Question

Shipyard Progres^[1]

Introduction

Shipyard Progres is located alongside the Winscotencanal in theprovince of Groningen, in the north of the Netherlands. Since 1837,when the business was established, it has been engaged mainly inbuilding ships for what is nowadays called Shortsea shipping.Progres specializes in multipurpose dry-cargo vessels, but itsometimes builds other types of ships as well, such as tankers forliquefied gases and chemicals, tugs, fishing boats, and ferries.The shipyard has about 140 permanent employees and its sales over2000 amounted to approx. €25 million.

Progres and the other shipyards in the north of the Netherlands,most of which are located alongside the Winscotencanal, concentrateon building relatively small sea-going vessels. Progres is one ofthe largest shipyards alongside the Winscotencanal. Like the othershipyards in the north of the Netherlands, Progres contracts out aconsiderable portion of its work to all kinds of specializedsuppliers, such as engineering firms and wainscotingbusinesses.

Despite fierce international competition, Progres and severalother shipyards in the north of the Netherlands have managed tokeep going for the past fifteen years. Their success is largely dueto their great expertise, innovativeness, and the fact that theyspecialize in high-quality types of ships. The total turnover ofDutch shipyards specializing in ‘relatively small’ sea-goingvessels was approx. €400 million in 1999.

However, the shipyards alongside the Winscotencanal, includingProgres, have to contend with limitations on the dimensions of theships to be built. These limitations relate to the draught and –because of the maximum opening of the bridges between the shipyardsand the sea – the width of the ships, in particular. For variousreasons, the dimensions of ships for the shipyards’ main customershave gradually been increasing more and more. Most of thesecustomers are small shipping companies, family businesses in theNetherlands and a few other countries in North-West Europe, whichhave done business with the shipyards for a long time.

The increasing size of the ships means that some of the shipsrequired by the usual customers can no longer be built by theshipyards alongside the Winscotencanal, or at least cannot becompleted there by them. Their inventiveness has resulted in anincrease in the maximum dead weight of their ships (expressed astons deadweight all told (DWAT) and tons deadweight cargo carrying(DWCC)), in which shipowners are particularly interested. However,slowly but surely the shipyards have reached the limit of what isfeasible without the stability of the ships being affected, e.g.Progres cannot build ships of over 6,000 to 6,500 DWAT at theshipyard alongside the Winscotencanal. The shipyards realize thatin the long run this situation may lead to big problems. They willmiss out on orders for large ships and at some stage some of theirloyal customers might place all of their orders elsewhere.

For many years the shipyards have examined and discussed thepossibility of a joint investment in a large, capital intensive,offshore shipyard in Eemshaven harbour in the north of Groningen.Their consultations have not yet led to any concrete results,despite inducements offered by Dutch and European authorities. Onthe one hand, the shipyards know that they have to rely on eachother to find the best possible solution to the problems caused bythe increasing dimensions of the ships they build. On the otherhand, the owners of the shipyards – mostly families which have beenshipbuilders for generations – have always been used to runningthings their way. Moreover, to a certain extent the shipyards arecompetitors.

A dock in Eemshaven harbour

Financially and technically speaking, Progres was one of thestrongest businesses alongside the Winscotencanal in 1999. Becausethe shipyards had been making little headway with their plans forbuilding an offshore shipyard, the board of Progres decided to takeit upon itself to explore the possibility of building ‘large’ shipselsewhere.

A temporary and relatively inexpensive solution was the purchaseof an existing dry dock – which could be moored in Eemshavenharbour – where Progres’s ships could be assembled and completed.In that case, sections built by Progres alongside theWinscotencanal would be transported by tugboat to Eemshaven harbourand assembled there, after which the ship would be completed. Allthis would obviously lead to certain organizational and technicalcomplications. However, the board of Progres did not think thatthere would be any insurmountable problems.

After a detailed analysis of the anticipated revenue and expenseresulting from the purchase of the dock, the board of Progresreported the data mentioned in Table 1 to the supervisory board ofProgres during a meeting in February 2000. The supervisory board,which had to assess the project, had decided to limit itself to therevenue and expense over the next five years, because it could notsay anything with certainty about the following years.

During the supervisory board meeting Chris van der Burg,financial manager of Progres, explained the dry dock project. ‘Ofcourse’, he said, ‘it would be wrong to make light of thedifficulties of working at two locations’.

In addition, he stressed the necessity of constantly obtainingsufficient orders for large ships and the rather low cost of thesimple plans. The enthusiastic financial manager said that the netcash flows in Table 1 (i.e. additional annual inflows minusadditional annual outflows) were, as usual at Progres, ratherconservative estimates.

‘Assuming that the data in the table are correct and Progres’scost of capital amount to 11%, the dry dock will be an attractiveinvestment to us, even if there should be a temporary slump in thedemand for newly built ships’, Van der Burg added.

Table 1 Estimated net cash inflows after the purchase of a drydock (€ million)

2002	1.0
2003	1.4
2004	1.9
2005	1.5
2006	1.2

At the end of 2001 an amount of € 4,1 million would be requiredfor the dock and further investments in Eemshaven harbour. The netcash inflows in Table 1 would be coming in at the end of eachyear.

The investment and the strategy of Progres

After the plans had been presented during the supervisory boardmeeting, those present ended up discussing much more than the drydock project. During the lively discussion numerous pots of tea andcoffee and lots of biscuits were brought in, and the box of cigarsand cigarettes on the conference table was opened. It was not longbefore the conference room was blue with smoke. The nonsmokingpolicy pursued by the government for many years had evidently notyet had an impact on the board and supervisory board ofProgres. During this discussion Jan Smit,general manager of Progres, said the following.

‘This project is completely in line with our strategy and that'swhy it is a good idea to start building larger ships and developingan extra production site. We want to keep focusing on the marketfor high-quality ships, where arguments for purchasing such a shipare quality, flexibility and expertise rather than low prices.Also, we want to keep up our profits and keep supplying relativelysmall Shortsea shipping vessels for containers and other dry cargoto our current customers, mostly from the Netherlands, Germany andthe United Kingdom’, Jan said.

‘In addition’, Jan continued, ‘we want to retain or attractcustomers for relatively large Shortsea shipping vessels. We wantto enter new geographical markets as well as pay more attention totypes of ships that we have not really focused on until now. Ourexpertise will be required for those types of ships and may resultin good profit margins. So we will be trying to specialize in awider range of ships, particularly gas tankers. To that end, wewill increasingly be focusing on customers outside North-WestEurope. The dock may be one of the means of achieving all ourgoals. If we invest in the dock, we will have to strive for ahigher average building cost of the ships and try to increase theannual output from five to seven ships now to a total of eight totwelve ships in about three years’ time. The average building costof the Shortsea vessels and tankers that we can build at thepresent location is now about €8 million. An amount somewherebetween €4 million and €6 million is for our shipyard’.

‘By the way’, Van der Burg added, ‘when we were calculating thefigures for the dry dock project in Table 1, we hardly took accountof that desirable increase in output. Being sensible men fromGroningen, we did not want to be too optimistic’.

‘Let me tell you more about our future after investing in thedock’, Smit said enthusiastically. ‘To be able to build more shipsand new types, we will also have to invest in increasing knowledgeof building new types of ships, phasing production processes at twolocations, and marketing. Most of our current buyers are loyalcustomers. We know them and maintain good relations with them.Chris or I visit them when they have had good or bad news. Ofcourse we should keep doing that. But we must take far more activesteps to approach prospective customers, especially outside Europe,for expensive and more profitable types of ships, likegastankers’.

‘To be able to supply high-quality products and make the most ofthe dock, we will have to improve our employees’ expertise all thetime, because it is one of our great strengths. If the employeesalways know the latest production techniques, we will be able touse the latest in cutting, forming, welding, and coating, andcontinue doing a good and efficient job. Internal production andcontracting out must become even more efficient and flexibleprocesses than they are now, particularly because we will havestaff on two production sites’.

‘Luckily, most of our employees are quite enthusiastic about ourplans. Many of our employees will have to commute more because ofthe two locations, but I am sure most of them will not mind. Thereare strong bonds between a lot of our employees and our business,sometimes these bonds have existed for generations. Our employeesare proud of our products and they know we value our employees. Weemploy down-to-earth, discerning men and women of few words. Butthey know very well what innovations are necessary to the future ofour business – and to their jobs. It is our experience that changeshardly ever cause problems among our employees, partly because theyknow that we do not talk rubbish to them’.

‘I have touched on a number of things that we will be faced within the coming years. Clearly, quite a lot of factors play animportant part in the dry dock project. It will not be easy toincorporate the project into our strategy and turn it into a realsuccess. I do realize there may be problems in store for us; we donot yet know what is going to happen. But it is clear that wecannot keep talking about an offshore shipyard forever withoutdoing anything about it’, Smit concluded.

Balanced scorecard: means of concretizing and realizingthe strategy of Progres?

‘Maybe it is time for a drink now’, supervisory director JopGerards sighed, when Smit had finished. ‘But first I would like togo into what you have said, Jan’, Jop, who was a professor ofmanagement accounting, added immediately.

‘Good short-term financial results do matter’, Jop said. ‘But weshould also check regularly what the project contributes to thestrategy of Progres. The point is whether Progres will achieve itslong-term goals and stay healthy’.

‘The possibilities outlined by you’, he said, ‘show that weshould see the project in a much wider context, so not only as arelatively simple solution to problems caused by the presentlocation. I am not really concerned about the amount of moneyinvolved in the dock; Progres is sure to come up with the money.No, what I am concerned about is that we should focus regularly andsystematically on the subjects you have just brought up with somuch enthusiasm. Now we have been philosophizing about these thingsthis afternoon, we must make sure that we will discuss them againsoon. Especially because what you have just said, Jan, is soimportant. The supervisory directors, myself included, should talkthings through too’.

‘The significance and consequences of the dock to the strategywe have recently decided on obviously cannot be expressed infinancial figures only. If our profit over next year were €3.5million, it would be a wonderful result. But how was that profitrealized and how is the business doing in general? That isimportant too. The strategy of Progres seems quite clear, we havediscussed it once or twice with small groups of people who workhere. But what exactly do we want to achieve and what should ourmessage be for the heads of the office, the sales department, thedesign department, and the production teams? Can we say to them:look, this is the strategy of Progres, you had better get cracking?Or should we be more specific and say to them: look, this is thestrategy, that is the direction Progres is going in and that may bethe consequences for your department, we think. To my mind, weshould ask them there and then: are you fine with that or do youdisagree?’

‘Of course we can use our strategy to indicate that we want toinnovate, enhance marketing, and constantly improve our productionprocesses’, Jop continued. ‘That is all very well, but what does itmean exactly? Should we also specify the profit on the new types ofships to be made five years from now? And how do we determine intwo years’ time that we are on the right track? If we succeed indefining more concrete goals on the basis of our strategy, I wouldalso like to know exactly how those different goals areinterconnected. Actually, I believe I am getting more and moreenthusiastic about such an approach, while talking about it’.

‘So you are saying’, Jan Smit responded, ‘the goals Chris and Ihave thought and talked about among ourselves should be put down onpaper. That we should consult with our people. And that we shouldcheck regularly whether what we wanted to achieve through the dock,is actually becoming a reality. We should not only focus onobtaining orders and then making sure that we get the new ships offthe slipway on time’.

‘Yes’, Jop Geerards said, ‘we should talk regularly with eachother. We need not philosophize every month, but it could be veryuseful to do it once or twice a year. The balanced scorecard mightbe a good tool for us, although it has been criticized by someacademics and businesses that have been using it. Of course thereis no magic formula, but our ambitions, the board’s enthusiasm, andour personnel’s positive attitude make me think that we could besuccesful in developing a scorecard. In any case, we should thinkit over. Perhaps you, Chris, and your financial staff could developfurther ideas and the first concrete elements of such ascorecard’.

CASE REQUIREMENT:

Please write a brief report on thefollowing.

1. Assuming that it is now the end of 2001, pleasecalculate the internal rate of return on the investment in the drydock, using the data mentioned in the Progres case (see Table1).

Give a detailed example of the calculation of Progres’ssafety margin, i.e. calculate the decrease in annual net cashinflow which does not result in an internal return which is lowerthan Progres’s cost of capital. Comment briefly on the results ofyour calculations and on Progres’s preferred method of evaluatingthe project, i.e. evaluation based on data about net cashinflows.

2. Please describe briefly and in general terms what thebalanced scorecard is and what its developers, Kaplan and Norton,see as its aims.

3. Using the available data – and any reasonableassumptions –, please give an example of a concrete balancedscorecard (BSC) for Progres. Develop this BSC without necessarilyincluding any figures in your BSC. Put forward arguments for thegoals and indicators included in your BSC and describe therelationships you expect to exist between the goals and indicatorsin the four perspectives of the BSC. Give a clear explanation ofthe contents of your BSC.

4. Please discuss to what extent the way in whichProgres is being run is conducive to the implementation of abalanced scorecard. Discuss how the implementation and use of thebalanced scorecard by Progres relates to the use of two levers ofcontrol described by Simons, namely diagnostic control andinteractive control.

^[1] Authors: Henk J. ter Bogt and G. Janvan Helden, Faculty of Economics, University of Groningen (theNetherlands).