T4- Part B – Case Study Papy – Sustainable trading case – November 2011 REPORT by Chartered Institute of Management Accountants

T4- Part B – Case Study Papy – Sustainable trading case – November 2011 REPORT To: Chief Executive of Papy From: Management Accountant Date: 24 November 2011

Review of issues facing Papy Contents 1.0 2.0 3.0 4.0 5.0 6.0 7.0

Introduction Terms of reference Prioritisation of the issues facing Papy Discussion of the issues facing Papy Ethical issues and recommendations on ethical issues Recommendations Conclusions

Appendices Appendix 1 Appendix 2 Appendix 3 Appendix 4 Appendix 5 Appendix 6 Appendix 7

SWOT analysis PEST analysis Evaluation of the proposal to reduce electricity usage Evaluation of reductions in carbon emissions from the 2 proposals and comparison to target for 2013 Possible change in the number of supermarkets re-built Comparison of capital expenditure of reducing carbon emissions for the 2 proposals Presentation and graph on the proposals to reduce carbon emissions

1.0 Introduction Papy is a large food retailer with over 1,100 stores across 8 European countries. A new Chief Executive, Lucas Meyer, has recently been appointed and he would like to change Papy in order for the company to become a more sustainable retailer. A small team has been established, headed up by Arif Karp, the newly appointed Corporate Affairs Director, to identify and implement proposals to reduce carbon emissions. This team is also tasked with bringing about change within the company.

2.0 Terms of reference I am the Management Accountant appointed to write a report to Lucas Meyer, Chief Executive of Papy supermarket chain which prioritises, analyses and evaluates the issues facing Papy and makes appropriate recommendations. I have also been asked to prepare a presentation on the savings in carbon emissions if Papy were to implement the proposal to re-build 12 stores and the proposal to reduce electricity usage, together with a graph showing Papy’s carbon emissions as measured by “carbon emissions in kilograms (kg) per square metre of sales area”. This is included in Appendix 7 to this report.

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3.0 Prioritisation of the issues facing Papy 3.1 Top priority – Management of change and carbon emission targets The top priority is the need to manage the change in Papy in order for it to become a more sustainable retailer and to meet the new targets for carbon emissions. Additionally, Lucas Meyer, Chief Executive, wants Papy’s carbon emissions to be reduced to 700 kg per square metre for 2013. The company needs to decide whether this target is acceptable and whether it is achievable and what proposals it could undertake to reduce its carbon emissions. 3.2 Second priority - Balanced Scorecard The second priority is considered to be the recently agreed introduction of the Balanced Scorecard from 1 January 2012 both as a way of measuring progress towards the achievement of a wide range of targets and also as a mechanism for rewarding employees with free shares. It is important that all employees are working towards the achievement of Papy becoming a more sustainable retailer to ensure goal congruence. It is also important that the correct key issues are identified and measured in the Balanced Scorecard. 3.3 Third priority – Proposal to re-build 12 supermarket stores This is considered to be the third priority as it is a significant proposal to temporarily close and re-build 12 profitable supermarket stores. However, as they are older stores and have high heatloss, it would be a sensible way to reduce carbon emissions. The proposal is to re-build 12 new supermarket stores which are more energy efficient and incur lower operating costs and generate lower levels of carbon emissions. 3.4 Fourth priority – Proposal to reduce electricity usage In order to meet Lucas Meyer’s target of 700 kg per square metre by 2013, it will be necessary to invest in as many projects that reduce carbon emissions as possible. The range of investment projects to reduce electricity usage is less urgent than the other issues prioritised above but are worthy projects. A SWOT analysis summarising the strengths, weaknesses, opportunities and threats facing Papy is shown in Appendix 1. A PEST analysis is shown in Appendix 2.

4.0 Discussion of the issues facing Papy 4.1 Overview Papy operates a successful and profitable chain of supermarkets, which generated revenues for the year ended 31 December 2010 of almost €13 billion. The profit for the last financial year was €454.4 million after tax and finance costs. Papy’s gearing was only 29.25% (measured as debt of €870.0 million / debt plus equity of €870.0 million + €2,104.4 million). Tesco’s gearing was 46.0% at the end of February 2010. Papy has also repaid debt of €150 million in the last financial year. So there is room to increase debt financing in order to fund the proposals to reduce Papy’s carbon emissions which are set out in this report. Papy’s interest cover is 9.5 which is high and demonstrates a good ability to pay the interest on its current debt. In order to become more sustainable and reduce its carbon emissions, Papy will need to change the way in which it operates in order to reduce electricity consumption which in turn will result in long-term savings in operating costs. European companies which do not reduce their carbon emissions will be subject to possible fines in the future as the first deadline of 2020, which was

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agreed in the Kyoto protocol, becomes closer. Therefore, the proposals for change in order to become more sustainable and to set reduced carbon emission targets and 2 proposals to reduce carbon emissions all reflect the right attitude for a large listed European company to embrace. 4.2 – Management of change and carbon emission targets Lucas Meyer wants the Papy chain of supermarkets to be a more sustainable retailer. For this to happen there will need to be 2 principal changes: 1. Focus on achieving lower targets in carbon emissions and how to achieve these targets 2. Management of change in order for Papy’s employees to become focused on targets other than financial targets. There is a need to get all employees involved in Papy’s proposed change to become a more sustainable retailer. Without employee “buy in” the company will not be successful. The case material states that many members of Papy’s senior management team consider themselves too busy to become involved. There needs to be a full commitment from all members of the management team and this must be driven by Lucas Meyer. Many managers and employees consider the subject of climate change not worthy of their attention, especially in difficult trading times where costs are being cut and growth in revenues are difficult to achieve. It is necessary to brief them and explain what Papy’s new targets are and why and to explain the need for them to be involved. It is suggested that a “top down” approach to briefing is started with all senior managers briefed by Lucas Meyer and Arif Karp to explain what they are trying to do. They should explain how cultural change in Papy could be brought about and explain that this is a new long-term objective for the company. Perhaps some of the senior management team do not appreciate the importance of long-term objectives and are focused too much on the achievement of short-term profitability targets. Therefore, the introduction of the Balanced Scorecard (as discussed below) will help Arif Karp and Lucas Meyer to set a range of meaningful targets. The Balanced Scorecard views profitability as being a “lag” rather than a “lead” as an indicator of the business’s performance. An article in Financial Management (March 2011 article) referred to the United Nations Global Compact (UNGC) survey of global CEO’s and highlighted that one of the main challenges facing organisations wishing to improve their sustainability practices, is the transition from strategy to the execution of their plans. It will then be necessary to communicate the need for change with all store managers and finally with all store employees. Change cannot be “enforced”. Instead it must be embraced and accepted by the employees if the company is to re-focus on being a sustainable retailer, rather than a profit-driven retailer. Therefore a series of “road shows” to brief managers in each of the 8 European countries will be required and communication documents drawn up to explain the changes to all employees. The use of external consultants who are not familiar with the supermarket industry should be discouraged as this could further antagonise store managers. It is important for Papy managers and all other employees to be involved and not to use consultants excessively, except where expertise on specific aspects is required. Employees may be naturally fearful about change and not understand what is expected from them. The reason for new requirements for data must be explained and they must understand what is required and for what reason, in order for them to become actively involved.

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Within Arif Karp’s team, it is suggested that a small team should be exclusively committed to communication with managers and all other employees throughout the company. Communications could be face to face, by web cast, email or by posters in the staff areas of each store. In summary, a range of initiatives that Arif Karp could consider introducing are: 1. To ask Lucas Meyer or possibly Abdul Yarkol, Finance Director, to be the senior champion for environmental issues within Papy and to work across the company to align financial and non-financial results. The introduction of the Balanced Scorecard, as discussed below, will help to identify and measure a much broader range of performance measures linked to sustainability. 2. Arif Karp could benchmark what other leading supermarkets are currently doing and compare each of their competitors’ targets to Papy’s. For example, some initiatives from Tesco’s latest annual Corporate Responsibility Report include supporting Climate Week in the UK (21-27 March 2011) and introducing an “energy league” between stores in Malaysia to reward lower energy usage. If successful, this energy league concept will be rolled out across other countries. 3. As it is stated many of Papy’s employees either do not know, or understand, what Arif Karp is trying to do, then they could consider following Tesco’s lead which has trained thousands of employees to be “Energy Champions”. All of the employees appointed as “Energy Champions” are tasked to reduce energy and to encourage colleagues to do the same within each store or within stores in their region. 4. The use of management frameworks that organisations can use to help manage the process of change. These include, for example, Kurt Lewin’s Change Management Model of “unfreeze, change and refreeze”, and developments of Bruce Tuckman’s model of “Forming, Storming, Norming and Performing”. Models such as these are commonly used as tools to help bring about changes in employees’ behaviour. Perhaps Arif Karp’s leading global consultancy company where he used to work before he joined Papy, could assist with helping to bring about change. However, it must be stressed that it is Papy’s employees who need to understand the need for change, but external consultants can usefully act as facilitators for change. 5. There is a clear need for an IT system such as the Environmental Management System (EMS) in order to capture non-financial data on a wide range of issues such as waste, recycling (by type of material), energy usage, carbon emissions etc, by store, for each country and for the Papy group. It is necessary for senior managers to become involved with specifying the data requirements and sources of data and whether the data is currently being measured or not. Only Papy employees and managers understand this data and therefore the use of external consultants should be minimised. They do not know the business or the people and it may engender a “them and us” attitude. It is necessary for Papy’s management to become much more involved.

Lucas Meyer has set a target of 700 kg per square metre by 2013. Papy can only achieve these reduced carbon emission targets if it invests in projects to help deliver large volumes of savings in carbon emissions, such as the re-building of the 12 supermarkets and the proposal to reduce electricity usage. These proposals could deliver large savings in carbon emissions as shown in Appendix 4. In summary these savings are as follows:

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Total carbon emissions Based on average square metre of 1,457,000 for 2013

2013 kg millions

Carbon emissions per square metre of sales area 2013 kg per square metre

Latest forecast for 2013

1,274

874.4

Re-build 12 supermarket stores

(264)

(181.2)

Reduced electricity

(97)

(66.6)

Revised forecast after these 2 proposals

913

626.6

The table above shows that these 2 proposals could bring Papy’s carbon emissions down to 626.6 kg per square metre which is 73.4 kg below Lucas Meyer’s new target. 4.3 – Balanced Scorecard The Balanced Scorecard is a useful management tool to measure, monitor and set targets across a wide range of performance indicators. For Papy, it would represent a move away from setting only financial targets as a basis for rewarding its employees. However, this initiative needs to be handled with great care. It has already been identified that employee morale is low, and that many are resistant to change. With increased profits over the past 5 years employees have been rewarded with free shares, and therefore this raises employees’ expectations for the future should profits continue to grow, which they are expected to. The use of the Balanced Scorecard as a tool to reward Papy’s employees with free shares is also useful as this will help employees to focus and understand the range of measures upon which they will be rewarded. This will help Papy to achieve goal congruence and also help Papy in its transition to become a more sustainable retailer. This cannot happen overnight and change in employees’ attitudes and understanding will take time. Investments in sustainability are likely to have an impact on store profitability since inevitably payback periods are relatively long, although the effect on carbon emissions is beneficial. This point has already been raised by Arif Karp with store managers, and is a sensible justification in itself for having a broader spread of performance measures. Through the introduction of the Balanced Scorecard in January 2012, a range of stated and measurable objectives and targets can be set. Then actual results can be monitored and reported. Over a period of several years, this will help employees to understand the important issues and the strategic direction the company is trying to pursue. The most important measure of carbon emissions has been omitted from these proposals completely. It is suggested that the measure of “kg of carbon emissions per square metre of sales area” should be included as an Internal Business Process measure. It is therefore suggested that the proposed measure of “electricity usage” is removed and replaced by carbon emissions. The suitability of the measures proposed by Arif Karp and potential conflicts are as follows: Financial The financial measures proposed do seem to be appropriate, since they complement each other. One is volume based, which is a good measure of marketing success, whilst the operating profit margin is a key measure of store effectiveness in terms of effective purchasing, control of waste and of store overheads. To some extent however local store managers may be inhibited by central control over suppliers and product range.

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There is a conflict between “percentage growth in sales revenue” and some carbon reduction proposals which could reduce sales revenue, such as the electricity usage reduction which is forecast to reduce sales revenue by a small amount. There is also a conflict between operating profit margin (which is after depreciation charges) and the higher depreciation charges that will arise as a result of capital expenditure for carbon emission reduction projects. The more Papy invests, the higher the depreciation charges, which will reduce operating profit margins.

Customer focused: The customer focused measures again seem to be relevant and can be influenced by good store management and a keen workforce. Customer satisfaction surveys are an important source of information for store managers to highlight where there may be areas for improvement. The problem of course is getting sufficient customers to complete the surveys in order to make the data meaningful. Customer loyalty card information is very useful information. Supermarkets want regular customers, for example Sainsbury’s regularly mail-shot a month’s discount vouchers to households in an attempt to get them to change their purchasing habits. Customer satisfaction could be adversely affected by the electricity reduction proposal which would reduce heating (or reduce air conditioning) and make shopping perhaps a little less “comfortable” for customers.

The innovation and learning measures: Training days on sustainability issues would seem to be suitable, and would support Papy’s CSR plans. Training is also a useful TQM approach to continuous improvement. There is also the conflict between operating profit per store and the cost of training days for sustainable training issues. Training however should be viewed as an investment in the future, rather than as a current cost. A better measure than the cost of investment in carbon reduction projects should be considered. It would be far better to focus on outcomes, which is the drop in carbon emissions. Focusing on investments alone, without considering their impact, could lead to over-investment and damage to both cash flows and profit margins. Therefore, instead of the measure of the cost of the investment in carbon reduction programmes, and as a way to involve all employees in the need o change, then a new measure of the “number of new carbon reduction programmes introduced by store employees” is proposed. The internal business processes: As noted above, the key sustainability measure of “carbon emissions per square metre” has been omitted. It is suggested that this should replace electricity usage as carbon reduction is crucial to Papy becoming a more sustainable retailer. This measure is at the heart of hat Papy is trying to change and therefore it is crucial that this should be incorporated in the new Balanced Scorecard measures. The other measure concerning the “percentage of packaging and other materials recycled” is valid in principle but is not a realistic measure for the Balanced Scorecard as Papy could not measure this. Customers may recycle packaging in many ways or not recycle at all and this could not be effectively measured.

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It is suggested that an alternative measure is used which is “the reduction (in volume) of packaging for all products”. Therefore, the reduction in volume of packaging for products delivered to stores is a more sensible and realistic measure.

There is also the problem with setting targets for each of the proposed Balance Scorecard measures that employees can understand and that are “SMART” i.e. Specific, Measurable, Attainable, Relevant and Time-bound. There is a need for the Papy management team to ensure that it achieves goal congruence and the Balanced Scorecard is widely used as a tool to focus all employees and management away from solely financial targets. Tesco uses the Balanced Scorecard to ensure that its performance is measured against a range of relevant business targets. If Papy can achieve its sustainability targets, then this should lead to improved customer focus and profitability. Papy could usefully follow The Co-operative Group in this respect, which whilst it is an organisation focused on profits was also awarded the “Responsible trader of the Year” in 2009 by the Grocer magazine. The final 8 measures to be used in the Balanced Scorecard need to be considered and then discussed with employee representatives, before being introduced in January 2012. 4.4 – Proposal to re-build 12 supermarket stores This is a risky proposal to close down temporarily (for almost a year) 12 profitable supermarket stores. However, they are older stores and a complete re-build will make them more efficient and the new stores would generate significantly lower levels of carbon emissions, at only 0.4 million kg for each new-built store. Many supermarket chains have plans in place to cut their emissions. Tesco has a goal of being a zero-carbon business by 2050 and has opened several new stores built to a new low-carbon blueprint. Tesco has several new stores which are zero-carbon, including some in the UK, Europe and in Asia. If Papy is to remain competitive, it must follow the lead set by Walmart, Carrefour and Tesco, which are the 3 largest supermarket chains in the world. However, the underlying forecast assumptions for revenues and operating profit are suspect and I, as Management Accountant, will need to resolve all of the questions before the proposal is submitted to the Papy Board. This is also discussed in Ethics below. The revenue per store after re-building is shown as €28.50 million, an increase of €1.0 million from current levels, despite the sales area remaining the same at 2,800 square metres. The assumptions behind this increase in sales revenue needs to be resolved before the proposal is submitted to the Papy Board. The operating profit is forecast to be €2.0 million per store after rebuilding, which is an operating profit margin of 7.0% which is considerably higher than current performance at these 12 stores of just 2.0%. However, the newly built stores will have lower operating costs and this is possible. Papy’s current average operating profit margin in 2010 was 5.1%. The proposal would reduce carbon emissions from 22.4 million kg per store to 0.4 million kg per store. This represents a total saving of 22.0 million kg per store with a total of 264 million kg for all 12 stores. This represents an equivalent of 181.2 kg per square metre for 2013, which is a significant volume. This is shown in Appendix 4. The re-building of these 12 stores could help Papy to meet Lucas Meyer’s new target of 700 kg per square metre by 2013. Indeed, together with the proposal to reduce electricity usage, it could exceed the target by 73 kg per square metre. This is also shown in Appendix 4. It is necessary for Papy’s Human Resources department to give all employees at these 12 store re-assurance over their jobs and explain what will happen to them during the 10 month re-

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building process. It may be possible for them to work at nearby stores or to attend training sessions. In order to maintain employee loyalty, all of the affected employees will need reassurance that they will continue to receive their salary and that their jobs are secure. The cost of the proposal should include the cost of these employees on a retainer during the period of the rebuilding of the 12 supermarket stores. It would be possible for Papy’s management team to choose to only re-build only 8 supermarket stores in 2012 and the remaining 4 in 2013 and still meet the target of 700 kg per square metre. Whether all of the 12 supermarket stores were re-built in 1 year or over 2 years, this would still enable Papy to meet the proposed target of 630 kg per square metre for 2014. This is shown in Appendix 5. There is some concern over the loss of customers and customer loyalty whilst these 12 supermarket stores are being re-built. How can Papy try to retain customers? It could issue its existing customers at these stores with special vouchers or even provide a bus service to other Papy stores nearby, assuming there are other stores in the same cities as the stores which will be re-built. Furthermore, the marketing budget needs to be agreed in order to launch the opening of the 12 newly re-built stores and regain its customer base. The total capital expenditure is €24 million per store, with a total cost for this proposal of €288.0 million. This proposal is forecast to save 264 million kg of carbon emissions. Appendix 6 shows the comparison of capital expenditure for this proposal and compares it to the proposal to reduce electricity usage. The capital investment is €1.09 million per 1 million kg of carbon emissions. This is less expensive than the other proposal to reduce electricity usage, which costs an average of €1.34 million per 1 million kg of carbon emissions reduced. In summary, this proposal can be evaluated using Johnson, Scholes and Whittington’s framework of suitability, acceptability and feasibility, as follows: Suitability: This investment would achieve substantial reductions in carbon emissions as required by Lucas Meyer for 2013, and also go a long way towards achieving the even lower target for emissions in 2014. Acceptability: In terms of acceptability this investment would meet the need for reduced carbon emissions of some important stakeholders (using Mendelow’s framework). In particular it would satisfy Lucas Meyer and the Board. Arif Karp of course would also be pleased as he has a performance related bonus linked to reductions in carbon emissions from a 2010 base. Investors should find the investment acceptable as it generates higher levels of operating profit at these stores. However, the Management Accountant is concerned that this is based on what is perceived to be optimistic forecasts for profit improvements from the re-built stores and it is not clear what the basis is for the 3.6% increase in sales revenue (i.e. from €27.5 to €28.5 million per store) after the re-building, since there is no increase in sales area. Feasibility: There would appear to be no feasibility problems with this investment. Papy had a significant cash balance of €603.9 million at the end of 2010 and Lucas Meyer has set a challenging target for reductions in carbon emissions which this proposal addresses.

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4.5 – Reduction in electricity usage If Papy is to become a more sustainable retailer it must embrace not just the large investment projects such as the re-building of stores but also address the many smaller projects across its entire property portfolio in order to save electricity costs and to reduce carbon emissions. Many of Papy’s competitors have much lower levels of carbon emissions as measured by “carbon emissions per square metre”. The Case Study Pre-seen material shows that Competitor 2 has a level of only 243 kg per square metre, so even the new 2013 target of 700 kg per square metre is still high. Papy has a long way to go and therefore it needs to find a wide range of small projects to help it to reduce carbon emissions. It should also get employee involvement for other suggestions on how electricity usage could be reduced. The proposal to reduce electricity usage included reducing the outside lighting for signs. However, this needs to be weighed up against possible loss of customers, some of whom may think that the store is closed. A sensible compromise needs to be taken to reduce wastage of electricity. Reducing levels of heating and air conditioning also needs to be carefully considered and measured so that the temperature is comfortable for staff and also for customers. If customers are not comfortable, this may affect repeat business and customer satisfaction. Concern has also been expressed by store managers over the disruption that could be caused by this investment, and the potential loss of customers arising from the change in store temperatures. However, this would demonstrate to all store managers, employees and customers that Papy is trying its best to reduce its carbon footprint by taking this range of measures to reduce electricity usage. Reducing lighting at night is sensible but the lighting needs to be at a reasonable level to allow staff to work effectively and safely during night shifts. The proposal to reduce electricity usage is forecast to generate savings in carbon emissions totalling 97 million kg in total as shown in Appendix 4. This is equal to 66.6 kg per square metre in 2013 and will help Papy to achieve (and even exceed) the target of 700 kg per square metre. The capital cost is €130.137 million, as shown in Appendix 6. Papy has adequate cash funds at the end of 2010 to fund this proposal. The investment is to be depreciated over 14 years, which is also the payback period of the investment (as per Appendix 3). This is quite a long time period. However, the operating cost savings are all on-going so this should not be a major problem. This proposal is forecast to save 97.0 million kg of carbon emissions. Therefore the capital investment is €1.34 million per 1 million kg of carbon emissions. This is higher than the equivalent measure for the proposal to re-build 12 supermarket stores, which is only €1.09 million per 1 million kg of carbon emissions. Appendix 3 shows the effect on Papy’s profitability for this proposal for 2013 only. This proposal shows that the savings in electricity usage are €11.29 million, but this could be partially offset by a reduction in gross margin as a result of a small fall in sales. After taking into account the depreciation charge of €9.29 million (€130.139 million / 14 years), then there is a small fall in operating profit of €(0.22) million for the entire company. This is very small compared to the savings in carbon emissions. Appendix 3 shows that the effect on the operating profit for 2013 will be a small increase of €0.29 million for small convenience stores, whereas the effect for supermarket stores is a fall in operating profit of €(0.51) million. Therefore the proposal is financially viable for small convenience stores. The forecast fall in sales, perhaps due to customers not seeing “Papy supermarket” signs or customers not spending as much time and money due to less than “comfortable” store

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temperatures, needs to be carefully monitored to try to reduce or eliminate this potential fall in revenue. In respect of Lucas Meyer’s new target of 700 kg per square metre for 2013, it would be possible to still meet this target even if this proposal were not to be approved, as the proposal to re-build 12 supermarkets generates sufficient savings in carbon emissions to meet the target. However, this proposal is to introduce a wide range of electricity saving proposals across Papy’s entire property portfolio and would encourage all employees to become involved with reducing carbon emissions.

5.0 Ethical issues and recommendations on ethical issues 5.1 Range of ethical issues facing Papy There are a range of ethical issues facing Papy including the following: 1. Management Accountant’s dilemma concerning possible incorrect revenue and operating cost assumptions in the proposal to re-build 12 supermarket stores 2. Proposal to change packaging 3. The dilemma of whether the Papy Board should accept both proposals or not as this would result in the target of 700 kg per square metre being exceeded in 2013. Alternatively, Papy could cut back on some of the initiatives or even delay the rebuilding of up to 4 supermarket stores until 2013 or later but this would be unethical. 4. Duty of care to employees and that shelf stacking should not occur in semi darkness conditions 5.2 – Management Accountant’s dilemma concerning incorrect assumptions 5.2.1 Why this is an ethical issue This is an ethical issue as myself, Management Accountant, have serious concerns about the underlying assumptions for the revenues and operating profit for the 12 stores after re-building. There is something suspicious going on as I have overheard a conversation between Arif Karp and the Marketing Manager about whether the proposal to re-build the 12 stores would be approved if it were to be known that a lower level of sales revenue and operating profit were likely to occur after re-building these stores. Perhaps Arif Karp is trying to make this proposal more attractive as it reduces Papy’s carbon emissions and would generate a higher performance related bonus for him personally. There is a conflict of interests here. I do not believe the revenue and operating profit assumptions are correct and fear that there is some sort of cover up to make the proposal appear to be more financially attractive. Having been appointed as a member of the project team headed up by Arif Karp, I am unsure as to who I should raise my concerns with. 5.2.2 Recommendations for this ethical issue It is recommended that the Management Accountant’s concerns about the integrity of these figures should not remain unanswered. The Management Accountant needs to consider both his/her own integrity and CIMA’s code of ethics. In particular the Management Accountant needs to consider the fundamental principles of objectivity (i.e. not to allow the undue influence of others to override business judgements), and also professional competence and due care.

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It is recommended on ethical grounds therefore that he/she raises the concerns with the Finance Director. It is important that business decisions are made based on realistic figures, particularly high profile and high capital expenditure projects such as this one. They should be accurately and honestly prepared and presented to the Papy Board. It is further recommended that Arif Karp’s performance related pay is changed or re-negotiated (if possible) and that it is linked to the new Balanced Scorecard and not just Papy’s reduction in carbon emissions. Perhaps his 3 year contract cannot be changed during his first 3 years but this is a specific clause that should be changed when the contract comes up for renewal. 5.3 – Proposal to change packaging 5.3.1 Why this is an ethical issue The general idea to reduce the volume of packaging is good, but this is an ethical issue for 2 separate reasons, which are: 1. The proposal to change from recyclable glass to plastic which is not easily recycled, is not in the spirit of Papy becoming a more sustainable retailer 2. The change would reduce Papy’s carbon emissions by a small amount but would actually increase its suppliers’ carbon emissions Supermarkets have a large power over its suppliers, and Papy could force this change through. Customers could also view this initiative in a positive light because of inadequate local recycling facilities for glass. The ethical issue this raises therefore is whether Papy should just consider itself or the impact it has on the whole supply chain?

5.3.2 Recommendations for this ethical issue It is recommended that the change to plastic containers is not pursued as the use of plastics should be discouraged. Glass is a recyclable material and therefore this is a good material for a sustainable retailer to use. Furthermore, it is recommended that Papy should actively promote and encourage the recycling of glass containers. If local recycling facilities are not available then Papy should establish its own or raise this concern with local authorities. It is recommended that a large container for glass recycling is set up within the car parking areas of as many Papy stores as possible. This could be a new measure for encouraging recycling in the communities in which it operates. It is stated that only 20% of customers recycle their glass bottles. As part of being a sustainable retailer, Papy should encourage its customers to recycle glass. Regular customer surveys should be held to see whether the level of glass recycling is increasing. 5.4 – Accept carbon reduction proposals and exceed targets or delay or cancel some 5.4.1 Why this is an ethical issue There is an ethical dilemma as to whether Papy should approve both proposals and exceed the target of 700 kg per square metre in 2013. The proposals would reduce carbon emissions to 626.6 kg per square metre. This is 73.4 kg per square metre lower than Lucas Meyer’s new target.

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Each of the 12 supermarkets saves 22 million kg which equals 15 kg per square metre. Therefore the Papy Board could decide to delay the re-building of 4 supermarket stores (60 kg per square metre) as shown in Appendix 5. Alternatively, Papy’s management team could choose not to undertake the electricity reduction proposal (66.6 kg per square metre) and still meet the target of 700. Should Papy consider delaying or cancelling the re-building of 4 stores until 2013 or not to undertake the electricity reduction proposal? Is this an ethical stance for a company trying to prove that it is committed to reducing its carbon emissions? 5.4.2 Recommendations for this ethical issue It is recommended that both proposals are approved in full and are undertaken without delay. This will result in Papy exceeding the target of 700 kg per square metre and the forecast is to achieve 626.6 kg per square metre for 2013. Papy must show its commitment to reducing carbon emissions and not be distracted by short-term loss of profitability. 5.5 Duty of care to employees and that shelf stacking should not occur in semi darkness conditions 5.5.1 Why this is an ethical issue As an employer, Papy owe a duty of care to its employees to provide a safe working environment. Therefore, the store managers who are trying to save electricity costs by instructing employees to fill the supermarket shelves during night shifts in semi-darkness are breaching this duty of care. 5.5.2 Recommendations for this ethical issue It is recommended that this unsafe and unethical treatment of employees should stop immediately. Arif Karp should send a message to all store managers telling them that adequate lighting for night shift employees should be provided. Furthermore, it is recommended that the operations department investigate installing motion sensors and low energy lighting, so that lighting is provided only in the areas of supermarket stores where employees are actually working, rather than for the whole store.

6.0 Recommendations 6.1 – Management of change and carbon emission targets 6.1.1 Recommendation Lucas Meyer’s wish to see Papy become a more sustainable retailer is a sound one and it is important to set challenging targets to reduce carbon emissions. It is recommended that the target of 700 kg per square metre is agreed and that both of the proposals (see below) are accepted. This would result in Papy exceeding this target for 2013 with forecast carbon emissions of only 626.6 kg per square metre. It is recommended that the company supports Arif Karp in his initiatives to bring about change within Papy. If the company is to achieve Lucas Meyer’s stated aim to become more sustainable, then a change of attitude is needed from the Board of Directors down to all employees across all stores. Change is not easy to bring about, but can happen if it is driven from the top.

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It is important to get all of Papy’s employees on board with the need to become more sustainable. It is also clear that many employees are confused by the apparent change of focus away from cost control to carbon emissions. There is also a significant change proposed to the method of calculating performance related pay, which if not handled carefully would further affect employee morale. Recommendations on the Balance Scorecard are shown below in paragraph 6.2.

6.1.2 Justification Papy needs to change and adapt in order to survive and stay competitive. Papy’s carbon emissions are materially higher than some of its competitors (Case Study Pre-seen material page 5). At some stage in the next 5 to 10 years it is expected that the European Union (EU) will tax or impose fines on any company that do not make substantial reductions in its carbon footprint. It will be better for Papy to change voluntarily now, rather than have changes, or substantial fines, imposed on the company.

6.1.3 Actions to be taken 1. Lucas Meyer should be the senior “Champion for change”, and to work with Arif Karp and store managers to get the message on sustainability across to all employees. 2. Simona Papy, the HR Director, could also work with small groups of store managers, possibly on a regional basis, to help drive the Board’s messages through the organisation. 3. Because many employees do not understand what the company is trying to do then Papy should train a number of store employees to be “Energy Champions” who are tasked to reduce energy and to encourage colleagues to do the same. This would also support one of the proposed Balance Scorecard performance measures under Innovation and Learning. 4. It will be necessary to hold ”Road Shows” for managers and staff in each country and for communication on sustainability targets and plans to be cascaded down by store managers in each store. It is necessary for employees to understand why Papy needs to change. 5. The establishment of “League tables” of carbon emissions by store should be introduced and linked to monthly awards for achievements. 6. Arif Karp should seek advice from his previous consultancy company, and appoint it if necessary, to advise him on other practical ways in which Kurt Lewin’s Change Management Model of “unfreeze, change and re-freeze” could be used to change organisational culture within Papy. 7. To introduce and communicate ways of measuring energy and waste management and getting employee involvement. 8. To invest in a new IT system to capture a range of non-financial data, such as an Environmental Management System (EMS). 6.2 – Balanced Scorecard 6.2.1 Recommendation The Board has already given its approval for this initiative. It should help Papy’s sustainability agenda because 4 of the 8 proposed performance measures are clearly linked to sustainability.

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However, as noted in paragraph 4.3 above, the crucial measure of “carbon emissions in kg per square metre” should replace the electricity usage measure in “Internal business processes”. Additionally, it is recommended that the internal business process measure concerning packaging is re-worded as shown below. These new performance measures should have a significant influence on employee performance related pay, but because of the current low morale of store employees, these measures should be fully discussed and explained to all employees. It is recommended that there should be some changes to the performance measures in the proposed Balanced Scorecard due to conflicts and the omission of the important target of carbon emission reductions. The new measures should be: 1. Financial – percentage growth in sales revenue per store (no change from proposed measure) 2. New measure: Financial – growth in operating profit margin excluding depreciation charges – as capital projects approved by Arif Karp’s team will increase depreciation charges which are outside the control of store managers 3. Customer focused – customer satisfaction survey including comfort in stores (no change from proposed measure) 4. Customer focused - number of customer shopping visits each year (using data from customer loyalty card information) - (no change from proposed measure) 5. Innovation and learning - training days specifically on sustainable trading issues (no change from proposed measure) 6. New measure: Innovation and learning – number of new carbon reduction programmes introduced by store employees 7. New measure: Internal business processes – Reduction in volume of packaging 8. Internal business processes – recommend removal of electricity usage and replace with: New measure: Internal business processes: carbon emissions - as measured by kg per square metre of sales area, for each store.

6.2.2 Justification Performance related pay (free shares) should be linked to the achievement of long-term objectives. As Papy realigns its objectives to become a more sustainable retailer, it is correct for the reward mechanism for free shares for employees to also change. Therefore the Balanced Scorecard is an appropriate tool for Papy to use. As the focus should be on Papy becoming a more sustainable retailer and reducing carbon emissions, then the performance measure of carbon emissions must be included within the Balanced Scorecard.

6.2.3 Actions to be taken Then it will be necessary to set targets for the new measures by store and for the Papy group. Arif Karp and his team should set up meetings with Simona Papy and representatives from both store managers and other store employees to discuss the implications for performance related pay based on the Balanced Scorecard.

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Actions: measure actual progress for each of the agreed measures to communicate progress to all store managers and other store employees to monitor progress and take appropriate corrective actions to try to exceed targets set to speed up Papy’s progress towards becoming more sustainable

6.3 - Proposal to re-build 12 supermarket stores 6.3.1 Recommendation It is recommended that these 12 old stores are temporarily closed and re-built. The new stores will generate higher levels of profit and substantially lower levels of carbon emissions. It is also recommended that myself, as Management Accountant, resolves my concerns over the underlying assumptions for forecast sales revenues and operating profit figures after the rebuilding of the 12 stores before the proposal goes to the Papy Board for approval. It is recommended that I refer this concern to Papy’s Finance Director.

6.3.2 Justification If Papy is to become a more sustainable retailer it must reduce its carbon emissions and these 12 stores generate very high levels of carbon emissions at 22.4 million kg per store. This is over 7 times greater than an average store with only 3 million kg of carbon emissions. The newly re-built stores are forecast to generate only 0.4 million kg which will generate good publicity for Papy and will demonstrate to key stakeholders that Papy is serious about reducing its carbon emissions. It will enable Papy to meet, or even exceed, Lucas Meyer’s target of 700 kg per square metre for 2013. The rationale for the referral of the financial aspects of this proposal to the Finance Director is because I have overheard a conversation concerning the accuracy of the financial aspects of the proposal. Irrespective of this referral concerning the financials, my recommendation is that the proposal should proceed as it will reduce Papy’s carbon emissions and allow Papy to meet Lucas Meyer’s target of 700 kg per square metre by 2013. Therefore, whilst I recommend that the proposal should proceed, it is subject to clarification of the financial data.

6.3.3 Actions to be taken The Papy Board should invite tenders from a number of construction companies, and prepare a short-list of companies for the Board to choose the contractor. It is further recommended that there should be local marketing initiatives undertaken explaining to the local community why Papy is causing short-term disruptions in these 12 supermarkets, emphasising the environmental benefits. It is recommended that the Human Resources department gives reassurance to all of the employees at these 12 stores and confirmation that they will continue to receive their salary and that their jobs are secure.

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Myself, as Management Accountant, need to resolve the questions concerning the forecast level of revenues and operating profit after re-building of these stores. 6.4 – Reduction in electricity usage 6.4.1 Recommendation It is recommended that Papy does invest in these projects at a total cost of €130.137 million as they will lead to a fall in operating costs (due to lower electricity usage) and also lead to substantial reductions in Papy’s carbon emissions across all of its stores. The forecast reduction in carbon emission is 97 million kg from this proposal.

6.4.2 Justification This proposal will help to contribute towards Papy reaching and even exceeding its target of 700 kg per square metre by 2013. This proposal will save a total of 97 million kg of carbon emissions, which is equal to a saving of 66.6 kg per square metre for 2013. The capital cost for this proposal, as expressed as the cost per 1 million kg of carbon emissions, is €1.34 million on average. This is almost 23% higher than the other proposal to re-build 12 stores, which is only €1.09 per 1 million kg of carbon emissions. The forecast small loss of operating profit of €(0.22) million for 2013 is due to forecast lower levels of revenues. Revenue forecasts needs to be monitored closely to see if this reduction can be reduced or eliminated.

6.4.3 Actions to be taken The Papy Board to approve this proposal. All store managers to be briefed on the range of proposals and the target savings in electricity usage by store. Actual usage should be measured against these targets after the measures have been taken. Contractors need to be selected and a timetable for the work on all 1,215 stores planned. Employees’ suggestions for other ways to reduce electricity usage should be gathered. Store managers to plan when and how work can be carried out to minimise the disruption to stores.

7.0 Conclusions Papy needs to change in order to achieve its plans to become a more sustainable retailer. Lucas Meyer has set a challenging target of 700 kg per square metre. This target could even be exceeded if both of the proposals to re-build 12 supermarket stores and undertake the proposals to reduce electricity usage were both to be agreed and implemented. The future for the Papy chain of supermarkets will be greatly enhanced if it is able to embrace and achieve its desire to become more sustainable. Its long-term future will be improved if the management team is able to bring about change throughout the company and to get employees involved in the achievement of the new targets. This is a long-term objective and changes in employees’ attitudes can take time to happen. The Papy brand will be greatly enhanced by the proposals outlined in this report.

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Appendix 1 SWOT analysis

Strengths Successful and profitable listed company New Chief Executive with determination to bring about change Environmental expertise and experience of Arif Karp Strong CSR objectives Good IT systems Increase in customer numbers Growing market share in its home country High operating profit margin compared to 2 of its competitors Reduction in long-term debt in last financial year Increase in cash balance over the last financial year

Opportunities To change to become a more sustainable retailer and reduce carbon emissions To achieve a target for carbon emissions of 700 kg per square metre for 2013 To re-build 12 supermarket stores to reduce carbon emissions To reduce carbon emissions through reduced electricity usage at all stores To engage all employees in a wide range of targets through the introduction of the Balanced Scorecard To create a new EMS IT system to capture and report on a wide range of nonfinancial data To develop Internet shopping and increase the number of non-food products and â&#x20AC;&#x153;own brandâ&#x20AC;? products To expand outside of Europe in the future

Weaknesses Employee resistance to change and difficulty in bringing about change Employee morale and scepticism about changing the focus from profit targets to reduction in carbon emissions Some employees are frustrated and are considering resigning Papy has the highest carbon emissions per square metre in comparison with 3 of its competitors Dependent on store managers to achieve targets set How to measure CSR targets Performance related targets are currently only financial targets Papy does not offer Internet shopping

Threats Poor employee commitment to sustainable trading focus Risk that capital expenditure may not achieve the planned savings in electricity costs or not achieving planned reduction in carbon emissions Loss of customers following the temporary closure of 12 stores whilst they are being re-built Losing key staff whilst Papy undergoes a period of change The effective management of change in the face of the highly competitive food retailing industry Possible employee opposition to performance related pay (free shares) linked to the Balanced Scorecard starting in January 2012 Long-term damage to Papy brand if reduction in carbon emissions is not achieved

Note: The above SWOT analysis is detailed for teaching purposes. However, in exam conditions a SWOT containing fewer bullet points, which cover the main issues from the case and the unseen material, is expected.

ÂŠ The Chartered Institute of Management Accountants 2012

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Appendix 2 PEST analysis Political/Legal Possible future fines or taxes based on levels of carbon emissions Pressure from different EU governments to reduce carbon emissions to meet EU targets Possible subsidies from EU governments for investment in low carbon technologies

Economic Pressure from competitors and the need to maintain market share Shareholders’ demands Will finance be available for the proposed investment opportunities due to bank lending restrictions? Shareholder reaction to investment in low carbon emissions stores (both the re-building of 12 supermarket stores and the reduction in electricity usage at all stores)

Social Customer reaction to Papy’s changes – will becoming a more sustainable retailer attract more customers? Customer reaction to the temporary closure of 12 supermarket stores whilst they are rebuilt Greater awareness of carbon emissions and the need for investment in low carbon technologies to meet EU carbon emission reduction targets Customer choice of products and store layout – changes in tastes and choices could affect Papy’s success in future Alternative ways to shop, such as Internet shopping, which Papy does not offer, could lead to a fall in its market share

Technological New low carbon technologies becoming available New ways to reduce electricity usage

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Appendix 3 Evaluation of the proposal to reduce electricity usage

Evaluation on operating profit for 2013 only: Forecast revenue reduction

Forecast reduction in Gross Margin*

Annual savings in electricity costs

Sub total before Depreciation

Depreciation charge (over 14 years)

Forecast effect on operating profit for 2013

€ million

Supermarkets

(4.81)

(1.92)

7.87

5.95

(6.46)

(0.51)

Small convenience stores

(0.74)

(0.30)

3.42

3.12

(2.83)

0.29

Total stores

(5.55)

(2.22)

11.29

9.07

9.29

(0.22)

*Note: Forecast reduction in Gross Margin is based on 40% of forecast revenue reduction as cost of good sold is 60%

Depreciation charges are calculated as follows: Supermarkets: 437 stores x €207,000 = €90.459 million / 14 years = €6.46 million per year Small stores: 778 stores x €51,000 = €39.678 million / 14 years = €2.83 million per year Total capital cost = €130.137 million

Payback period: The payback for this investment = capital expenditure of €130.137 / annual cash flows (sub total above before depreciation charge) of €9.07 = 14.3 years.

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Appendix 4 Evaluation of reductions in carbon emissions from the 2 proposals and comparison to target for 2013 Savings in carbon emissions from the proposal to reduce electricity usage: Average number of stores for 2013

Savings in carbon emissions per store

Total savings in carbon emissions

Kg per store For 2013

Kg million

Supermarkets

437

157,400

68.8

Small convenience stores

778

36,300

28.2

Total

97.0

Evaluation of reductions in carbon emissions from the 2 proposals

2013 is based on 1,457,000 square metres

Latest forecast Reduction from: Re-building of 12 supermarket stores* Reduction in Electricity usage

Updated forecast including the 2 proposals Lucas Meyerâ&#x20AC;&#x2122;s target

Exceeded target for 2013 by:

2013 Carbon emissions

kg million

kg per square metre of sales area

1,274

874.4

(264) (97)

(181.2) (66.6)

913

626.6

1,020

700.0

107

73.4

*Note: Reduction in carbon emissions from re-building 12 supermarket stores is 22.4 kg million less 0.4 kg million = 22.0 kg million x 12 stores = 264 kg million. This is equal to 181 kg per square metre. The reduction in carbon emissions that could be achieved by implementing these 2 proposals would result in a lower level of carbon emissions for Papy overall that the target of 700 kg per square metre. The carbon emissions would exceed target by 73.4 kg per square metre for 2013.

ÂŠ The Chartered Institute of Management Accountants 2012

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Appendix 5 Possible change in the number of supermarkets re-built Each supermarket that is re-built saves 22.0 kg million = 15.1 kg per square metre in 2013. If Papy were to only re-build 8 of the proposed 12 supermarkets then Papy can still achieve the target of 700 kg per square metre, as follows:

Updated forecast carbon emissions including the 2 proposals (as shown in Appendix 4)

Reduction of 4 supermarkets at 22.0 kg m each (i.e. To re-build only 8 supermarkets for 2013) Revised total carbon emissions

2013

Total Kg millions

Kg per square metre

913

626.6

60.4

1,001

687.0

2014 targets: The re-building of these 4 supermarkets could be deferred by 1 year. Irrespective of when they were to be re-built, they would help Papy to achieve the target of 630 kg per square metre for 2014.

ÂŠ The Chartered Institute of Management Accountants 2012

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Appendix 6 Comparison of capital expenditure of reducing carbon emissions for the 2 proposals

Savings in carbon emissions

Capital cost

Capital cost per 1 million kg of carbon emissions saved

Kg million

€ million

Re-build 12 supermarket stores - 12 stores

264.0

288.0

1.09

Reduction in electricity usage: Supermarket stores – 437 stores Small stores – 778 stores

68.8 28.2

90.459 39.678

1.31 1.41

Overall for reduction in electricity usage

97.0

130.137

1.34

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Appendix 7 Part (b) – Presentation and graph on the proposals to reduce carbon emissions The savings in carbon emissions from the re-building of 12 supermarket stores is 264.0 million kg. This is equivalent to 181 kg per square metre in 2013 The savings in carbon emissions from the proposals to reduce electricity usage is 97.0 million kg by 2013. This is equivalent to 67 kg per square metre in 2013 Together these 2 proposals could bring Papy’s carbon emissions down to 627 kg per square metre by 2013. This is 73 kg per square metre below the target of 700. Total investment required for both proposals is €418.1 million. It is recommended that both proposals are accepted, assuming the funding can be secured, so that Papy can reduce its carbon emissions down to 627 kg per square metre and beat its target for 2013.

Carbon emissions (kg) per square metre of sales area

Carbon emissions (kg) per square metre of sales area 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100 0

1,077

1,042

1,022 948

627

2009

2010

2011

2012

2013

End of answer

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