CASE 6 RQL LIMITED: BUDGETING AND COST CONTROL SYSTEMS

Structure 6.0 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 Objectives Introduction Company Background Domestic Competition Budgetary Process at RQL Marketing Costs Sales and Distribution Costs Developmental Costs Cost Control Exercise at RQL Market Scenario Issues before the Company Discussion Questions

6.0
a) b)

OBJECTIVES
Appreciate the dilemmas and difficulties in sales budgeting and cost control Get and exposure to planning a sales budget and cost control system.

After going through the case, the students will be able to :

Inherently, there is no best or correct answer to a case.

6.1

INTRODUCTION

The case on RQL Ltd. is a disguised case on `Budgetary and Cost Control'. Mr. Dhanpat the CFO of RQL is brooding over the ways and means of reducing and controlling expenses of the company. The company which till last year was increasing the Budgetary allocation for marketing costs by an average of 15% per year, now wants to freeze the allocation for this year at the last year's level, hence the headache for CFO. The names of some of the organizations and the data has been altered for purposes of confidentiality. Students may like to read units 15 and 16 for conceptual clarity, before attempting this case.

6.1

COMPANY BACKGROUND

RQL came into being in 1961, when its founder Mr. Suresh Sharma, at that time a non-resident Indian working in England, nursed a vision. A vision to pioneer the manufacture of superior quality electronic products in the country. The vision became a reality with the setting up of a factory for the manufacture of Black & White televisions in an industrially obscure place, Palghat, in Kerala. Thus a tradition of firsts emerged, along with a commitment of quality. Today, with over 35 years of experience, RQL has solidly established its position in the Consumer Electronics Industry. Its spectacular growth is reflected in its modem and comprehensive manufacturing infrastructure that harnesses the power of superior technology to mass-produce quality products. Today Company is divided into three divisions 1. Color Televisions 2. Home Appliances 3. Refrigeration
Case prepared by Dr. Harish Chaudhry, Associate Professor, School of Management, 1IT, Delhi.,

47

Rs.1300 cr. CTV division deals in different models of CTV's. Rs.200 cr. Home Appliances division deals in washing machines and Rs.290 cr. Refrigeration division in refrigerators. The company manufactures 16 models of CTV's; 5 models of washing machines and 6 models of Refrigerators (Details of models are given in Exhibit - 1). Over the years such a large range has been necessitated by the ever-increasing competition and to cater to the specific needs of different consumer segments.

63

DOMESTIC COMPETITION

The market for both consumer electronics and white goods has become crowded in the past two years with the launch of several transnational brands such as Samsung, Akahi, Thomson, LG, Panasonic, Whirlpool, GE and Electrolux, Added to this is the competition from home players like Videocon and Onida, In such a scenario RQL will have to match the financial strengths and marketing clout of it's domestic and transnational counterparts. Moreover RQL has to cut costs as its net profit margins are being hammered. For instance, RQL's

net margins dropped from 7.33% in 1994-95 to 3.72% in 1996-97 for its color TVs' division (see exhibit 2 for l last year performance). EXHIBIT NO.2 RQL'S 1996-97 PERFORMANCE (Rupees Crores) Total Income Net Profits Reserves & Surplus Debt NET MARGIN Ctv Division 1290.60. 48.46 271.34 380.09 3.72% Home Appliances 198.21 6.21 25.19 75.81 3.13 % Refrigerator Divn. 288.82 5.18 89.43 121.1 1.79%

Not surprisingly, RQL spent whole of 1996-97 trying to slash its costs. For starter RQL introduces the Japanese management technique kanban, which enables a company to control inventory levels. Despite such cost cutting exercises, RQL has found it extremely tough to improve its profitability levels: as exemplified by its falling net margins. Now another area, which the company is looking at with hope, is the reduction in the costs of its marketing set up. The company thus is trying to tighten the screws on the budgetary process and wants to strictly control the expenses.

6.4

BUDGETARY PROCESS AT RQL

RQL works on profit-center basis whereby every division, every region and every branch is a profit center for the company and has to justify its existence in terms of expenses and earnings. RQL has divided the whole country into four regions. It has 20 branches across the country and nearly 3000 dealers. (exhibit - 3 gives list of branches) EXHIBIT NO.3 RQL'S Distribution Set-up REGION Eastern Region (Calcutta.) Western Region (Mumbai) Northern Region (Delhi) Southern Region (Bangalore) CORRESPONDING BRANCHES TOTAL NO OF DEALERS Calcutta, Patna, Bhubhaneswar, Guwahati 461 992 857 685

Mumbai, Pune, Ahmedabad, Nagpur, Panaji, Indore Delhi, Chandigarh, Jaipur, Kamal, Lucknow, Ghaziabad Chennai, Cochin, Hyderabad, Bangalore

The distribution channel, being used by the company typically involves : factory, Central marketing organization (CMO), regional warehouse, distributors, dealer and customer - in the following order. Factory -* Central Marketing Organization (C.M.O) -a Regional Office -3 Distributor -4 Dealer -a Customer The distribution channels of most of RQL's competitors are slightly different. The distribution channels typically used by them are shown in Exhibit 4. Most of the RQL's competitors use one of these channels or a combination of them.

49

Since RQL operates on a profit center basis, therefore, each entity in its distribution channel passes the material onto the next element of the channel, for a price after keeping some margin for itself. These transfer prices for all the products are enumerated in Exhibit 5. EXHIBIT NO.5 STOCK TRANSFER PRICES Amount in Rupees Products COLOUR TVs 14" 20" 21" 25" 29" MASHING_ MACHINE (ALL MODELS) REFRIGERATORS 3504/3503 3102 2503/2502 1852 Cost to CMO Cost to Regional Office 8450 12500 15517 19500 21815 6500 8765 13290 16140 20075 24215 7150 Cost to Distributor Cost to Dealers Selling Price

9230 13886 16787 21090 26112 7300

9670 14215 17315 22712 27897 7570

10125 14798 18077 24224 30989 8100

31200 21716 16987 13987

33720 23215 18795 15053

35215 24846 20053 15917

34914 26117 21817 16817

3697027825 23678 17985

Now the budgeting at RQL starts with preparation of budget proposals in all the branches and regions. These proposals enumerate the branch-wise/region-wise sales targets, expenditures and expected profits

The budget proposals are then sent to the head office, which is entrusted with the task of preparing overall budget Thereafter begins the budgeting exercise at the head office, which starts with fixing the sales targets (in numbers) for all the branches, for the next financial year. These targets may or may not be the same as projected by the regions, in their budget proposals. This is followed by determining stock transfer prices among various constituents of the distribution channel. Thus the company arrives at the budgeted total contribution margins which would be earned by both CMO and the regions. For example if the company's target for 29" LTV's is 2 lacs sets and contribution from each set is Rs.2,400 for the CMQ. Then, the budgeted contribution for CMO from the model would be Rs.48 Cr. Similarly total contribution would be calculated after finding budgeted contribution from each model of CTVs, Washing machines and Refrigerators. Likewise budgeted contributions for regions are calculated. The budgeting exercise then is divided into two parts: 1). CMO: Wherein corporate level budgeting for expenses is done 2). Regions: Wherein budgeting for regional expenses is done. This way the budgets for CMO & regions are prepared at the corporate office. These budgets provide for fixed as well as variable costs, which can be incurred by the CMO and regions. The constituents of fixed costs are the normal establishment costs, maintenance, salaries of permanent staff etc. and the prime variable costs are 1). marketing costs 2). sales and distribution 3). developmental costs

6.5

MARKETING COSTS

These costs are incurred at two levels at RQL i.e. corporate and regional levels. At the corporate level, it is primarily the corporate training, renovation and advertising costs. The advertisements are placed across the nation on a variety of media (TV, Print., Hoardings etc.). Some other costs incurred by the C.M.O. are on account of rebates, which are given to the regional offices for promotional purposes. At the regional level these costs are incurred on account of local advertising, local promotional schemes, gifts and giveaways etc.. These costs are incurred entirely at the discretion of regional marketing heads but within the budgets given by the corporate d1fice. Further, the branches have their own marketing costs which might be used for advertising in vernacular press and other promotional schemes.

6.6

SALES AND DISTRIBUTION COSTS

The costs incurred in this category are primarily trade discounts, transportation, insurance and merchandising etc.

6.7

DEVELOPMENTAL COSTS

The costs under this head are generally costs towards marketing research, manpower training and newmarkets' development. Other costs incurred by regional offices4re service expenses and travelling expenses of the staff. In order to keep track of the expenses, RQL has implemented a control mechanism so that actual expenditure does not go haywire vis-a-vis budgeted provisions.

6.8

COST CONTROL EXERCISE AT RQL:.

RQL has put in place a control mechanism to monitor its costs. As per this system the yearly budgets are broken down to month-wise budgets. And every branch is required to send to the regional office, the reports on monthly basis Where in the actual expenses are compared to, the budgeted provisions (format of the report is shown in exhibit - 6). The regional office in turn sends the collated results to the head office.

51

In the whole process, the erring branches or regions are questioned in case of excessive costs are incurred or if targets are not achieved or any other type of variance is noticed. The company believes that this control system keeps the marketing team on its toes, which the company feels is necessary to check the rising competition in the market place. The company now plans to tighten its cost control system further, because the company believes that key to the survival in the competitive environment is reduced cost and increased sales-volumes. Although the sales of the company are increasing but it is showing downward slide on profitability and market share fronts. Therefore the company has started feeling the heat of the competition.

6.9

THE MARKET SCENARIO

Competition is here to stay, The consumer durable industry is under severe attack from multinational competition and it is likely that things will get only worse in the coming years. Using their. deep pockets and strong marketing muscle, new multinational entrants into the market like Akai, Sony, Samsung, Daewoo & LG etc. have increased their share of color TV market to about 26% in the last two years. Situation for RQL is no better in case of the washing machines and refrigerators markets. In refrigerators market all the big names of the industry are here: Godrej, Electrolux, Whirlpool, LG, Samsung, etc. in addition to competing with these giants, RQL has further limited its market by choosing to be only in the frost free segment. The total demand for Refrigerators is 1.8 mm per annum of which around 6% constitutes the frost free refrigerators' demand. In the washing machines' market, the main players are Godrej, Whirlpool, Videocon, RQL, LG, Onida and Voltas. Here RQL has products in the semi-automatic segment. Total annual demand for washing machines is 0.75 mn of which 95% constitutes the semi-automatic machines demand. Despite all this RQL has been able to increase its ales primarily because the demand for consumer durables is increasing at about 20% per annum and RQL is still a strong brand in almost all the products it has launched. This can be seen from the fact that RQL is number one in CTV market with 24% market share. It has 45% of market share in the frost-free refrigerators and it has 15% share in the semiautomatic washing machines market. But this is not the time for RQL to be complacent as the multinationals are eating into market shares of all the Indian players including RQL. Under the onslaught of the multinationals, profit margins of all the Indian companies including RQL are on the decline on account of the extra effort each has had to put in for marketing, while not raising prices. In case of RQL'S CTV division the profit came down to 3.72% in 1996-97 from 7.33% in 1994-95. This year is expected

to be worse keeping in view the fact that in order to counter competition from foreign brands in the domestic market, the company has been incurring higher selling expenses in the form of dealer discounts and advertising leading to drop in margin. This trend if not arrested will lead to the end of a leader, hence the emphasis cost cutting in the company.

6.10 ISSUES BEFORE THE COMPANY

Although RQL has a strict expenditure control system but the company is unable to understand from its control exercise, whether or not the system is getting the required results in terms of market share, brand image, availability of the material in the market, visibility of its products in the market etc. The company is also unable to figure out whether the budgeted costs are doing justice to all the regions and the brands it has in its stable. Mr. Dhanpat, who is now preparing the budget for the year 1997-98, wants his budget to be fair to all quarters. The issues he has to address are : a) b) c) d) Freeing the marketing expenses at the last year's level while increasing the sales by at least 15% in each region. Properly distributing the expenditure budget among the four regions and products. Best possible distribution of costs under various heads viz. marketing costs, sales and distribution costs, developmental costs, etc. The helping tools that Mr. Dhanpat has at his disposal are : 1). Last year's budget (exhibit - 7) 2). Last year's actual performance - figures (exhibit - 8) 3). Budget proposals of the four regions (exhibit - 9) for next year.

53

EXHIBIT NO 9 Budget proposals for the year 1996-97 Particulars I . Sales g)CTVs h) Washing machines I) Refrigerators Total Sales Transfer Price Contribution Marketing Expenses Sales & Distribution Developmental costs Other Costs Fixed Costs Net Contribution Eastern Region 28800 3250 2400 34450 23395 11055 2350 1895 595 1470 2150 2595 Western Region 41000 7200 14100 62300 43475 18825 4650 3290 1800 2100 3750 3235 Northern Region 37600 6050 9550 53200 36470 16730 4150 2950 950 1800 3310 3570 Southern Region 34100 5000 5500 4460 31150 13450 3140 2450 550 1560 2820 2930 CMO

105450. 17100 18950 141500 113720 27780 7370 4475 3665 4150 6977 1143

6.11 DISCUSSION QUESTIONS

1. How can Mr. Dhanpat design a better budgeting and cost control system that would: i) ii) iii) 2. Enable RQL to tap market opportunities at the optimal cost. Empower the marketing and sales teams to function effectively. Provide timely and adequate information to the top management on the budget and cost studies on a regular basis.

How should such a system be monitored?