Chicory operates a chain of depots in Deeland, supplying and fitting tyres and other vehicle parts to lorries, buses and agricultural vehicles. Chicory’s objective is to maximise shareholder wealth. Due to a slowdown in the Deeland economy, Chicory’s recent performance has been weak. An unsuccessful acquisition has also caused cash flow problems and a write-off of goodwill of $24·7m in the year to 30 June 2017.

The board has commissioned a benchmarking exercise to help improve Chicory’s performance. This exercise will involve comparison of a range of financial and other operational performance indicators against Fennel, a similar business in Veeland. Fennel has agreed to share some recently available performance data with Chicory as they operate in different countries. The reason Fennel was chosen as a benchmark is that as well as supplying and fitting tyres and parts to heavy vehicles, a large part of Fennel’s business involves supplying electricity to charging points to recharge electric cars. Fennel installs and operates the charging points in public places, and users pay Fennel for the electricity they use. The board of Chicory intends to follow a similar business model as the use of electric cars is increasing in Deeland.

The Veeland economy is growing strongly. Electric car use there has increased rapidly in the last two years, encouraged by tax incentives for businesses, like Fennel, to install and operate charging points. The Veeland government has also underwritten loans taken out by businesses to finance this technology, which has enabled Fennel to borrow funds for the significant capital investment required. The cost of components used in the charging points is falling rapidly. Capitalisation of development costs related to this technology is permitted in Veeland, but not in Deeland. In 2015, Fennel invested heavily in IT systems which significantly improved performance by increasing the availability of parts in its depots, and reducing inventories.

Chicory uses return on average capital employed (ROCE) as its main financial performance indicator, and this is to be benchmarked against Fennel. One board member suggested that, though it may have some disadvantages, EBITDA (earnings before interest, tax, depreciation and amortisation) could have advantages as a performance measure over the existing measure, and should also be included in the benchmarking exercise.

You have been given the most recently available financial data for both businesses in Appendix 1, with the data for Fennel being converted into $ from its home currency.

Required:

(b) Advise Chicory on the problems of using the benchmarking exercise with Fennel as a way to improve performance. (9 marks)

Appendix 1

Benchmark data ($)

Extract from statement of financial position

Income statement

Notes
Note 1:  $6m of new capital was introduced into Fennel on 31 March 2015. Normally, new net investment is spread evenly over the year.
Note 2:  Operating profit is after charging depreciation of non-current assets of $18m in Chicory, and $25m in Fennel.