How Afroplast Enterprise Ltd should reverse falling profitability

Introduction

Background

Packaging is the art, science or technology of enclosing or protecting goods for distribution, storage, sale, and use. [1] Afroplast Enterprise Limited is such a business that deals with the production of plastic containers and other articles for the intended use of storage of medicine, juices and other liquids.

Afroplast Enterprise Limited established over fifteen years ago in 1995 is a private limited company that deals with the production and sales of plastic bottles and jars of different capacities and uses. It is ISO (International Standards Organization) certified and reputed to be one of the leading producers in plastic containers and other articles. It is located far away from town, in Portbell Luzira adjacent to Upper Prison – approximately 8km from the city centre of Kampala.

Some of the articles that are produced by Afroplast Enterprise Limited include: Juice/Milk/Liquids containers, pharmaceutical containers, Shampoo and Powder containers, Household Relief supplies, Water/Juice PET Bottles, PET Sweet Jars, cooking oil PET bottles etc. Afroplast does not only manufacture the products according to the customer’s orders but also provides other facilities such as printing logos, brand names, and instructions on the plastic containers to make them aesthetically appealing.

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Every business faces competition for the market and so does Afroplast. It has many competitors – some emerging in the market recently while the others are those who have been in this business probably for the same time as Afroplast. Some of the competitors names are; Uganda Plastics Industries, Nice House of Plastics, Oxy Plastics, Rwenzori Beverages Co. Ltd and many others.

The company has been on average experiencing large profits per annum. However, for the past three years (2007 to 2009) the company has been experiencing a fall in the profitability. Profit maximization is one of the major objectives of most businesses including Afroplast Enterprise Limited. Put simply, profit is the difference between sales revenue and cost of sales. Profitability refers to the amount of profit received relative to the amount invested into the company which is often measured by the rate of profit or the rate of return on capital employed (ROCE) – which is a profitability ratio that shows the effectiveness of a company in returning profits to the shareholders’ investments in the company. It is evident from the interview with the Managing Director (Appendix 1) that the management of the company is concerned about the emergence of competitors who were first purchasing products from Afroplast but then decided to manufacture it themselves thus capturing part of the market that was controlled by Afroplast Enterprise Limited affecting their profitability. It is here that the significance and worthiness of my investigation lies.

The purpose as to why this research study was chosen is because of the increasing demand for the packaging containers and articles by the product manufacturing companies and also because of the employment opportunities that the company offers to the people in Uganda.

Therefore, this extended essay will aim to answer the question: ‘What should Afroplast Enterprise Ltd do to reverse the trend of falling profitability in 2010 and beyond?’

Methodology

In order to effectively assess the reasons underlying the falling profitability trends of Afroplast Enterprise Limited, sales revenue, cost of sales and expenses were obtained from the profit and loss accounts(herein referred to as income statements) dating from 2007 to 2009. Other documents obtained for this purpose include; the cash flow forecasts.

I compared the income statements of the 3 years of the company and examined the factors that have contributed to the trend of falling profitability of the business.

Using questionnaires, the opinions of the existing customers (a sample of 20) of Afroplast about Afroplast Enterprise Limited were determined and analyzed to evaluate the marketing strategies of the company in terms of the pricing policies and to some extent the promotion carried out by the business. This was employed in order to evaluate both the company’s profitability and to what extent their marketing strategies are affecting their profitability with a view to identifying the factors underlying the falling profitability of the business.

The Managing Director of the company was interviewed to obtain the target data needed – the background of the company, competition in the market and competitors of the company, any marketing strategies that the company has employed and the possible impact on the sales.

Other analytical tools used for analyzing the company’s profitability and its position in the market were:

Ansoff’s matrix to help Afroplast Enterprises Ltd. decide their product and market growth strategy enabling them to improve the sales revenue, a factor that greatly affects the profitability.

SWOT analysis of the company in order to identify the strengths that the company should capitalize on, weaknesses that the company should address, as well as the possible opportunities that the company should seize and threats that the company should look out for from the business environment.

Scope of the Secondary Data and its limitations

The secondary data was only obtained from the company making it a limiting factor to the analysis of the market for the same products. One of the limitations in collecting and analyzing the secondary data was the lack of willingness on the part of the competitors in disclosing their company’s income statements that would have enabled me to make effective comparison with the profitability position of Afroplast Enterprise Limited.

Findings and Analysis of Primary Data

Questionnaires were given out to a sample of 20 customers of Afroplast Enterprise Ltd. and the results are illustrated using various forms of charts and graphs below.

Figure 1: Doughnut Chart showing the rating of Afroplast Enterprise Ltd. products (1 being poor and 10 being excellent)

Nearly half of the customers were found to have thought that the products of Afroplast Enterprise Ltd. are of good quality and satisfactory. This suggests that the company stands a high chance of increasing their sales revenue thus increasing the company’s profitability. The company should also aim to continue maintaining and further improving the quality of their products in order to attract a greater number of customers and avoid losing their existing customers to competitors.

Figure 2: Pie Chart showing the frequency of purchasing Afroplast products

From the results it is evident that most of the customers purchase the products twice a year. This result shows that the frequency of the customers purchasing the goods is not good enough for the company to achieve greater sales in order to increase their profitability. These results also show that the business needs to diversify in order to enlarge the market as well as augmenting its sales revenue which will help the firm improve its profitability.

Figure 3: Bar Chart showing the customers’ opinions on the pricing

In view of the results above, it is clear that most of the customers appreciate that the current pricing policy is acceptable, that is not very expensive and also not very cheap – indicating the quality of the product. This indicates that Afroplast should fully exploit this pricing policy and maintain their pricing policies, that is the promotional pricing and competitive pricing.

Figure 4: Pie Chart showing the customer’s opinions on the company’s deficiency

Considering the customer survey, it is evident that half of Afroplast’s customers believe that the problem with the company is mainly the promotion of their products. This indicates that quite a number of people are not aware of the company’s product which therefore calls for aggressive promotion.

Sales Revenue

Sales Revenue is the total amount of money that a firm earns from the sale of all or part of its goods and provision of its services during a given trading period. It is also known as the sales turnover

It is known that the sales revenue is dependent on the price charged and the quantity of products sold by the business. Thus,

Considering the fact that the prices at which the products are sold affect the sales revenue which in turn affects the profitability of the business, it necessitated me to analyze the pricing strategies and policies used by the company in order to get to the bottom of the matter, that is, the reasons for the falling profitability in Afroplast Enterprises Limited.

Therefore if the sales revenue of a business is high, the gross profit is likely to be high as well. In the case of Afroplast, over the three years under investigation, the sales revenue has been increasing as seen in Appendix 2. This trend in increase is shown in the graph below:

Graph 1: Increase in sales revenue

This upward trend in the sales revenue is attributed to the large quantities sold to the large clients such as; Unilever Uganda and Uganda Pharmaceuticals industries as seen in Appendix 1. From the interview – in Appendix 1 – with the managing director, I discovered that the company adopted mainly competitive pricing policy but in 2009 they used more of promotional pricing which allowed them to grab the attention of more customers. The increase in the sales revenue from 2007 to 2008 is 332,437,277 Ushs, which is an 11% increase per annum. The increase in the sales revenue from 2008 to 2009 is 457,333,902 Ushs, which was a 13.6% increase per annum. However, this can only be useful if there are other years to compare the trend of increasing sales revenue with this percentage increase.

Cost of Sales

Cost of sales, on the other hand, is the sum of the cost of purchasing the raw materials in order to convert them into semi-finished or finished products. Over the three years under investigation, the costs of sales incurred by Afroplast Enterprise Limited showed an upward trend (Appendix 2). This trend in increase is illustrated in the graph below:

Graph 2: Increase in cost of sales

According to the Managing Director [2] and also seen in the SWOT Analysis [3] , the appreciation of the dollar to the local currency, Uganda shillings, had a great impact on the costs of importing the raw materials from Saudi Arabia. Thus it is an indicator as one of the major contributors to the rising costs. The increase in the cost of sales from 2007 to 2008 is 449,110,075 Ushs, which is an 18.7% increase per annum. The increase in the cost of sales from 2008 to 2009 is 651,606,330 Ushs, which is a 22.8% increase per annum. Again, this can only be useful if there are other years or other similar businesses to compare the trend of increasing cost of sales with this percentage increase.

Cost of sales also affects the gross profit that a business makes during its trading period. If the cost of sales is high, even if the sales revenue is high, the gross profit that the business earns reduces in value as shown in the graph below for Afroplast Enterprises Limited:

Graph 3: Trend of gross profit for 2007, 2008 and 2009

Between the years 2007 to 2008, the sales revenue increased by 11% while the cost of sales increased by 18.7% during the same period and the percentage decrease of the gross profit was 19%.

Between the years 2008 to 2009, the sales revenue increased by 13.6% while the cost of sales increased by 22.8% during the same period and the percentage decrease of the gross profit was 38.8%.

In the two situations, the cost of sales has increased by a greater percentage than the sales revenue clearly explaining the declining trend in the gross profit and thus showing that sales revenue and cost of sales are the major determinants of the gross profit of a business. Therefore,

Expenses/Overheads

Overheads are ongoing expenses that an operating business incurs and that cannot be directly assigned to a particular product or department. They are also known and ‘indirect costs’. Examples of such expenses of Afroplast are; labour costs, depreciation, machinery repairs and administrative expenses.

Net profit is the amount earned by a business after subtracting the expenses from the gross profit. Overheads are major factors that affect the net profit of a business. When the gross profit of the business is high but these expenses are equally high then the net profit will be lowered compared to when the gross profit is high and these expenses are relatively low. This shows that the net profit is dependent on these two variables and also it highlights the significance and need to manage the expenses effectively in order to yield a high net profit. Thus,

For Afroplast, the expenses increased over the period under consideration (Appendix 3), as shown in the graph below:

Graph 4: Increase in expenses/overheads

This increasing trend of overheads certainly impacted negatively on the net profitability of Afroplast; hence the need to discover a solution since this essay is investigating ways and means of Afroplast to reverse the trend of falling profitability.

Since the gross profit and the expenses varied during the three years, there were variations in the net profit as well as shown below:

Graph 5: Trend of Net profit (before taxation)

Graph 6: Trend of Net Profit (after taxation)

In the graphs above, the decreasing/downward trend of the net profit is attributed to the increasing expenses/overheads and the decreasing gross profit.

Profitability Ratios

These are financial ratios that measure the performance (whether it is good or poor) of a company by analyzing the profit made by the firm and these figures are compared with the size of the firm, the total assets of the firm and the total sales made by the firm in the trading year.

From the profit and loss accounts and balance sheets, I was able to calculate the relevant ‘profitability’ ratios namely: the gross profit margins, the net profit margin and the Return On Capital Employed (ROCE), with a view to assessing Afroplast’s financial performances, especially its ability to control expenses and to be able to recommend whether investors should risk their money in the business.

Gross Profit Margin (%)

Gross profit margin is the gross profit as a percentage of the sales revenue. The gross profit margin indicates what the firm receives as the return after the variable costs are deducted from the sales revenue. [4] The gross profit margin can be calculated using the formula below:

A low gross profit margin indicates that the company generates low amounts of earnings from the revenues and that the production costs are beyond the control of the business.

Table 1: Gross profit margin of Afroplast Enterprises Limited for the years 2007, 2008 and 2009

2007

2008

2009

Sales Revenue, Ushs

3,023,634,982

3,356,072,259

3,813,406,161

Cost of sales, Ushs

2,406,646,173

2,855,756,248

3,507,362,578

Gross profit, Ushs

616,988,809

500,316,011

306,043,583

Gross profit margin, %

20.41

14.91

8.03

Comparing the three years, it is evident that the gross profits of the company have been decreasing over the time period even if the sales revenue has been increasing. The reason as to why this is seen through the figures of the cost of sales that are increasing by approximately a factor of 1.2.

Net profit margin (%)

Net profit margin is the net profit – after taxation, as a percentage of the sales revenue. For example, in table 2 in 2007, the firm made a net profit margin of 7.08% which means that for every $100 of sales $7.08 is net profit. This is the profit that is left after all costs of production (both direct and indirect costs) have been accounted for.

This margin is a measure of the profitability of a business and gives the ability of the business in controlling its expenses. Net profit margin is calculated as shown below:

The lower the net profit margin, the lower the safety margin which means that the company is at a higher risk that a decline in the sales will minimize or even completely eliminate the total profits thus lowering the net income/profits earned.

Table 2: Net profit margin of Afroplast Enterprises Limited for the years 2007, 2008 and 2009

2007

2008

2009

Sales Revenue, Ushs

3,023,634,982

3,356,072,259

3,813,406,161

Net Profit, Ushs

214,057,161

206,455,164

12,262,459

Net Profit margin, %

7.08

6.15

0.32

Comparing the three years, it is evident that the net profit of the company has been decreasing over the time period even if the sales revenue has been increasing. The reason as to why it is like this is because the net profit decreased drastically from 2007 to 2009. A decrease in the net profit is attributed to the rising cost of sales and expenses during the three years. A decrease in net profit margin also illustrates that Afroplast is increasingly losing on its profits and thus the company as a whole has a lower safety margin. This underscores the urgency of Afroplast managing their expenses efficiently and effectively.

ROCE (Return on Capital Employed)

ROCE is referred to as a primary ratio that informs the stakeholders of a business about the effectiveness of the business in returning profit from the capital that has been invested into the business. [5] In short, this ratio compares the earnings of a business to the capital invested in it.

It is also known as the Return on Net Assets (RONA) and calculated using the formula shown below:

The greater the ROCE is, the higher the shareholder’s earnings since there will be a decrease in the borrowings. The capital employed is another word for the working capital which is calculated by total assets minus the current liabilities.

Table 3: ROCE of Afroplast Enterprises Limited for the years 2007, 2008 and 2009

2007

2008

2009

Net Profit before taxation, Ushs

241,030,062

306,118,902

12,262,459

Total Assets, Ushs

2,465,212,083

2,637,513,470

3,016,978,394

Current Liabilities, Ushs

294,426,649

706,472,837

968,402,598

Capital Employed, Ushs

2,170,785,434

1,931,040,633

2,048,575,796

ROCE

11.103

15.853

0.599

There is fluctuation in the return on capital employed from 2007 to 2008 where the return on the capital employed increased implying that the shareholder’s earnings increased as well. However, from 2008 to 2009 the return on the capital employed decreased by 96.2% implying that the shareholder’s lost a lot of their earnings possibly even more than the capital they must have invested. A decrease in the shareholder’s earnings indicates that the borrowings of company must have increased during the trading period of 2009 thus resulting in a lower total income earned affecting the profitability of the business. The net profit (before taxation) is what has attributed to the drastic fall in the ROCE from 2008 to 2009.

Recommendations

Market Development

Market development is part of Ansoff’s product and market growth strategies. Market development involves the marketing of existing products in new markets. In the case of Afroplast, the company can venture into new markets like the greater lakes region especially Burundi, Rwanda and Democratic Republic of Congo (DRC).

Furthermore, the poor infrastructure in these countries may be a limiting factor to accomplish this strategy. Also, there is still insecurity in some of these countries like Burundi. Existent companies in a similar field pose as competitors thus limiting their market share.

Market Penetration

Market penetration is also one of Ansoff’s product and market growth strategies which involves marketing current products in existing markets.

The SWOT analysis shows that one of the weaknesses of the firm is lack of advertisement and aggressive sales staff [6] . This serious weakness has to be addressed by Afroplast as they embark on market development in these foreign countries. Since their target audience is mainly business organizations, then, Afroplast could use media such as televisions, national newspapers, billboards as well as professional magazines in these countries. Successful advertisement (both informative and persuasive) helps to increase the sales revenue – something that Afroplast desperately needs. As for not having aggressive advertising staff, Afroplast should use off-the-job training where some of the workers are sent to colleges. This will serve to complement the on-the-job training already being employed by the firm. However, it should be noted that all of these measures will increase costs incurred by the firm, at least in the short run but will pay off in the long run.

Furthermore, the questionnaire given out to customers reveals the opinions of the customers on the company and especially shows how the business is deficient of effective and enough marketing of their products.

Diversification

Diversification occurs when a company produces new products that are intended for new markets. Afroplast Enterprises Ltd deals in plastic products, however they could venture into other products such as mineral water which they can sell into other markets like southern Sudan. The purpose of this is to increase their revenue and minimize the dependability on the existing products and markets. Increase in revenue will therefore imply increasing profitability.

This option should also be considered since the customers purchase the products from the business mostly twice a year which is not a good sign in terms of the sales revenue as seen from the primary research that was carried out. This shows that the business needs to diversify in order to enlarge the market as well as augmenting its sales revenue which will help the firm improve its profitability.

Michael Porter (1980) in his book ‘Competitive Strategy’ suggested that under certain circumstances business can influence the markets in which they operate. One of the five forces that determine the extent to which businesses are able to manage competition within their markets is the ‘threat of new entrants’. [7] In the case of Afroplast Enterprises Ltd the threat of new entrants arises from the previous customers who are now manufacturing the products, which they used to purchase from Afroplast, themselves. This decreases the revenue earned by Afroplast and in turn affect their profitability negatively.

This happens because it is simpler for the new entrants to penetrate the market. It is possible that businesses may be prevented or deterred from entering the existing markets due to barriers of entry. For example, for Afroplast the business may have to invest in promotions heavily that will act as a barrier for other businesses in the same field who will find it difficult to match such high level of promotional spending thus they will be unable to attract as many customers as Afroplast does. Attracting more customers will imply that the sales of the products have increased thus the sales revenue increases. As a result of the sales revenue increasing the profitability is most likely to increase. However, since the business will be spending heavily on the promotion, the expenses that the business has will increase which might worsen the condition of the business. This can suggest that this method of increasing sales revenue will not be really feasible.

Conclusion

In answering the research question ‘What should Afroplast Enterprises Ltd do in order to reverse the falling trend of profitability?’ I determined the trends in the sales revenue, costs of sale, gross profit as well as net profit.

The sales revenue has been rising and should continue rising by diversifying, that is, developing new products for new markets and market development. The rising cost of sales should be reduced by securing cheap cost of raw material if possible, for example, from China. However, the business may not have much control over the costs of raw materials imported because of the appreciating exchange rate of the local currency, Ugandan shillings, against the US dollar [8] .

I also determined the trend of the expenses that the business had in the three years and discovered that they rose drastically mainly due to increase in the financial costs especially the interest charges that almost doubled. The expenses can be reduced by choosing different sources of finance other than loans such as sale of more shares to relatives and friends since it is a private limited company. Afroplast can also think of other long-term sources of finance like converting into a public limited company where the pool of capital increases drastically by the sale of shares to the general public on the stock market. The problem with this is that it is a very expensive process because of the legal technicalities and the expenses of producing a prospectus for the prospective investors. There is also the danger of the current shareholders losing control over the business once turned public.

The company should also maintain their pricing strategies that have been employed in the past such as promotional and competitive since these strategies are being accepted by the customers as seen in their responses to the questionnaires as seen below:

I should mention here that the final accounts I have used (herein referred to as ‘income statements’) do not reveal anything about Afroplast’s non-financial matters (qualitative factors) such as; ethical objectives, and the location of the firm that could seriously impact on the sales revenue and/or cost of sales and thus the profitability of the firm. Furthermore, the income statements used, while lawfully produced, it does not mean that they report the complete truth.

Bibliography

Paul Clark, Peter Golden, Mark O’Dea, John Weiner, Phil Woolrich, Jorge Olmos. Business and Management Course Companion. New York: Oxford University Press, 2009.

Biz/ed. What is sales revenue? 29 October 2010 .

MapXL. Profitability Ratios. 20 November 2010 .

Tutor2u. tutor2u. 23 November 2010 .

WebFinance. Net Profit Margin. 15 November 2010 .

Wikipedia. Profit Margin. 19 September 2010. 19 November 2010 .

Appendix 1: Interview with the Managing Director of Afroplast Enterprise Limited, Uganda

Hello, my name is Kalgi Desai and I am carrying out this interview as part of my investigation for my Extended Essay- a requirement for the IB curriculum. This interview is intended for purely academic investigation with extreme confidentiality. No one can and will ever gain access to the information that you provide.

Afroplast Limited in Kenya, as mentioned in the brochures, backs this company with their technical expertise. What is the connection between the Afroplast Enterprise Limited in Kampala and that in Kenya?

Afroplast Enterprise Limited in Kenya is not a direct partner with the company in Kampala. However the two companies have common shareholders and when any one of them is in a crisis situation, the other company will come in to help with any kind assistance needed.

With COMESA in place, are there any plans in taking advantage of this opportunity? If yes, what does the company plan to do in order to make it more competitive and have an edge of the other companies dealing in the same products in Kampala?

COMESA has its own opportunities and challenges. Afroplast Uganda already has associates in Nairobi that covers the market over there and Afroplast Uganda is responsible for covering the market in Uganda so there isn’t much requirement to venture into Nairobi in order to minimize the transportation costs. All competitors use the same raw materials as we do that are imported so the costs are the same except for the transportation.

Who are the competitors – major ones?

Nice Plastics Ltd.

Rwenzori Ltd.

Multiple industries

How have they affected the company’s sales?

The industries that now deal in the same products were not in this exact field. They ventured into this field of plastics upon realization that Afroplast is producing such goods. The competitors have of course affected the sales and it is quite concerning and worrying since part of our customers have become our competitors and so there is a reduction in the sales revenue. However, there are customers who remain loyal to the company so there is a change in the market but not complete loss of the market

How is the company trying to cope with the competition being faced in this field of plastics?

Matching the market prices in order to maintain the current market size and share

Making customized products (products according to the customer’s wishes)

Controlling costs of production and making the production process more efficient to have a competitive edge over the other companies.

What is the Unique Selling Point (USP) of the products manufactured by the company?

The company provides various services apart from the just making the products such as:

Punctual delivery

Fast services in case of technical problems with the finished products

Quality products at reasonable prices

Are there any incentives or tax holidays or any sort of help from the Ugandan government?

There are no tax holidays in Uganda since the only aid or incentives given are for the start-up of businesses. There aren’t any additional incentives given to already operating businesses. A possible reason for the minimal help can be because the Ugandan government does not have enough resources and also the cost of running and operating a business in Uganda is high