6653538-Deutsche-Brauerei

DEUTSCHE DEUTSCHE BRAUEREIBRAUEREI

B.B.ChakrabartiB.B.Chakrabarti

IIM CalcuttaIIM Calcutta

August 2005August 2005

The Agenda for the January, The Agenda for the January, 2001 Meeting of BOD2001 Meeting of BOD

Approval of the 2001 financial Approval of the 2001 financial budgetbudget

Declaration of the quarterly dividendDeclaration of the quarterly dividend

Adoption of a compensation scheme Adoption of a compensation scheme for Oleg Pinchukfor Oleg Pinchuk

Deutsche Brauerei (DB)Deutsche Brauerei (DB)

Entirely owned by 16 uncles, aunts Entirely owned by 16 uncles, aunts and cousins in the Schweitzer familyand cousins in the Schweitzer family

Year 2000:Year 2000:

Sales=€ 92.1 mn, Profits= € 2.9 mn.Sales=€ 92.1 mn, Profits= € 2.9 mn. Founded in 1737Founded in 1737 Produces High Quality BeerProduces High Quality Beer

Expansion into UkraineExpansion into Ukraine

Expanded into Ukraine in 1998 due Expanded into Ukraine in 1998 due to surplus capacityto surplus capacity

Ukrainian currency ‘Hryvna’ Ukrainian currency ‘Hryvna’ depreciated by around 50% against depreciated by around 50% against DM within 3 months following DM within 3 months following Russian debt crisis in 1998.Russian debt crisis in 1998.

DB overcame the lowering effect by DB overcame the lowering effect by increased volume.increased volume.

Expansion into UkraineExpansion into Ukraine

By early 2001 Ukraine accounted for By early 2001 Ukraine accounted for 28% of DB’s sales.28% of DB’s sales.

DB’s volume growth over the past 3 DB’s volume growth over the past 3 years was primarily due to Ukrainian years was primarily due to Ukrainian sales.sales.

DB marketed beer in Germany DB marketed beer in Germany through a network of independent through a network of independent distributors, who purchased beer distributors, who purchased beer from DB and sold to the retail from DB and sold to the retail distribution chain. Marketing in distribution chain. Marketing in Ukraine was different.Ukraine was different.

Views of Uncle on Oleg Views of Uncle on Oleg PinchukPinchuk

Quite pleased with Oleg.Quite pleased with Oleg. Oleg organized 5 distributorships, Oleg organized 5 distributorships,

211 customer accounts and 211 customer accounts and warehousing arrangements in warehousing arrangements in Ukraine in 30 months on a small Ukraine in 30 months on a small budget(!).budget(!).

He really produces results(!).He really produces results(!).

Views of Uncle on Oleg Views of Uncle on Oleg PinchukPinchuk

Current earnings: € 81,440 (Base Current earnings: € 81,440 (Base salary-€40,000 and incentive of 0.5% salary-€40,000 and incentive of 0.5% on annual sales increase in Ukraine.on annual sales increase in Ukraine.

Proposal is to increase base salary to Proposal is to increase base salary to €48,000 and incentive payment to €48,000 and incentive payment to 0.6% of the annual sales increase in 0.6% of the annual sales increase in Ukraine.Ukraine.

Views of Uncle on New Views of Uncle on New InvestmentsInvestments

If present growth continues, unused If present growth continues, unused productive capacity will be productive capacity will be exhausted by late 2001.exhausted by late 2001.

2001 budget - € 7 mn investment in 2001 budget - € 7 mn investment in plant and equipment.plant and equipment.

Proposed investment in 2002 as Proposed investment in 2002 as suggested by Oleg - € 6.8 mn. in suggested by Oleg - € 6.8 mn. in warehouse and distribution center in warehouse and distribution center in Ukraine.Ukraine.

Views of Uncle on DividendsViews of Uncle on Dividends

Increase in dividends for this quarter Increase in dividends for this quarter to a total of € 698,000, one-fourth of to a total of € 698,000, one-fourth of the dividends projected to be paid in the dividends projected to be paid in 2001.2001.

Traditionally DB pays 75% dividend Traditionally DB pays 75% dividend payout from earnings each year to payout from earnings each year to serve older family stockholders.serve older family stockholders.

Oleg’s Marketing Strategy and Oleg’s Marketing Strategy and Achievements in Ukraine Achievements in Ukraine

Oleg set up distribution line from Oleg set up distribution line from scratch.scratch.

There were willing entrepreneurs but There were willing entrepreneurs but without capital.without capital.

Oleg extended credit unlike the Oleg extended credit unlike the practice in Germany.practice in Germany.

Initially 2/10, net 40 to now 2/10, net Initially 2/10, net 40 to now 2/10, net 80.80.

He wants to increase the credit He wants to increase the credit period to 90 days.period to 90 days.


He anticipates bad debts to only 2%. He anticipates bad debts to only 2%. Oleg considers the distributors as Oleg considers the distributors as

real entrepreneurs.real entrepreneurs. Some have past due on their Some have past due on their

payments, but Oleg is confident of payments, but Oleg is confident of recovery.recovery.

Retailer are growing without bank Retailer are growing without bank support. Uses “bootstrap financing”. support. Uses “bootstrap financing”. Delays payments.Delays payments.


Oleg feels that the return on Oleg feels that the return on investment in receivable in Ukraine is investment in receivable in Ukraine is 130% against cost of funds of 6.5%.130% against cost of funds of 6.5%.

His marketing strategy involves field His marketing strategy involves field warehousing i.e. carrying a warehousing i.e. carrying a substantial part of distributors’ substantial part of distributors’ inventory in the books of DB.inventory in the books of DB.

Sales in Ukraine grew 47% in 2000.Sales in Ukraine grew 47% in 2000.

Analysis of Exhibit 1Analysis of Exhibit 1

Modest increase in sales in Germany.Modest increase in sales in Germany. Sales growth is primarily in Ukraine.Sales growth is primarily in Ukraine. Accounts receivable in Ukraine Accounts receivable in Ukraine

rapidly increasing.rapidly increasing. Inventories increasing. Inventories increasing. Short-term bank borrowings rapidly Short-term bank borrowings rapidly

increasing.increasing. Modest increase in Shareholders’ Modest increase in Shareholders’

equity.equity.


Operating profit margin declining.Operating profit margin declining. Huge receivables growth rate in Huge receivables growth rate in

Ukraine.Ukraine. Days in receivables stand at 87.1 in Days in receivables stand at 87.1 in

2000.2000. Inventories to sales increasing.Inventories to sales increasing.


While calculating ROI, investment is While calculating ROI, investment is taken as the marginal investment in taken as the marginal investment in receivables. Return is taken as the receivables. Return is taken as the marginal after-tax contribution.marginal after-tax contribution.

ROI in Ukrainian sales is shown as:ROI in Ukrainian sales is shown as:

1998- 327%1998- 327%

1999- 118%1999- 118%

2000- 130%2000- 130%

Distributors in UkraineDistributors in Ukraine

Kiev is relatively strong while Kiev is relatively strong while Donetsk is decidedly weak.Donetsk is decidedly weak.

Distributors are greatly assisted by Distributors are greatly assisted by trade payables and relatively low trade payables and relatively low inventories.inventories.

Distributors are extending credit to Distributors are extending credit to retailers.retailers.

Low levels of ST and LT debts signify Low levels of ST and LT debts signify dearth of bank financing.dearth of bank financing.

Profitability of Eastward Profitability of Eastward ExpansionExpansion

ROI should be calculated considering ROI should be calculated considering investments in inventories and fixed investments in inventories and fixed assets for Ukrainian sales.assets for Ukrainian sales.

Considering these and no bad debts, Considering these and no bad debts, the ROI in 2000 is 33% and expected the ROI in 2000 is 33% and expected to be 26% in 2001 and 27% in 2002. to be 26% in 2001 and 27% in 2002.

With 10% credit loss the ROI in 2001 With 10% credit loss the ROI in 2001 drops to 19.9%.drops to 19.9%.


Ukraine market is more risky. So Ukraine market is more risky. So more returns needed.more returns needed.

Ukrainian Govt. borrowed Ukrainian Govt. borrowed internationally at around 16% yield in internationally at around 16% yield in January 2001.January 2001.

So, any foreign business should earn So, any foreign business should earn more than 16% to compensate for more than 16% to compensate for higher risk.higher risk.

6.% cost of funds in Germany is 6.% cost of funds in Germany is certainly not applicable.certainly not applicable.


Ukrainian expansion does not appear Ukrainian expansion does not appear profitable.profitable.

Profitability depends on luck and the Profitability depends on luck and the ability to manage foreseeable risks.ability to manage foreseeable risks.

Sensitivity Analysis of Sensitivity Analysis of Alternate ScenariosAlternate Scenarios

Base case as projected by UncleBase case as projected by Uncle

ROE in 2001 – 12.7%ROE in 2001 – 12.7%

ROE in 2002 – 14.2%ROE in 2002 – 14.2%


Credit period in Ukraine cut to 41 days Credit period in Ukraine cut to 41 days with sales growth of 2%with sales growth of 2%

ROE in 2001 – 12.3%ROE in 2001 – 12.3%

ROE in 2002 – 12.6%ROE in 2002 – 12.6%


Credit period in Ukraine cut to 41 days Credit period in Ukraine cut to 41 days with sales growth of 2% and no plant with sales growth of 2% and no plant

expansion in 2001 and 2002expansion in 2001 and 2002

ROE in 2001 – 13.2%ROE in 2001 – 13.2%

ROE in 2002 – 14.2%ROE in 2002 – 14.2%


Dividend payments reduced to 25% of Dividend payments reduced to 25% of net incomenet income

ROE in 2001 – 12.2%ROE in 2001 – 12.2%

ROE in 2002 – 13.0%ROE in 2002 – 13.0%

What should DB do?What should DB do?

Stop capital expansion oriented Stop capital expansion oriented toward the East.toward the East.

Tighten credit policy toward the Tighten credit policy toward the Ukrainian distributors. This will Ukrainian distributors. This will reduce sales. reduce sales.

Improve profitability.Improve profitability. Cut dividend to 25%.Cut dividend to 25%. Pinchuk was sales-focused. Needs to Pinchuk was sales-focused. Needs to

focus on collections, profits and focus on collections, profits and efficient use of assets. His efficient use of assets. His compensation needs to be ????compensation needs to be ????

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6653538-Deutsche-Brauerei