outsiders (Fao.org 2017).
This is a form of raising funds through use of online and networks like social media where large numbers of people contribute their money towards a project in exchange of equity, service or goods. It is good if strong networks are already available and loyalty needs to be built before start (Business Victoria 2017).
The best source of financing for the company can be seen in Equity Financing whivh involves giving specified percentage of the company or specified number of its shares for specified sum of money. The argument behind this source can be seen in:
For companies that are not profitable or profitable but having negative cash flows, equity provides with flexible funding needs. The net profit ratio of the company is very low which equals to 0.115%. The cash flow position is also not favorable (Thomas Cook Group 2016). Because the companies are required to pay only dividends or distribute the capital if they have surplus of cash, the company will be able to use all the cash provided by issuance of equity to fund the expansion.
The Company is already under huge burden debt, it pays Pounds 146 million for its financing costs (Thomas Cook Group 2016). Hence it is not advisable for the company to burden itself with more debt in the form of bank loans or any other source of external financing and continue making interest and principal payments (nibusinessinfo.co.uk 2017).
No liens are placed on the company’s assets being collateral or personal guarantees if the company opts for equity financing.
Cost behavior can be associated with the learning of how costs change due to a change in level of activity in the organization. It is requisite for the managers not only to understand the cost behavior underpinnings but to apply them in real world. For understanding it is imperative to know the business’s cost structure. The three types of cost are variable, fixed and mixed costs.
Variable costs are those costs which are directly proportional to changes in the organization’s level of activity (BARBU 2015). The most common examples include raw material, labour and sales commission. For better understanding a pictorial depiction is given hereunder:
Total Variable Cost: The total long distance bill here would be based on the minutes talked.
Variable Costs per Unit: The cost of talking per minute remains constant, like 15 cents per minute
Few costs that are variable show behaviour that is exactly linear except two which are – step function and curvilinear function.
This cost is the opposite of variable cost. They do not show any fluctuation with the changes in the organization’s level of activity (BARBU 2015). They remain the same. An example for this would be factory rent which would be charged irrespective of the fact that the factory operates or shut downs.
Discretionary costs that can be discontinued or changed by management provided enough available time is there. Example: Advertising.
Committed Costs required when the operations are temporarily closed down. Example: Depreciation.
Total Fixed Cost: The monthly telephone bill is fixed and would not change when we don’t or make more local calls.
Fixed Cost per unit: The fixed cost per local call would decrease if more local calls are made.
Mixed costs imbibe the components of both variable and fixed costs. The most common example can be mobile bills which charge a fixed monthly plus usage charges for extra minutes and text messages. These types of costs are harder for evaluation as they change in response to volume fluctuations (BARBU 2015).
y = total mixed cost
a = total fixed cost (vertical intercept of line)
b = variable cost per unit of activity (slope of line)
x = the level of activityAnalysis of Mixed Cost:
-High Low Method
-Scatter graph Method
-Lease Square Regression Method
The CVP Analysis can help in planning profit. It helps in determining:
-Entity’s breakeven point
-Impact on volume of sales and profit from increased costs of advertising
-Sales level required to make profits
-Changes in selling price and its impact
-Most profit yielding sales mix
-Revenue required for avoiding losses
-Budgeting for discretionary expenses
-Whether organization is being exposed to unacceptable risk level due to fixed costs (Abraham 2017)
Analyzing the CVP relationships for planning profits
Effective profit and marketing plans must be concerned of the impact on the profit of:
Change in selling price
Change in fixed and variable cost
Change in variable cost
Change in fixed cost and sales volume (Ciftci Mashruwala and Weiss 2014)
Comparing the actual with planned results of profit to calculate:
Sales price variance
Sales volume variance
Variable cost variance (Abraham 2017)
The picture shows Input Data CVP Analysis, its Assumptions and its uses:
The right price is that which satisfies both the tourists and meets tourism businesses profit objectives (University of Pretoria 2017). Hence, it becomes necessary to develop price structure, strategies and objectives for establishing strategic role of pricing in marketing mix (AZIRI and NEDELEA 2013).
Regardless of the reservation price, this pricing involves charging same price to all the buyers. Those buyers whose reservation price exceed single price gain consumer surplus and vice versa. It is practiced when sellers do not exercise enough pricing power for changing single price as per buyer’s reservation price (Living Economics.org 2017).
Discounts are offered in off seasons to give assistance to yield management. Usually in discounted pricing no differentiation is made to a product from competition- because the same can be matched by the competitors quickly. Hence it is necessary to remain cautious so that the business does not get devalued due to regular discounting. This is also known as Dynamic Pricing (destinationnsw.com.au 2014).
Value adding is feature adding to the product so that the perceived value is enhanced. Comparing with discounting it can create a competitive edge attracting greater share in market. It helps in prevention of business fluctuations for products that are subjected regularly to peaks and troughs. Example can be purchase incentives like champagne on arrival, package and products bundling (destinationnsw.com.au 2014).
Discount package components like meals, accommodation, transport, entry fee are presented as one cost that is upfront. In this method individual component’s exact cost and the discount given is disguised. Generally three elements should be included for disguising price (destinationnsw.com.au 2014).
When a range of attractions, activities and options of each component are priced at full price then the final package becomes less appealing as it is expensive. For overcoming a flexible package can be offered where each component is priced separately and can be purchased individually. Customers can accordingly select the preferred package components as per budget and preference (destinationnsw.com.au 2014).
This pricing strategy is used to generate sales in traditional slow periods.
The price has a psychological impact on the consumers.
This pricing is done based on perception of the customer. For Example: prestige pricing is used by hotel and restaurants focusing to establish luxury image.
Thomas Cook is operating in many countries and hence single pricing is suggested for it. This will help in combating confusion of consumers regarding prices (travelweekly 2013). This would establish price parity. Also with the advent of Internet which is here to stay it is not possible for any company to defeat the Internet, the consumers are highly informed and they already do the homework for determining price they should be paying for anything that is being sold on the internet, here one price policy or single price become inevitable and give competitive advantage.
This report envisages sources of finance in the form of equity financing, business angels, venture capital, retained earnings, bank loans, bootstrapping and crowd funding. The best source of finance for the company was found in equity financing. We have underlined here behavioral costs in form of variable, fixed and mixed costs. We have explained these costs with proper examples. We have outlined the role of CVP in decision making and explained the variouss ways in which it can help management to take decisions that would help in enhancing business operations. To conclude we have given an oversight of the different pricing strategies that are used in the travel and tourism industry including Single pricing and Differential pricing. We have sketched how single pricing strategy is beneficial for the company as compared to other strategies.
Abraham, A. 2017. Cost-volume-profit analysis for decision making.
AZIRI, B. and NEDELEA, A. 2013. Business Strategies in Tourism. ECOFORUM, 2(1(2).
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