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Management - Kings SAS Pty Ltd - Brock Technologies Case Study - Reflective Writing Assessment Answer

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Management Assessment Answer

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Kings SAS Pty Ltd - Brock Technologies Case Study -

KINGS SAS PTY LTD ABSTACT - Kings SAS Pty Ltd has a long-established and mutually beneficial business relationship with a major international automotive parts company, Brock Technologies.  Management at Brock has approached Kings with a request to provide additional routes that are important to the efficiency of its supply chain. Kings’ management wishes to nurture the business relationship with Brock but is concerned about the available capacity to service the new routes, potential risks, and profitability associated with Brock’s request. INTRODUCTION Alan James founded Kings SAS Pty Ltd in 1978 and has grown the business into a sizeable operation with 90 trucks and 180 trailers.  His largest customer, Brock Technologies, has submitted a proposal to him to add delivery routes that would improve the efficiency of  Brock’s supply chain.  Alan was not certain that Kings could handle the additional routes since the company currently was operating at (or near) full capacity. Brock offered a total of $2.15 per kilometre (including fuel service charge and miscellaneous fees) for the new route.  But Alan knew that to accept the offer he would have to add more trucks and perhaps incur additional debt. The question was whether the rates offered by Brock were high enough to offset the associated risks of growing the fleet.  Although the business had been growing organically through the years by reinvesting profits, it incurred debt from time to time to replace older equipment (usually in blocks of five trucks). Alan knew the slim profit margins associated with trucking, coupled with a downturn in the economy, could spell disaster if saddled with too much debt.  See Exhibits 1 and 2 for the company’s most recent statement of income from operations and the balance sheet, respectively. Roger Simmons, Kings’ operations manager for the past 16 years, had been reviewing the Brock proposal and approached Alan.  “Alan, we need to discuss this offer from Brock. I think it is a great opportunity for our company, and we need to find a way to make it work.”  Within 10 minutes Alan and Roger were in a closed-door meeting discussing the pros and cons of Brock’s offer. Roger began by stating the obvious: “Alan, this is a huge opportunity for us to grow the business.  Not to mention, as Brock becomes more dependent on our services, we will be in a stronger position to negotiate future rate increases. I know you are opposed to debt, and I understand the risks of carrying more debt, but there is more than one way to grow our fleet.  If you would consider using independent contract drivers, we could grow the fleet enough to accept Brock’s offer without incurring more debt.” Alan cringed at the thought of using independent contract drivers.  Although independent contractors owned their own trucks, Alan viewed them as difficult to deal with and not worth the headache.  “Roger, I hear you, but this new route will not last a week if we cannot give Brock great service. Independent contractors call the shots, not us.  They own the rig and will sit at home if they want to. I would rather deal with our own company’s rigs and drivers. The rewards just do not justify the risks of damaging our relationship with Brock. “But I am not sure we should take on any more debt at this point to purchase additional rigs.  The economy is in the tank, and it is a bad time for us to leverage the balance sheet any further.  Roger, my success in this business was not built by jumping on every offer that came along. Sometimes you have to say no, even to your biggest customer.  Unless you can find a way to squeeze out more capacity within our current fleet, I just do not think we can accept Brock’s offer at this time,” Alan concluded. As the two men left the room, Roger was convinced that Alan was wrong.  Roger knew that Alan was leaving money on the table. He just needed to prepare a financial analysis that would prove it.  Was it possible to squeeze out more capacity from an already fully utilized fleet? Perhaps they could shift trucks from another account.  Was taking on more debt truly “risky” given the profit potential of this new route? Roger knew he had to make a convincing argument before Brock took its offer to another truck line. INDUSTRY TERMS
  • A tractor-trailer rig is a truck that consists of a tractor attached to a trailer.  The tractor typically is powered by a diesel engine.
  • A flatbed trailer is long flat platform with no sides.
  • A dry van trailer is a boxed cargo compartment designed for non-refrigerated freight.
  • Trucking companies often have a revenue-generating load in one direction but need a revenue-generating contract for the return trip.  The return trip is known as a backhaul. Often trucking companies contract with freight brokers to acquire backhauls.
INDUSTRY BACKGROUND AND COST STRUCTURE Trucking firms generate a variety of revenue types from hauling goods for their clients.  Presented next is a brief overview of key types of revenues included in the 2018 income from operations of Kings SAS Pty Ltd. Linehaul revenue is earned from hauling freight. Fuel prices in recent years have been volatile.  Because trucking companies are exposed to fuel price volatility when they sign a long-term contract with their customers, they may charge an additional fee associated with fuel costs when prices exceed predetermined levels.  Thus, the primary purpose of the fuel surcharge (FSC) revenue is to protect the truck line from fuel price increases during the contract term. Included in miscellaneous revenue are the following: Storage fees are collected when Kings stores a loaded trailer on its lot for a customer. Lumper revenue is collected if a driver assists with unloading a trailer. Certain flatbed loads, such as gyprock, unpainted steel, and some types of wood products, that would be damaged by rain must be covered.  Trucking companies typically charge a tapping fee for such loads. Additional insurance is required when transporting high-value cargo.  Practices vary throughout the industry. If a load is above a company’s standard cargo insurance limits, many companies simply will not haul it.  Trucking companies that are willing to bind additional cargo coverage normally do so for a fee that covers only the extra cost of insurance. (Alternatively, this revenue line item could have been booked as a reduction to the “Insurance” expense account.) Loads transported on flatbed trailers must be secured by straps or chains.  These types of loads often are associated with higher worker’s comp claims. Thus, an extra strapping and chaining fee is charged only for a flatbed load. If a truck sits idle at the dock for more than two hours, customers can be charged a fee that is classified as detention revenue.  Placing a detention revenue clause in the contract encourages customers to load trailers efficiently in order to avoid further constraints on Kings’ tractor capacity. TYPES OF BUSINESS ARRANGEMENTS WITH DRIVERS Kings have potentially two arrangements with drivers.  They are classified as employees or as independent operators. Employees receive traditional employee benefits. These persons are typically engaged in work for the company that is considered “permanent.” Alternatively, independent operators are not considered employees and have to invoice Kings in order to receive payment for work done.  These operators typically provide the tractor but generally do not provide the trailer. In addition to driver salaries and depreciation on trucks, expenses incurred by independent contractors include the following on their invoices to Kings:
  • Tags (known as International Registration Plan (IRP)) – The independent contractor buys the IRP tag for the tractor, while the shipping company buys the tags for the trailer.
  • Heavy Road Use Tax.
  • Diesel fuel, engine fluids, and all maintenance-related parts and items.
  • Physical damage insurance.
  • Non-trucking “bobtail” Liability Insurance (needed for when the truck is not transporting a trailer).
  • Tolls and scale fees.
Independent contractors generally control their own working hours, unlike an employee.  Further, independent contractors’ work generally is considered temporary, rather than permanent (unlike for an employee).  In the trucking industry, an independent contractor often signs a one-year contract for a temporary job. But an employee is hired permanently under the assumption that he or she will make deliveries until further notice.  This arrangement constitutes a permanent job. CAPACITY ISSUES AND INDUSTRY PRACTICES Kings Trucking typically assigns one driver to one tractor.  But this practice can constrain the available hours the tractor can operate.  For example, laws require a driver to take a 10-hour break after 11 hours of driving.  Further, a driver cannot work more than 70 hours in an eightday period without taking a 34-hour break.  To improve tractor utilization by avoiding constraints based on legal driving time requirements, some trucking companies use “slip seating.”  This is a practice that permits greater tractor utilisation by placing a fresh driver behind the wheel at the end of the former driver’s shift.  Slip seating is similar in practice to an airline company that keeps its planes flying longer by inserting fresh flight crews as the previous crew goes off duty.  It also is efficient to utilize “team drivers” that are commonly husband-wife teams. One person drives while the other sleeps. Relative to a single driver, this arrangement basically doubles the number of kilometres driven in a given week.  Typically, teams are paid more, but additional line haul revenues offset the extra labour costs. Another strategy to improve tractor utilisation is to use trailer pools, commonly referred to as “drop and hook” systems.  For example, trucking companies will leave an empty trailer with customers, who will load it with products as units are produced.  When the trailer is filled, a tractor arrives, drops an empty trailer to replace the trailer just filled, then immediately hooks onto the loaded trailer and departs.  Tractor utilization improves because tractors are not sitting idle while a customer loads a trailer. This approach is economically feasible because trailers are far less expensive to purchase and operate than tractors. Most trucking companies keep some tractors “on the fence” as spares, in case one breaks down.  There is considerable disagreement, however, over what constitutes too many spares. Some owners believe a truck line should put all available equipment on the road and rent a tractor if a spare is needed.  Others disagree and maintain a small number of tractors in reserve. Currently, Kings SAS Pty Ltd keeps a small number of tractors and trailers out of service but prepared for duty in case a rig breaks down.  Some managers believe this policy is an expensive luxury and that some of these idle rigs could be used to add the new routes requested by Brock. When estimating a tractor’s practical capacity, management at Kings use 85% of total potential kilometres driven in a period.  Theoretical (or 100%) capacity utilization is virtually impossible in the industry because of factors such as traffic and loading delays. THE PROPOSAL AND RELATED ISSUES Management at Brock has asked Kings to consider adding two dry van loads per week; each load would require 1,500 round-trip kilometres.  Because Brock is a long-term client with a strong financial position, the company’s management has asked for a very favourable rate of $2.15 per kilometre including FSC and all miscellaneous fees.  Roger believes the potential volume of freight from Brock can be used to grow Kings’ business and profitability. There is also risk associated with not taking the new lines. If Kings does not accept the new routes, another trucking line will, thus building loyalty with Brock. Brock is a stable, solvent company that presents no question of collection, thus ensuring a reliable cash flow.  If Brock decides to restructure its supply chain in the future, Kings could find itself in the undesirable position of holding dedicated assets (trucks and trailers) for routes that no longer exist.  The owner’s aversion to increased debt levels further exacerbates concerns about acquiring additional fixed assets. Perhaps Kings could service the initial demand with existing equipment. But, as additional routes are added in the future, Kings must acquire more tractor-trailer rigs or consider outsourcing the kilometres by using independent contractors. Exhibit 1 presents Kings’ income from operations for the year ending June 30th, 2018. This statement is not prepared in accordance with Generally Accepted Accounting Principles (GAAP) but presents costs by behavior.  Exhibit 2 presents Kings’ balance sheet for the year ending June 30th, 2018. THE DECISION Kings’s management is considering the proposal from Brock.  There are many issues involving strategy, cost, risk, and capacity.  Prepare a formal written report to management that analyses this case and makes recommendations to management. Ensure that you provide appropriate and relevant quantitative and qualitative analysis to support your assessments and recommendations.  Use the following questions to guide your analysis:
  1. Assume Kings could service the contract with existing equipment.  Use Exhibit 1 to identify the relevant costs concerning the acceptance of Brock’s request to add two additional loads per week.  Which costs are not relevant? Why?
  2. Calculate the contribution margin per kilometre and total annual contribution margin associated with accepting Brock’s proposal.  What do you recommend? (Use 52 weeks per year in your calculations.)
  3. Consider the strategic implications (including risks) associated with expanding (or choosing not to expand) operations to meet the demands of Brock.  Analyse this question from a conceptual point of view. Calculations are not necessary.
  4. After a closer examination of capacity, management believes that they can handle one of two additional loads being with existing capacity but that an additional rig is required to handle the second load.  Assume Kings’ management chooses to invest in one additional truck and trailer that can serve the needs of Brock (at least initially). Assume the annual incremental fixed costs associated with acquiring the additional equipment is $50,000.  Further, Brock would agree to pay $2.20 per kilometre for both loads (including FSC and miscellaneous) if Kings would sign a five-year contract. What is the annual number of kilometres required for Kings to break even, assuming the company adds one truck and trailer?  What is the expected annual increase in profitability from the Brock contract? (Use 52 weeks per year in your calculations.)
  5. Kings has business relationships with independent contractors, though Alan is reluctant to use them.  Another possibility for expanding capacity to meet the second load requirement is to outsource the kilometres requested by Brock.  One of Kings’ most reliable independent contractors has quoted a rate of $1.65 per kilometre. As with question 4, assume Brock would agree to pay $2.20 per kilometre if Kings would sign a five-year contract and that Kings would use their own capacity to cover one of the weekly loads.  Further, assume Kings would incur incremental fixed costs of $20,000 annually. These costs would include insurance, rental trailers, certain permits, salaries and benefits of garage maintenance, and office salaries such as billing.  How many annual kilometres are required for Kings to break even if the second weekly load is outsourced?  What is the expected annual increase in profitability from the Brock contract? What are your conclusions?
  6. Why might Kings use an independent operator if the variable cost per kilometre is higher than if the company had purchased a rig and hired a driver?
  7. At what point would management be indifferent between the scenarios illustrated in questions 4 and 5?  Based on your analysis, would you recommend adding capacity by purchasing an additional rig or by utilizing the services of an independent contractor? Why?
  8. Prepare a short, no more than 300 word, reflection on how completing this task can help you assess short term decisions that you are likely to face as you establish your own business venture.
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