DEUTSCHE

BRAUEREI
B.B.Chakrabarti
IIM Calcutta
August 2005
 The Agenda for the January,
2001 Meeting of BOD

 Approval of the 2001 financial

budget

 Declaration of the quarterly dividend

 Adoption of a compensation scheme

for Oleg Pinchuk
 Deutsche Brauerei (DB)

 Entirely
owned by 16 uncles, aunts
and cousins in the Schweitzer family
 Year 2000:

Sales=€ 92.1 mn, Profits= € 2.9 mn.

 Founded in 1737
 Produces High Quality Beer
 Expansion into Ukraine
 Expanded into Ukraine in 1998 due
to surplus capacity
 Ukrainian currency ‘Hryvna’
depreciated by around 50% against
DM within 3 months following
Russian debt crisis in 1998.
 DB overcame the lowering effect by
increased volume.
 Expansion into Ukraine
 By early 2001 Ukraine accounted for
28% of DB’s sales.
 DB’s volume growth over the past 3
years was primarily due to Ukrainian
sales.
 DB marketed beer in Germany
through a network of independent
distributors, who purchased beer
from DB and sold to the retail
distribution chain. Marketing in
Ukraine was different.
 Views of Uncle on Oleg
Pinchuk

 Quite pleased with Oleg.

 Oleg organized 5 distributorships,
211 customer accounts and
warehousing arrangements in
Ukraine in 30 months on a small
budget(!).
 He really produces results(!).
 Views of Uncle on Oleg
Pinchuk

 Current earnings: € 81,440 (Base

salary-€40,000 and incentive of 0.5%
on annual sales increase in Ukraine.
 Proposal is to increase base salary to
€48,000 and incentive payment to
0.6% of the annual sales increase in
Ukraine.
 Views of Uncle on New
Investments
 Ifpresent growth continues, unused
productive capacity will be
exhausted by late 2001.
 2001 budget - € 7 mn investment in
plant and equipment.
 Proposed investment in 2002 as
suggested by Oleg - € 6.8 mn. in
warehouse and distribution center in
Ukraine.
Views of Uncle on Dividends

 Increase in dividends for this quarter

to a total of € 698,000, one-fourth of
the dividends projected to be paid in
2001.
 Traditionally DB pays 75% dividend
payout from earnings each year to
serve older family stockholders.
Oleg’s Marketing Strategy and
Achievements in Ukraine
 Oleg set up distribution line from
scratch.
 There were willing entrepreneurs but
without capital.
 Oleg extended credit unlike the
practice in Germany.
 Initially 2/10, net 40 to now 2/10, net
80.
 He wants to increase the credit
period to 90 days.
Oleg’s Marketing Strategy and
Achievements in Ukraine
 He anticipates bad debts to only 2%.
 Oleg considers the distributors as
real entrepreneurs.
 Some have past due on their
payments, but Oleg is confident of
recovery.
 Retailer are growing without bank
support. Uses “bootstrap financing”.
Delays payments.
Oleg’s Marketing Strategy and
Achievements in Ukraine
 Oleg feels that the return on
investment in receivable in Ukraine is
130% against cost of funds of 6.5%.
 His marketing strategy involves field
warehousing i.e. carrying a
substantial part of distributors’
inventory in the books of DB.
 Sales in Ukraine grew 47% in 2000.
 Analysis of Exhibit 1
 Modest increase in sales in Germany.
 Sales growth is primarily in Ukraine.
 Accounts receivable in Ukraine
rapidly increasing.
 Inventories increasing.
 Short-term bank borrowings rapidly
increasing.
 Modest increase in Shareholders’
equity.
 Analysis of Exhibit 4

 Operating profit margin declining.

 Huge receivables growth rate in
Ukraine.
 Days in receivables stand at 87.1 in
2000.
 Inventories to sales increasing.
 Analysis of Exhibit 6
 While calculating ROI, investment is
taken as the marginal investment in
receivables. Return is taken as the
marginal after-tax contribution.
 ROI in Ukrainian sales is shown as:

1998- 327%
1999- 118%
2000- 130%
 Distributors in Ukraine
 Kiev is relatively strong while
Donetsk is decidedly weak.
 Distributors are greatly assisted by
trade payables and relatively low
inventories.
 Distributors are extending credit to
retailers.
 Low levels of ST and LT debts signify
dearth of bank financing.
 Profitability of Eastward
Expansion
 ROI should be calculated considering
investments in inventories and fixed
assets for Ukrainian sales.
 Considering these and no bad debts,
the ROI in 2000 is 33% and expected
to be 26% in 2001 and 27% in 2002.
 With 10% credit loss the ROI in 2001
drops to 19.9%.
 Profitability of Eastward
Expansion
 Ukraine market is more risky. So
more returns needed.
 Ukrainian Govt. borrowed
internationally at around 16% yield in
January 2001.
 So, any foreign business should earn
more than 16% to compensate for
higher risk.
 6.% cost of funds in Germany is
certainly not applicable.
 Profitability of Eastward
Expansion

 Ukrainian expansion does not appear

profitable.
 Profitability depends on luck and the
ability to manage foreseeable risks.
 Sensitivity Analysis of
Alternate Scenarios
Base case as projected by Uncle

ROE in 2001 – 12.7%

ROE in 2002 – 14.2%
 Sensitivity Analysis of
Alternate Scenarios
Credit period in Ukraine cut to 41 days
with sales growth of 2%

ROE in 2001 – 12.3%

ROE in 2002 – 12.6%
 Sensitivity Analysis of
Alternate Scenarios
Credit period in Ukraine cut to 41 days
with sales growth of 2% and no plant
expansion in 2001 and 2002

ROE in 2001 – 13.2%

ROE in 2002 – 14.2%
 Sensitivity Analysis of
Alternate Scenarios
Dividend payments reduced to 25% of
net income

ROE in 2001 – 12.2%

ROE in 2002 – 13.0%
 What should DB do?
 Stop capital expansion oriented
toward the East.
 Tighten credit policy toward the
Ukrainian distributors. This will
reduce sales.
 Improve profitability.
 Cut dividend to 25%.
 Pinchuk was sales-focused. Needs to
focus on collections, profits and
efficient use of assets. His
compensation needs to be ????