Axeon NV – group assignment Group B1 Ami Albihn Huijie Li Jiaoru Qian Patchara Thaisrivichai Wenli Ye

Question 1: What do you feel about the initial analysis Question 1: What do you feel about the initial analysis? Was there, in your opinion, anything wrong with it? Seems reasonable: Clear proposal - easy to see how the project will be profitable Actually not reasonable: The sales part is over-optimistic Analysis for sales based on confidence rather than evaluation The profitability view came only from the Hollandsworth perspective On one hand, the initial analysis of the proposal is reasonable, because they had clear report on manufacture proposal and operating cash flows estimation. It is visible for us to how this project was profitable and how they planned to conduct and manage it.   But on the other hand, it is over-optimistic at the sales part. As Ian presented at a Hollandsworth board meeting, their analysis for sales was based on their confidence rather than evaluation. They didn’t justify why they could enter the market initially with a selling price of 4,000 pounds and how they could ensure to achieve their target sales. When Ian planned the proposal, the more he thought was his little company, not the whole company. So he always delivered positive aspects to board members, and he didn’t think about that it might be more worthwhile to produce AR-42 in Netherland.

Question 2: Is construction of the new factory in the UK in the best interest of Axeon? No. It is a better choice to keep the production in the Netherlands, because: Saved fixed cost In the Netherlands (production of 1000 tons will save £240/ton) Not building a new factory in the UK Increase of variable cost due to shipment to the UK can be compensated by a decrease overall production cost (£60 × 400 tons = £40 × 600 tons) The cost for building the new factory in the UK exceeds the cost for changing the production in the Netherlands If the better quality AR-42 is only produced in the UK, it might create conflicts in the the future Axeon isn’t interested in constructing the new factory in UK, because the statements by two managers prove that it is not worthy to build a new factory in UK.   Marc Oosterling’s (director of manufacturing) opinion is that producing AR-42 in the Netherlands will be less overhead cost. With extra 400 tons production, the fixed cost per ton will be decreased and there is a large amount of savings. In addition, they can neglect the increase of variable costs (because of shipping fee and import duty) in UK market, since it can be compensated by the decrease of their average variable costs in domestic market. So even if compared with Ian’s optimistic estimation, constructing a new factory in UK will cost more than buying AR-42 from Netherlands. Moreover, the working capital estimation made by Arnold Koonts (vice president finance) shows that working capital required for manufacture of AR-42 in the Netherlands for sale in the UK is £30,000 less than manufacture and sale of AR-42 in England after three years. So the cost for building the new factory in the UK exceeds the cost for changing the production in the Netherlands. Furthermore, the production of a better quality AR-42 in the UK might create conflicts in the future. Problems in managing the subsidiaries in terms of its autonomy and profits.

Question 3: Why did Mr van Leuven behave as he did? Approved at first: The proposal itself is profitable Hold another meeting: Problems with the proposal: too optimistic of sales producing complication Not express opinion: let managers express their own idea without influence need more time for reflection and evaluation Say different to other managers and Ian: Other managers: let them consider Axeon.N.V as a whole company Ian: let him feel that the result won’t only be influenced by Axeon Dutch The proposal itself is profitable and good without considering the Axeon N.V. as a whole body, so he approved to the proposal quickly at the first meeting. But when consider deeper and discuss with other managers, so he take another meeting with other managers and Ian, they found that maybe: -the proposal is too optimistic of the sales in UK -AR-42 production is complicated, and the UK staff is inexperienced to do this; During the meeting Mr. Leuven did not express his own opinion, but just listen and ask questions, because he didn’t what to intervene at this early stage when things is not very clear and there are dispute among managers, this is helpful for managers to express their own ideas without influence top-management influence. And he gave no decision after the meeting to have some more time for reflection and reevaluation. After received letters from Mr. Noble, Mr. Leuven asked the other four managers to reevaluate the situation and give report, he also told them that this project is important for the company’s profit as well as decentralization structure and morale in order to make sure the managers consider the Axeon N.V. as a whole instead of making money only for Axeon Dutch. He told Ian that various members of the division and corporate headquarters are studying the proposal (but not the truth that only the VP financial and managers from Axeon Dutch are conducting the studies) in order to let Ian feel that the result will be more fair because it is not influenced solely by the Axeon Dutch, even though the proposal made by Ian considered only the profit of his own company.

Question 4: Discuss what transfer price should be established if AR-42 is supplied from the Netherlands to the UK? According to financial situation, three methods can be applied: Quasi market-based transfer price Negotiated transfer price Full cost plus markup transfer price the transfer price should between £2560/ton—£3346/ton Take the company’s current situation into consideration: Negotiated transfer price is not suitable Quasi market-based and full cost plus markup transfer price can both be used My recommendation: choose the full-cost-plus markup transfer price giving the Hollandsworth relatively more markup than the Axeon Dutch According to the financial situation without concerning about the other aspect of Axeon, three methods can be applied here properly, they are -quasi market-based transfer price -negotiated transfer price -full cost plus markup transfer price Let’s analyze the situation financially first: Here I assume that the promotion cost in UK is £364/ton (Exhibit 3, 910000/2500=364) the sales price is £3700/ton (Exhibit 3) For Axeon Dutch (A.D.), Variable cost per ton 2060 (Exhibit 6) Fixed cost per ton 360 (page 115, notation 2) Full-cost per ton 2420 (without promotion cost) -If it sells AR-42 to UK directly, it will cost 2420+364=£2784/ton If sell at 3700, the profit is 3700-2784=£926/ton -If it sells through Hollandsworth, it can save 364/ton for promotion If it still want to earn 926/ton, they will quote at 2420+926=3346/ton, which means that H. has profit of 3700-3346-364=0 So Axeon Dutch can ask for no more than £3346/ton For Hollandsworth, Variable cost per ton 2000 (Exhibit 3) Fixed cost per ton 560 (Exhibit 3, 1400000/2500=560) Full-cost per ton 2560 (without promotion cost) -If it sells AR-42 in UK by itself, it will cost 2560+364=£2924/ton If sell at 3700, the profit is 3700-2924=£776/ton -If it buy AR-42 from Axeon Dutch, it can save 2560/ton for full producing cost If it still want to earn 776/ton, they will quote at 3700-364-776=2560/ton, which means that A.D. has profit of 2560-2420=140/ton So Hollandsworth should ask for no less than £2560/ton (Hollandsworth has the same profit as it produces by itself if it buy AR-42 form Axeon Dutch at 2560/ton, while the A.D. still has profit of 140/ton, it can ask as low as 2420/ton with profit of 916/ton, but if so, the A.D. will ask H. to produce by itself with 776/ton) As can be seen from above, the transfer price should between £2560/ton—£3346/ton Let’s take the company’s current situation into consideration now. Negotiated transfer price is not suitable in this case. This method is effective if both profit centers have some bargaining power, which means that the Axeon Dutch has some possibilities to sell AR-42 outside the company and the Hollandsworth has some outside supply of AR-42. However, since H. is one of Axeon’s subsidiaries, it can not find outside supplier, so the bargaining power is unequal between these two subsidiaries. In addition, negotiated transfer pricing often accentuates conflicts between profit center managers, which means that in this case, this method may totally ruin the not-so-god relationships between Ian and the Axeon Dutch managers. And since Axeon emphasize high degree of decentralization, so top-management intervention is not recommended to be used here when conflicts arise. Quasi market-based transfer price and full cost plus markup transfer price can both be used here. Both of them can provide proper economic signals for decision-making and useful information for evaluation. And the prices determined by these two methods are approximate. The only difference is the markup is internally set, such transfer prices are not responsive to changes in market conditions. We know that usually for products produced in the Netherlands, the Axeon Dutch sales organization would quote the subsidiaries the same prices as they quoted agents in all countries, the subsidiaries can bargain and decide whether they will sell the products; at the same time, the subsidiaries can also build their own manufacturing plants if they could justify the investment in their own markets. But in this case, the overall interest of the Axeon is taken into account, not the single subsidiary’s interest, which means there is a control of all the subsidiaries. And according to the estimate of Hollandsworth, the sales of AR-42 will be quite stable. So I recommend to choose the full-cost-plus markup transfer price in which the markup is negotiated, but determined by the top manager. I also recommend giving the Hollandsworth relatively more markup than the Axeon Dutch as a compensation of not building a new factory in UK and giving the new producing methods to Axeon Dutch.

Question 5: What is Axeon’s corporate strategy? Corporate strategy = diversification strategy ( related or un-related) capturing inter-divisional synergies identifying and managing strategic uncertainty Axeon uses Related-diversification: Focus on their core business strategy: industrial chemicals Diversify in order to exploit economies of scope The company has a relatively elaborate planning and budgeting system Uses an incentive compensation system Transfer pricing problems, require considerable communication Corporate strategy, also called diversification strategy, mainly concerns how to create and capture more value in a diversified organization, and it consists of two parts: [i] capturing inter-divisional synergies--which is the extent of current thinking; and [ii] how the organization identifies and manages strategic uncertainty. （1）   Axeon uses Related-diversification: Focus on their core business strategy: industrial chemicals Diversify in order to exploit economies of scope The company has a relatively elaborate planning and budgeting system Uses an incentive compensation system Spend considerable resources addressing transfer pricing problems, require considerable communication economies of scope: An economic theory stating that the average total cost of production decreases as a result of increasing the number of different goods produced. (1) What is corporate strategy, really? , Raynor, Michael E., Ivey Business Journal Online • Nov-Dec, 2007 •

Question 6: What do you believe to be the CSFs in Axeon? Objective Candidate critical success factors Maintain a large supply of industrial chemicals (quantity) Efficiency Setting up more factories in subsidiary locations when it is considered profitable Improve the quality of their products when possible Appoint highly skilled people into the organization Encourage proposals of incremental innovations Achieve organizational synergy Standardized planning and budgeting procedures Suitable transfer price setting between subsidiaries Flexibility A high degree of decentralization Maximize sales Provide incentive compensation systems Take advantage of the geographical expertise of foreign subsidiaries In order to identify the Critical Success Factors (CSFs) in Axeon, we need to have a good understanding of what is a CSF. The definition as described in mindtools.com (1) states: The areas of your business or project that are absolutely essential to it success. By identifying these CSFs, and clearly stating them to the whole organization, you can help ensure that your business or project is well-focused and avoid wasting effort and resources on less important areas. This will keep the business and project on track towards common aims and goals. Ideally, there should be no more than five critical success factors. In the 1970s, John F. Rockart (MIT) defined CSFs as: "The limited number of areas in which results, if they are satisfactory, will ensure successful competitive performance for the organization. They are the few key areas where things must go right for the business to flourish. If results in these areas are not adequate, the organization's efforts for the period will be less than desired.“ The mission and objectives of the company will show us which areas of the business should be in focus and from that we can identify possible CSFs. We have therefore listed the objectives and possible CSFs in a chart, where the CSFs we consider to be critical highlighted in red. (1): http://www.mindtools.com/pages/article/newLDR_80.htm

Question 7: What do you believe to be the KRAs in Axeon? Because the company is dependent on its production and sales, the key recurring activities are: Purchasing the raw materials and manufacturing Marketing and sales Axeon NV is dependent on its production and sales. Therefore, the key recurring activities are: purchasing of raw materials for chemical production and manufacturing Marketing and sales We believe that the purchasing of raw materials is a key recurring activity since these materials are absolutely necessary in order to produce anything in the factories. Manufacturing is of course a key recurring activity since it is the prerequisite to have anything to sell. Sales is perhaps the most crucial key recurring activity for Axeon NV since it is through the sales that the company gets its revenues for investment in further production, expansion of the product line, appointment of skilled personnel, quality improvements, etc, etc, etc. Marketing is perhaps not a key recurring activity in the same sense as the others, but it is necessary in order to increase the company’s sales and as far as we could see, Axeon and its subsidiaries do not hire any other company for this purpose, therefore we have included it in our reasoning.

- Disadvantages: manufacturing division Question 8: discussion Axeon in terms of its centralization/decentralization? High Degree of decentralization (results control) e.g. incentives - Advantages: To attract right personnel Geographical and cultural reasons: less cost - Disadvantages: manufacturing division Internal competition of products Difficult to control subsidiaries, disputes Axeon had been using a high degree of decentralization as a result control by providing incentives (price system) and flexibility to its sub-managers to be able to make own decision of sales in its territory and relatively high degree of autonomy in its manufacturing division. Advantages of decentralization in Axeon are firstly, a motivational factor to attract potential personnel. Mr. Ian W. decided to join Hollandsworth mainly because Axeon would allow him the freedom to manage this subsidiary on his own. Consequently by giving the subsidiary managers freedom to maximize the subsidiary’s profits (rewarding them as a function of those profits i.e. bonuses), the local managers induced to make use of their specialized knowledge for the benefit of their subsidiary, and therefore for the firm. (Hollandsworth’s sales increase to 160 million pounds). Secondly, geographic and cultural distance between the subsidiaries and HQ are cheaper with the cost of establishing Decentralization (local expertise) rather than Centralization control. However, when comes to decentralization as a control in manufacturing division, problem had been shown that sometimes the foreign subsidiaries produced products that competed with those produced by Axeon factories from HQ and no solution had been given until a new dispute occur regarding the extent of the autonomy that the subsidiaries should have. Is decentralization desirable in this case? The down side of decentralization tends to involved only in manufacturing part of the firm. In this case, should Mr. Van consider more centralization as a result control in this part of division to solve any disputes which might occur in the future? As you can see that when HQ gives too much autonomy to its subsidiaries without establishing a clear company’s direction from the beginning, decentralization method of control can lead to chaos to the company. In addition, Hollandsworth’s management teams are so used to a high degree of Decentralization, any adjustment to it then leads to a high dissatisfaction and even the resignation of the valuable personnel. In this case, Hollandsworth’s proposal from Mr. Ian does not align with the overall goals of the firm, Axeon’s overall benefits (uneconomical to manufacture). Therefore, when the price system fails to act as efficient guides to Hollandsworth’s behavior, maybe it is more efficient to replace the Decentralized system with a Centralized one (Hierarchy). In this case of manufacturing division, the subsidiaries can collect limited type of information (product development) and to transfer the information to Headquarter to analyze the information, make decisions and send directions for execution. However, this perhaps should not be applied to sales function because once the subsidiary managers see their autonomy decline, especially when it comes to motivating of personal profits e.g. bonus and salary. This can decrease their incentive to work hard and show initiative to maximize their sales responsibility.

Question 9: What should Mr. van Leuven do? Solve the problem private communication, explain in detail offer to buy their patent transfer price should be reasonable Prevent similar problems in the future Action control: scrutinized expenditure approvals Cultural control: Codes of conduct Results control: Create a good balance between Decentralization (sales) and centralization (manufacturing) Solve the dispute: For the greater profit of the whole company, Mr. Van Leuven should try to persuade Ian to give up the proposal of building a new plant in UK, instead, sell the patent to headquarter and improve the quality and quantity of AR-42 production in Netherland, then AR-42 can be shipped to UK and Ian can sell it in the UK market. However, this should be handled very carefully or it will probably stimulate conflicts between UK subsidiary and Axeon headquarter.Three elements should be considered: (1)private communication, explain in detail. (2) offer to buy their patent. (3) transfer price should be reasonable. Prevent: proactive, rather than reactive. (1) Action control: scrutinized expenditure approvals (2) Cultural control: Codes of conduct (3) Results control: Create a good balance between Decentralization (sales) and centralization (manufacturing).