Part A

In the early 1980s, Bernard Hancock built a small brewery on his 150-acre property in the Macedon Ranges. The brewery, named Mountain Mist Brewery, was designed with ales in mind and Bernard introduced a number of cutting-edge and innovative technologies to make the well-known, popular pale ale Misty Hop and others such as Hazy Heidi, Mountain Maid and Sunny Sherpa. The brewery’s highest selling pale ale (Misty Hop) is widely recognised as a high-quality boutique beer and is sold, along with the brewery’s other ales, to clubs and restaurants around Australia.

All Mountain Mist Brewery ales are distributed in kegs (large containers) and 12-bottle cartons through its Victorian and national wholesalers. The brewery has continued to expand capacity on its site to meet growing consumer demands. Bernard’s vision for Mountain Mist Brewery is to:

• grow profitably with incremental investment into selected markets to become one of the top six breweries in Australia

• continuously improve perceived consumer quality by improving taste, freshness, package integrity and package appearance

• enhance distributor service with better lead times, accurate order fills and lower product damage

• continuously lower company costs per litre of beer so Mountain Mist can maintain resources for long-term productivity and success

• continuously improve business performance through engaging and developing employees.

Given recent sound performance, Bernard is pleased he had made the decision to expand Mountain Mist’s production interstate. This decision was made in line with Bernard’s key objective to be one of the top six national competitors. Mountain Mist currently holds seventh position. With its nearest competitor, Little Creatures, expanding into the eastern market from its Western Australian base, Bernard wants to ensure Mountain Mist will not only maintain market share but grow in size to take Little Creatures’ sixth position. Bernard wants to improve Mountain Mist’s brand presence in the western region, as well as reduce the transportation costs of moving beer across Australia. A local presence in Western Australia would also help reduce reliance on national retail distribution channels.

A production site has been selected. A production manager from the Macedon Ranges site has been given the role of overseeing the operational set-up and staying on to manage the new operation. Others, such as microbiologists from the Mountain Mist laboratory, have also been offered the opportunity to move interstate. Thus, Bernard is moving some expertise from the Macedon Ranges and employing more staff at both sites to meet the new staffing requirements. As well as wanting a smooth manufacturing set-up, Bernard argues that it is vital for the Mountain Mist beer to be 100 per cent comparable between manufacturing sites. For Bernard, there are many issues still to contend with in relation to sourcing raw materials.

Bernard also needs to employ a manager to oversee the sales side of the Western Australia venture.

He has offered the role of Western Australia Sales Manager to Matt Jerome. Matt is in his late 20s and had been working for Mountain Mist for about four years in the administration area as an accounts clerk. He has recently spent time on the administrative side of the new Western Australian operations. Bernard is pleased with Matt’s work and knows he is keen to move from administration and account keeping into managing sales at the new facility. While he has not had any previous sales experience, Bernard is keen to offer Matt this personal development opportunity.

Matt’s salary comprised a base salary and an incentive based on sales performance. While Mountain Mist had the corporate balanced scorecard (described earlier), they did not link scorecard results to their sales managers’ incentive plans. Bernard was concerned that the balanced scorecard measures would not drive the innovation and risk he required of his sales team. For example, Bernard wanted his sales team to continue to have the flexibility to make last minute changes if their customers required. He thought if they were influenced by rigid balanced scorecard performance measures, they might, in fact, be demotivated. He was also worried that they would work to the measure rather than profit maximisation through meeting customers’ unique, changeable and often immediate needs. 

Thus, Matt was able to earn a bonus based on the sales generated in the Western Australian region. Matt was also given the autonomy to hire his own sales and administration staff to help manage this new sales division. In addition, Bernard left Matt responsible for overseeing both sales and bookkeeping roles. After all, Matt had excelled at his administrative role in the past.

Bernard has contemplated varying remuneration options for Matt. Although Matt will have assets under his control, Bernard decides to reward Matt based on the following incentive structure:

• base salary — $120 000 per annum

• individual bonus — based on the Western Australian division’s EBIT (capped at $50 000 per annum)

• corporate bonus — based on Mountain Mist’s corporate performance (2 per cent share of ‘above budget’ corporate profit pool)

• other — 50 per cent of private health insurance cost, relocation expenses for Matt’s family. 

Matt has moved his family from the Macedon Ranges to Western Australia and begun to promote Mountain Mist Brewery. The aim is to have manufacturing operations and sales in place for summer.

Required

(a) Discuss the benefits and limitations of Matt’s incentive scheme proposed by Bernard.

(b) It is mentioned in the case that Matt has assets under his control. What performance measurement alternatives could Bernard have used? How might they improve (or otherwise) on the scheme proposed by Bernard?

Part B

Once the Western Australian operation has settled and sales are going well, Bernard considers further expansion opportunities. Given the mature life cycle status of the brewery industry, declining consumption, strong competition from leading producers and competition from substitute products, Bernard wants to expand his business in other value-adding ways. He calls on his management team for ideas. One potential idea worth pursuing comes from Damien Poulsen, a long-term employee.

Damien Poulsen has been Bernard’s one and only production manager in charge of Mountain Mist’s spring water. Bernard has great respect for Damien’s work ethic and long-standing commitment to Mountain Mist. Damien is also a qualified microbiologist and employs a team of experts to extract and process the Mountain Mist spring water for the brewing department.

A large portion of the Spring Water department’s (SWD) activities relates to the quality control (QC) function for Mountain Mist Brewery. Their main requirement is to ensure the spring water continually meets Mountain Mist’s strict specifications. The mix of sulphates, calcium, phosphorous and magnesium must be correct as excessive amounts of any ingredient can result in poor tasting ales. It can also lead to residue forming on the ale containers. As the spring water from Mountain Mist’s Macedon Ranges spring provides beautifully tasting spring water (free of excessive mineral content) and more than enough spring water for the beer manufacture, Damien Poulsen suggested to Bernard that they expand production into bottled water sales. He points out that spring water is the fastest growing beverage type in Australia and Mountain Mist would be foolish not to take advantage of the opportunity to participate in this market. Australians spent more than $500 million on bottled water last year, a 1.6 per cent increase on the previous year. The current key competitors in the bottled water market include Coca-Cola Amatil Limited (42 per cent), P&N Beverages Australia Pty Ltd (22 per cent) and others (36 per cent). These key competitors own prominent brands including Mount Franklin, Peats Ridge and Cool Ridge. Damien suggests to Bernard that a niche marketing opportunity exists and that they should compete with the higher-priced sparkling and still water brands, which include European imports such as San Pellegrino and Perrier.

Damien is also aware of exploiting the growing market sensitivities towards increased water consumption. For instance, climate change has increased demand for bottled water (because of the extended hot summers). However, the demand remains high throughout the cooler seasons of the year for other sports and health-related reasons. The factors that significantly contribute to increasing demand for bottled water include general health awareness and greater knowledge of the benefits of adequate water consumption, concerns about the microbiological condition and taste of tap water in some regions, and the fact that many consumers are beginning to acknowledge bottled water as a healthy alternative to high-sugar soft drinks.

In Damien’s proposal, he outlines the cost structure required for the bottled spring water proposal. He builds his figures from the industry data. He bases his figures on the average retail price for one litre of bottled water ($2.53). Damien outlines the purchases that are most significant to this industry. They include containers, labels and other packaging materials. He explains how the costs for water extraction, such as pumping equipment, have been included in the depreciation cost (but mentions that these costs are currently paid for in full by the brewery). Water costs are relatively minor. That is, they pay the Macedon Ranges Shire Council fees for ground water extraction; however, the fees are insignificant.

In the proposal, Damien also mentions that he could draw on existing labour for the production processes, but will need a small number of additional staff to handle the clerical, sales and marketing functions. The total labour costs are equivalent to 14.7 per cent of revenue. In this machineintensive industry, approximately 53 per cent of total labour is required for managerial, clerical, sales, marketing and other functions. The remaining 47 per cent of total labour is involved in the bottled water production.

Damien includes asset acquisitions and associated depreciation costs in his proposal. To begin, he includes full depreciation costs on existing equipment required for the filtration, UV sterilisation and zonation processes that remove undesirable compounds and organic elements from the spring water. Damien also includes the purchase of new assets such as computers and automated bottle production lines in his depreciation costs. In addition, he includes the purchase and depreciation on two trucks required to transport the bottled water to distributors from the Mountain Mist source. In Damien’s list of acquisitions required, he makes mention of new legislative requirements associated with environmental emissions. With this impending legislation, Damien allocates funds to the newly implemented carbon pollution reduction scheme (CPRS) that will measure, monitor and report on the Mountain Mist carbon emissions. To meet the legislative requirements, Damien needs to allocate a percentage of staff resources (15 per cent of one full-time employee’s wages) and equipment to correctly measure their carbon emissions. He notes that this additional cost will be incurred regardless of the decision to invest in the bottled spring water project.

Damien also includes accounting, auditing, repair, maintenance, market research and advertising as components of ‘other’ costs. Marketing is a significant cost to the bottled water industry given the need to differentiate a largely homogeneous product. He explains that, in Europe, for water to be designated ‘natural’ it must be bottled at the spring. This could be an important marketing feature for Mountain Mist bottled spring water, even though Australia does not have such a labelling requirement. He mentions how competitor water that has been transported in holding tanks to bottlers can risk contamination. As such, water that is not bottled on site may require chlorination which in turn affects the taste. Mountain Mist water, as it is bottled onsite, can truly offer the ‘natural’ European equivalent marketing feature. Damien explains how they would pitch this style of marketing in the up-market hospitality channel representing pubs, restaurants, cafés, cinemas and arenas. They will also focus on marketing to supermarkets and convenience stores as sales through these major outlets comprise 67 per cent of total bottled water sales, but, in this setting, they will not compete on price. He points out that while price is important (that is, they will compete with house brands and generics), the image, particularly from the large brands, remains the most important factor in establishing market share. The niche market could bear additional costs for perceived additional quality and image created by the brewery arm.

The main thrust of Damien’s argument is for Mountain Mist to exploit its economies of scope by expanding its beverage offerings. He explains that while materials and packaging are the main cost pressures, he hopes to achieve up to 60 per cent gross profit margin on the Mountain Mist private-label bottle water sales. He argues that he can reduce many of the costs. For example, input costs will be reduced as Mountain Mist has the spring water onsite. Rent is not applicable as Mountain Mist owns the Macedon Ranges facilities. In addition, wages, much of the depreciation and other costs can be allocated to the brewing division as it is currently paying for them anyway.

As Bernard evaluates Damien’s $30 million bottled water proposal, he also considers the key success factors in the bottled water manufacturing industry.

• Control of distribution arrangements — arrangement of distribution ensures timely delivery, low costs and maximised product reach.

• Economies of scope — economies of scope refer to the efficiencies in distribution, marketing and administration when a firm produces a wide range of beverage brands.

• Having a good reputation — first movers have an advantage in this industry in that they can establish strong reputations, which means new competitors need to spend heavily on marketing to catch up.

• Market research and understanding — market research into consumer profiles, attitudes and preferences are important for informing both brand promotion and bottle and label design.

• Marketing of differentiated products — product innovation and differentiation (including packaging) contributes significantly to selling the industry’s products.

• Economies of scale — scale economies are very important to a low-value product since high volumes must be produced and sold to achieve reasonable profits.

• Establishment of brand names — strong brand names contribute to the appeal of bottled water as an accessory, as well as building a product’s reputation of quality. This allows bottlers to both win market share within particular consumer segments, and to charge premium prices. • Attractive product presentation — the design of the bottle is of importance in winning market share and justifying higher pricing in this competitive industry.

• Effective product promotion — use of in-store merchandising can have a strong influence on consumer choice.

This all sounds quite interesting to Bernard, but he does wonder at the effect of the carbon pollution reduction scheme and the more recent negative publicity bottled water is receiving. This negative publicity surrounds the view that bottled water is not environmentally friendly as it requires significant greenhouse gas emissions and plastic bottles commonly end up in landfill.

Bernard wonders at the viability of Damien’s $30 million proposal. 

Required

(a) Advise Bernard on the types of strategic risks you might associate with Mountain Mist. In your discussion, include the risks associated with the expansion of Mountain Mist’s brewing to Western Australia and into the spring water market. You may also wish to discuss the beverage industry in general.

(b) What do you consider the level of risk exposure for Mountain Mist? Justify your answer using the risk profile discussion in this chapter.

(c) What suggestions do you have for Bernard to overcome these risks?