Pirates of Silverland
Pirates of Silverland
A. INTRODUCTION OF THE CASE
Palm Haul Sdn Bhd (PHSB) was actively engaged in the business of transportation of crude palm oil (CPO). It was in a niche market because of high demand in delivering the CPO from the mills to the refineries. In addition, due to this reason, the industry players were rewarded with high gross profit margin which ranged on 35% – 45% with low administrative overheads. However, as PHSB involved in service industry, high cost of sales was inevitable in the operations. This issue created higher competitiveness in the market because the industry players tend to operate more efficaciously in managing cost of sales. Furthermore, oil piracy was the major issue which was difficult to be solved and avoided by the industry players. It also caused to significant impact and losses in this industry. In more serious extent, the persons committed this siphoning cases were not identified and red-handed.
This was the reason contributed serious impact to PHSB, as the gross profit margin was substantially narrowed due to highly increased in direct costs. The drastic decrease of gross profit margin certainly not only caused by the single reason mentioned. PHSB was found to incur high compensation paid for CPO shortfall, inconsistency of drivers’ attendance and high expensed on maintenance. PHSB was in critical situation due to the emergence of these challenges. In depth of analysing problem encountered by PHSB, the CPO consigned by PHSB was justified and led to the quality issue in refineries.
Oilene Refineries Sdn Bhd (Oilene), one of the major customers of PHSB, criticised the CPO delivered was frequently short and contaminated with water or sludge. The low quality of CPO affected the processing plant of Oilene and additional works had to be performed for cleaning purpose, by shutting down the plant. Because of the serious impact given by PHSB, the management of Oilene decided whether not to proceed for the contract renewal, which would be expired in June 2009. Therefore, En. Rossly must review the operations of PHSB and necessary actions must be taken in order to secure the contract from Oilene.
B. COMPANY BACKGROUND
Palm Haul Sdn Bhd (PHSB) was established in 2002, in Taiping, Perak. It was a medium-sized enterprise in the CPO transportation business. It had about 200 employees, out of which, 80% was in operations, primarily drivers of the company’s customized tankers. Generally, PHSB was owned and chaired by Datuk S. Najeed, who was the former chief engineer of Ministry of Transport PHSB. The routine operation of PHSB was managed by En. Rossly, the CEO and son-in-law of Datuk S. Najeed. Furthermore, this company was branched into three major functions which included Account cum Finance, Human Resource and Administration functions. And, they were in charged by three key personnel, Romsee Rossly, Ramli Ali and Aliah Ibrahim, respectively. En Rossly decided to engage with a management consultant who was also a friend of En. Rossly’s, to provide effective solutions for the issues endangered PHSB.
C. ISSUES LEADING TO THE INCREASE OF DIRECT COST IN PHSB
1. Rising compensation to CPO shortfall and low operating margins 1.1 Issues
1.2.1 Compensation to the refineries
Referred to the PHSB’s two years financial reports (2008-2009), there were increasing trends of compensation being made by PHSB to the refineries due to the shortage of CPO during the transportation. It showed that until March 2009, PHSB compensated about RM2 million, which already increased more than 33 % from the compensation they made RM1.5 million in 2008. The compensation cost was on increasing trend which it could be seen from the compensation figures from 2006 until 2009. In 2006, the compensation that PHSB had to bear was RM345, 111 and it was increased double in 2007, RM645, 222, and then again another two-folded increased in 2008, which was at RM1.5 million. PHSB should shoulder the differences in the amount of CPOs that were short-delivered to the refineries.
The PHSB’s customer, Oilene Refineries Sdn Bhd (Oilene), claimed that the CPO delivered by PHSB’s tankers, were less than the recorded quantity in the delivery order and some of the CPO had been contaminated with water or sludge. Compared to another transporter hired by Oilene, Tiger Oils Transporter, PHSB’s consignment was the most difficult to be processed. Despite the claim by Oilene on the delivered CPO, there was also a possibility that the CPO turned into sludge because of their chemical reaction to the changes of temperatures in the tanker. Therefore, PHSB should look into this matter as well. Nevertheless, there was a possibility of five years contract, between PHSB and Oilene, would be insecure if these issues were not amicably settled by the PHSB as soon as possible.
1.2.2 Compensation to the staff
Another compensation that PHSB had to cover was regarding the compensation to the staff, such as salaries, allowances and ex-gratia. The compensation amount recorded until March 2009, costing PHSB around RM8.03 million, an increase of 7.1 % compare to 2008. There is a possibility that the increased amount was due too many festive seasons during the year’s end. The amount from both compensation lead to the lower operating margin for the PHSB in 2009 compared to 2008.
Operating margin is a measurement of what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. Low operating margin for the PHSB, meaning they are not making a good profit on every Ringgit that they spending on. It will jeopardise their bottom line for the financial year.
There are five possible recommendations for this issue, which are monthly financial report for the PHSB and to have an additional staff to monitor this irregularity in the account.
1.2.1 Monthly Financial Report
By implementing the monthly financial report, PHSB could monitor their expenses on a monthly basis, thus any regularity could be taken care as soon as possible. The standard monthly financial reporting package includes the following two core reports (University of Michigan, n.d.):
i. Statement of Activity (SOA)
The SOA reports display the posted revenue and expense transactions for an accounting period (i.e. one month period) for the specified parameters (e.g. Project/Grant). By presenting the SOA on the monthly basis, PHSB’s management could thoroughly monitor and review their activities for that particular month. If there is any unnecessary activity, the management could take corrective action before it could jeopardise their operations.
ii. Gross Pay Register (GPR)
The GPR report is a record of each employee’s paycheck salaries and allowances. By having this report every month, the management will be able to identify the compensation made to the employees on a monthly basis. And, they will be notified on the additional or irregularities payment that the PHSB made during that particular month.
1.2.3 Close Monitoring on the Tankers Temperature
To train and educate PHSB’s drivers on the measurement of the tanker temperatures in order to avoid any chemical reaction which it could turn the liquid form of CPO to sludge. PHSB also have to invest more on the reliable tankers to keep the CPOs in a suitable temperature.
1.2.4 Trucksecure’s System
PHSB may install tankers with the Trucksecure System. It is a unique, simple, non-invasive system fuel loss can be detected from either the main or secondary tank, whether taken through the fuel filler neck, sender hole or from puncturing the tank. One of the main problems encountered by haulers is detecting small but regular amounts of stolen fuel. The Trucksecure system has the ability to measure minimal fuel loss to combat this problem with the additional benefit for the operator to detect suspected internal theft covertly via an optional GSM text message. By installing this system, PHSB will be alerted on any attempt to siphon or steal the CPO immediately. Security Company will be alerted as well and they will investigate that particular tanker. This will decrease the possibility of siphoning and stealing of CPOs.
1.2.5 Balance Inventory Levels
PHSB have to cooperate with Oilene in implementing the balance inventory levels in checking and manage the CPO. Both companies could review the consignment through the purchase orders, receipt and credit notes, return notes as well as delivery notes which all of it will be validated by representatives from both companies. To follow-up on this method, both companies could have a thorough check on their inventory records. By implementing this method, PHSB could avoid the possibility of receiving less amount of CPOs than stated in the delivery orders.
1 High oil pilferage
2.1.1 Siphoning caused to higher direct cost incurred to refineries In the transportation industry, the transporter is required to bear for any losses incur during its consignment. The same practice applied to PHSB, hence, it had to reserve huge sum of money as the compensation to the refineries. In fact, the management found that many of the loaded tankers were not delivered to the refineries, but were found to be abandoned at the roadside by the irresponsible drivers. In addition, the siphoning case also contributed to the high compensation paid to the refineries. As per the case reported, the compensation cost per turnover hit at 7.7% in 2008, and increased to 8.3% as reported in total of three quarters of income statement in 2009. The increase of compensation cost had led to narrower of gross profit margin as it was a part of cost of sales.
2.1.2 Increase of insurance premiums
PHSB took a good practice where it mitigated the consignment risk to third party, the insurer. PHSB had bad track records because many cases happened to be the tankers left abandoned by the drivers. The insurer, Allianz Insurance might not be responsible on the abandoned tankers. Moreover, it brought to higher operation risk of PHSB. Thus, there will be a ground for the insurer to charge greater insurance premiums to cover the inconsistency of operation in PHSB. And, the cost of sales of PHSB will be risen significantly due to the Goods-In-Transit insurance is incurred directly to operation in the nature of transportation.
2.2.3 Implementation of Fleet Management System (FMS)
In the view of Mukhriz Mohd, FMS is a must to be enforced in PHSB. This system allows PHSB to minimise the risks associated with tankers in consignments, improve the operation efficiency and reduce in compensation cost. With this FMS, siphoning cases will be drastically reduced because the management of PHSB is able to detect the delivery locations of the tankers. In addition, it helps to reduce the fuel consumption as well. The problem of abandoned tankers will be eliminated as the drivers will be red-handed with serious punishments. Therefore, FMS is vital to be installed as PHSB operates in delivery services, despite the high cost of implementation. For the greater reduction in cost of sales and better preventive action, PHSB is strongly advised to enforce accordingly.
2.2.4 Serious disciplinary actions will be taken against drivers As the increase of insurance premiums was due to the irresponsible drivers, actions must be taken to penalise them. This solution is made to reduce or even eliminate such cases to be happened repetitively. Ex-gratia will be deducted for the drivers who are identified to commit on wrong-doing. In more serious extent, if the drivers ignore the disciplinary actions, termination of service will be given to the drivers. This solution may not contribute to immediate financial benefits, however, the insurer will reduce the insurance premiums in future when the abandoned tankers cases decline. In other words, it contributes to greater profit margin of PHSB in long term. 2 High Absenteeism/ Driver Shortage
As per reported by Ramli Ali, Human Resource Manager of PHSB, the company had the problem on driver shortage due to better offer from bigger company. The company also encountered issue on high absenteeism of drivers. The problem occurred because of irregular routes and away from home for a long period, caused the drivers tend to search for a better jobs or remunerations.
4.4.1. Unattractive remuneration package
According to Ramli Ali, PHSB was unable to offer an attractive remuneration package to their drivers. With more attractive remunerations offered by big companies, drivers tend to bite the bait, therefore, PHSB needed to hire and train new drivers more frequently. This activity had made increment in the Administration and Operation Expenses for year 2009. The pilferage activities are recognized to happen during year end. This was identified that most of the drivers more likely needed money during this period of time, hence, the temptation siphoning the CPO was high.
4.4.2. Irregular routes and tight scheduling
Ramli also declared that irregular routes and tight scheduling were the factors of drivers’ high absenteeism and shortage. By having this problem, it has affected the quality of operation service where refineries claimed that the CPO had not been delivered on time. Lack of drivers means that same driver might be running several deliveries. Each delivery requires them to stay away from home for a few days. Thus, some drivers might not get well rested and home away more than they supposed to be.
4.5.3. Offering attainable remuneration package
PHSB needs to consider giving year-end bonuses to the drivers in order to earn their loyalties. Hence, this will help to reduce drivers’ shortage as well as absenteeism problem that troubled PHSB throughout the year 2009. PHSB can emerge good remuneration package where year-end bonuses given to the drivers and staff. The bonuses will be much lower than the compensation cost that PHSB is currently bearing. PHSB can as well offer rewards to drivers with satisfaction attendance by giving performance incentives by year end. These incentives also can be applied to those who have delivered CPO as per Purchase Order or sludge-free. This will hope to lower the absenteeism percentage.
4.5.4. Realistic Schedule
PHSB shall also consider giving annual leave based on Malaysian Industrial Development Authority’s guidelines which is normally provided with annual salary increment that is calculated based on a certain percentage of the basic salary and performance. PHSB shall come out with more realistic schedule which drivers are allowed to have some rest after their long journey. PHSB may as well to schedule more carefully to avoid continual shifts. This may be seen as increment in PHSB’s expenses but in long term, it will help to reduce expenses in staff training as per stated in Administrative and Operating Expenses table. With new remuneration package and realistic schedule, drivers can give their greater commitments on their shifts, as a result, PHSB shall be able to enhance their transportation service. Consequently, PHSB will acquire higher profit since the customers are satisfied with the service provided, and indirectly, PHSB will able to expand to a bigger network.
3 High Cost of Maintenance
Being a logistic service provider specialised in transporting CPO, it is crucial to emphasise on the upkeep of its tankers. Indeed, PHSB’s predicament is also related to this matter. As we have gone through the case carefully, we have identified that PHSB is incurring high cost of maintenance. The maintenance costs incurred for the three quarters of years 2009 and 2008 are RM 5.5 million and RM 2,3 million respectively. Thus, PHSB faced a 143.8 % increase in maintenance cost for 2009 compared to 2008* (estimated based on average calculation of total maintenance cost for 3 quarters of the accounting period). Marginal planned cost accounting or flexible analytic cost planning and accounting studies by Sharman (2003) can be referred to understand the cost of sales in the case of PHSB better. Below are the possible root causes of this predicament.
4.4.5 No regular upkeep and maintenance of the tankers.
It was found that PHSB did not regulate the maintenance of its tankers. The tankers were only sent for service and repairs when the drivers complained of breakdown. At times, the damages occurred were severe, hence resulting in high cost of repairs. 4.4.6 No standardised administrative mechanism.
PHSB is lack of a standardised administration mechanism. At the moment, the perform vehicle and driver allocation and scheduling are done manually. Hence, a lot of time is wasted in the process. The situation get worse if there were any absentee, as the delivery route and allocation of drivers need to be rescheduled.
4.3.1 Scheduled maintenance program.
PHSB should practice a more systematic method of maintaining its tankers. It should ensure each of its tankers have gone total check-up, let say in a fortnight basis before be available for transporting scheduling. As we are concerned, PHSB is a small company with certain constraints. Its annual gross profit margin is just around 10% over the years. Thus, we understand it will be unable to spare extra cost especially if it wanted to establish an in house maintenance facility for its tankers. However, PHSB could overcome this problem by out-sourcing maintenance services from the market. A yearly contract with the service provider will assist PHSB to upkeep its tankers within a minimal cost.
PHSB could use its power of negotiation to get good deals from the service provider for this mean. Moreover, PHSB would have an option to discontinue the contract and assign a new service provider in case of dissatisfaction too. Thus, PHSB will be able to cut sales cost, add competitive value to its company and eventually increase operating profit.
4.3.2 Computerised Scheduling.
It was found that manual scheduling method utilised by PHSB delays time. Hence, a computerised scheduling method will be very convenient. This method will help PHSB to organise delivery routes, driver allocations, delivery durations, maintenance breaks and forecast the total cost of sales regarding this matter systematically. Some of Transportation Management System (TMS) softwares that are widely being used by major third party logistic (3PL) companies worldwide include RoadNet Technologies, TMW Systems and Precision. PHSB could employ any of these softwares too, to manage its operation and administration mechanisms.
Moreover, this method does not need an expert to carry out or additional staffs as it could be done by single person who knows how to operate computer and familiar with data entering. Besides, PHSB could always acquire consultations and trainings from the system provider if it faces any difficulties related to the software. The quality of CPO transported and the safety of the drivers who work for PHSB are greatly influenced by the condition of the tankers. These aspects would affect PHSB’s entire operation processes if not tackled immediately. Therefore, we believe the recommendations given will hinder such quandary plus contribute to lower direct cost of sales in the future. Consequently, PHSB will be able to increase its operating profit.
As displayed on the financial statements of PHSB, the loss of RM 1.8 million marked as the worst performance ever throughout seven years back. This circumstance shall not be repeated if PHSB wishes to remain its competitiveness and roles in the industry. From our analysis, we strongly believe the compensation cost to refineries is the “Achilles Heel” of PHSB operations. As mentioned above, 8.3% of turnover was solely contributed to compensation expenses. If PHSB is able to manage properly on the direct cost, the reduction portion of the compensation cost will be the additional gains to gross profit margin of PHSB. And, it surely remains PHSB at the higher competitiveness in the industry. However, the key personnel of PHSB must aggressively review on the inconsistencies of the financial reports. The financial reports shall be utilised effectively, as these reports provide a good avenue for the management to identify the weaknesses in the operations, although the information is historical.
It is reasonable that salaries and allowances of drivers are the leading cost component in direct cost, as the drivers are the human capital to PHSB. However, it should not be on increasing trend which the gap is bigger than the increasing turnover. Relevant of remuneration package is powerful to retain and attract more human capital. The relevance remuneration package would be in term of performance-based incentives. As this variable reward is individualised, drivers will be more motivated to work disciplinarily in PHSB. Although it will affect the gross profit margin, this direct cost is better to flow to the benefits of internal employees, which will improve the employees’ loyalty, rather than as the compensation cost to refineries. Besides, the upkeep and maintenance must be thoroughly monitored.
As mentioned in the case, most of the tankers are fully depreciated. In other words, these aged tankers may lead to higher possibility of breaking down during delivery of PHSB. It is considered cost inefficient when high maintenance cost incurred repeatedly because it will cost a boom to PHSB. As a good recommendation, the tankers must be properly scheduled for regular maintenance checks. This is because preventive maintenance can avoid high repair and replacement costs. Last but not least, the effect from the inefficient operation of PHSB leads to higher inventories held by Oilene. This is because of the inconsistencies delivery provided by PHSB. This circumstance further indicates that Oilene will have poor inventory forecasting. The management of Oilene may find difficult to manage the inventory, as PHSB failed to consign the accurate and planned quantities.
And hence, Oilene is required to maintain high level of inventories. Furthermore, the low quality of CPO, which often contaminate by the drivers, also raises an impact on Oilene’s inventories. Therefore, higher operation cost will be incurred by Oilene. Besides, Oilene will encounter the bottlenecks issue when the inventories level is high. Production capacity of Oilene may not require huge volume of inventories in short period of time. Also, the product under demand will be another constraint which worsening the bottlenecks. As such, the identified inconsistencies of the financial statements shall be addressed with solutions proposed. These recommendations may contribute to higher confidence and possibility of PHSB to secure the service contract with Oilene. With tight monitoring and reviewing on the financial data, PHSB will be operated more consistently and achieve more competitive advantages for greater future growth.
University of Michigan. Financial Operation. Retrieved October 5, 2013 from http://www.finance.umich.edu/finops/reporting/department/standar Sharman, Paul A. (2003). “Bring On German Cost Accounting”. Strategic Finance (December)