KIWI Transportation-Excel financial analysis

1.Evaluate the pros and cons of each option facing Bobby Allen and KTC

2.Which of these options do you recommend and why?

3.Who are the main stakeholders in KTC? What does each one of these groups expect from KTC? Do any of the expectations conflict? How can KTC manage the various expectations?

Your final paper will include an extensive Excel spreadsheet financially evaluating KTC options. (NPV analysis)

You will also need the handout for the case to help with the financial analysis.

As 2007 drew to a close, Robert (Bobby) Allen III, owner and president of Kiwi

Transportation Company (KTC) of Auckland, New Zealand, faced a number of

pivotal decisions. The company, which had been owned by the Allen family

since 1976, had established itself as an integral part of the community on Auckland

Harbor, with a consistent revenue stream derived from a mix of commuters and tourists

in the region. Kiwi’s mission was to be the Auckland Harbor ferry of choice for commuters

and tourists alike. Under Bobby’s direction, the company had undertaken a

number of new strategic directions in the prior three years, and some of these were starting

to show great promise. At the same time, the firm’s profitability had stagnated and

now faced new pressures from rapidly rising energy prices and ever-increasing payroll

costs, driven primarily by employee benefit expenses. In trying to bolster KTC’s bottom

line, Bobby considered several options which could have dramatic impacts on the company’s

fundamental character and business model. In particular, Bobby had to evaluate

whether it was time to shut down one of its routes, which could result in a much leaner

and more profitable firm. At the same time, closing the route would mean that KTC

would be much less diversified and, going forward, more vulnerable to any environmental

trends that impacted its remaining crossing. He also considered making a major

investment in a new vessel and entering into a new segment of the business, with all the

competitive challenges that implied.

COMPANY HISTORY

In 1908, the Kiwi Transportation Company was incorporated in New Zealand and

began business ferrying leisure travelers and commercial goods across the Auckland

Harbor. By 2007, it was one of only a few privately owned ferry companies in the country.

Bob Allen Jr. purchased KTC in 1976. Prior to Bob’s acquisition, the company had

seen three different owners over a fifteen-year period and survived many challenges,

including the introduction of the railroads, buses, and automobiles; economic ups and

downs; and World Wars I and II. Over the years, ferries operated by Kiwi

Transportation Company had become an integral feature of Auckland Harbor and were

used by commuters, commercial vehicles, and visitors. Under Bob Allen’s leadership,

KTC undertook many new initiatives: service hours were extended on the Auckland to

Kiwi Transportation Company 1

Kiwi Transportation Company

Robert Letovsky, Saint Michael’s College

Debra M. Townsley, William Peace University

is a disguised case. The authors wish to acknowledge the research assistance of Dr. Joanne Williams,

University of Southern Maine.

2 Case Research Journal • Volume 31 • Issue 4 • Fall 2011

Devonport (AD) crossing, new ferries joined the fleet, and island tour cruises were

introduced to attract the tourist market. After being brought into the business in 1998

by his father, Robert (Bobby) Allen III led the company into several new areas, including

tours and theme cruises. However, Bobby realized that in recent years KTC had seen

the margins on some of its routes drop, in some cases dramatically. He wondered if it

was time to radically restructure KTC’s portfolio.

MANAGEMENT

In the mid-1990s, Bob Allen Jr. began conversations with his son and only child, Robert

(Bobby) Allen III about the possibility of Bobby taking over the company. At that time,

Bobby was running his own small but very successful chain of coffee shops in and

around Christchurch, New Zealand. Bobby had moved there in the late 1980s to be

closer to several friends and for hiking New Zealand’s South island. He started his first

coffee shop in 1988 and within five years had developed a chain of four stores in and

around the city. Bobby had grown up on the water, working at KTC during summers

while a student and briefly after graduation as both a deckhand and then an assistant in

the office. In 1998, after lengthy discussions with his father, Bobby sold his coffee shops,

moved back to Auckland and returned to work full-time for KTC. While Bob maintained

his ownership of the majority of KTC shares, he named Bobby as president and

turned over those functions to him.

In 1999, Bobby began a wide-ranging change in the management team, hiring new

managers for human resource management, purchasing, engineering, and operations

management and retaining only one person from his father’s original management

team, CFO Barry Watson. KTC had always had a fairly long-serving workforce, with

the average time of employment with the firm about eighteen years. The senior management

changes Bobby introduced were difficult for some in the company to accept.

However, this resistance was mitigated somewhat by Bobby’s selection of a popular

employee as the new human resources manager.

In addition to the changeover in the management, Bobby added the Great Spotted

Kiwi cruise ship to the company operations. This was a direction that his father Bob

had not been interested in and was one of the first major strategic changes made under

Bobby’s leadership. In fact, Bob had made it clear over the years that KTC should stick

to what it did best—short haul crossings for daily commuters and tourists—and avoid

competing against other firms that had more experience in the hospitality industry.

Since Bobby joined the company, Bob began to travel more with his wife, spend more

time at their island home, and pursue his passion for photography. He served as a consultant

to Bobby but let him run KTC. Bob believed that he “needed to let his son make

his own decisions just as he had done when he bought the company in 1976.” Even

though Bob did not necessarily agree with Bobby’s directions for the company, he had

faith that Bobby would be successful in order to provide for his wife and new baby.

The final step in the transition took place with Bobby assuming full ownership of the

company in 2003 by purchasing his father Bob’s remaining shares in KTC. The purchase

was made by issuance of nonvoting preferred shares, whereby Bob would be repaid by a

share of future earnings coupled with fixed dollar payments over several years.

The challenges Bobby faced were different than those faced by his father when he had

purchased the company. Bob had focused on growth opportunities, such as offering

increased service on the AD crossing. Bobby’s overall vision was to improve what he

Kiwi Transportation Company 3

considered to be a “bullet proof” operation, and his father was a difficult act to follow.

Bobby’s plan for the company was to invigorate the management and leadership team,

maximize yield from a potentially narrower product line, further develop the cruise business,

and improve the productivity of the KTC fleet. It was clear that Bobby was prepared

to take KTC in directions that had not been considered in prior years and that he was willing

to assume the risks associated with these new directions. However, these new possibilities

raised several issues that KTC would have to confront as it moved forward.

CURRENT OPERATIONS

At the start of 2007, the company operated a commuter ferry crossing from downtown

Auckland to Devonport, another aimed at both residents and tourists, to Rangitoto

Island, and a scenic touring boat service around Auckland Harbor (see Exhibit 1 for

maps of the region).

Auckland/Devonport (AD) Crossing

The Auckland/Devonport crossing, KTC’s largest operation, offered year-round service

from early in the morning until late at night. The firm had up to eighty crossings during

weekdays, increasing to ninety-four crossings on Saturdays, but only sixty-two crossings

on Sundays. The service operated about every thirty minutes with a crossing time

of just twelve minutes and was heavily used by commuters traveling to and from work.

This ferry was considered to be a “bridge” crossing to Devonport, the oldest suburb of

Auckland. The schedule was designed so that if a customer could not get on the ferry

that was leaving, the next ferry would already be in sight. The Auckland/Devonport

crossing had experienced solid growth over the years with 2007 traffic of over 1,600,000

passengers, up over 11 percent from 2005 and more than four times the volume in the

late 1970s. The crossing was served by four of the company’s nine ships, with two ships

operating on any given day.

The largest ship serving the AD crossing was KTC’s flagship vessel, the 220-seat

Islander. The Islander had been acquired in the late 1980s and was considered one of

Bob Allen’s major achievements in terms of its then unprecedented capacity and efficiency.

The Islander operated during the morning (6:00–9:00 AM) and afternoon

(4:00–7:00 PM) rush hours, in conjunction with one of the other three smaller KTC

vessels assigned to the route. These other three ships (referred to as vessels 2, 3, and 4 in

Exhibit 2) had 115, 115, and seventy-five seats, respectively. Crossings during morning

and evening rush hours were generally full going into and out of downtown Auckland,

respectively, but return crossings during these times were practically empty. (Full was

defined by company management as about 86 percent of capacity after allowing for the

varying sizes of KTC’s vessels.) Meanwhile, mid-morning and night crossings could be

as little as 45 percent and 15 percent full, respectively. On average, therefore, AD crossings

were 49 percent full according to company estimates. Unlike the other commuter

crossings offered by KTC, the AD crossing was run purely on a commercial basis and

did not receive any subsidy from local authorities.

Rangitoto Crossing

This twenty-five minute scenic crossing had experienced a steady decline in traffic and

profitability over the past few years. The crossing left from KTC’s downtown Auckland

4 Case Research Journal • Volume 31 • Issue 4 • Fall 2011

dock, where the company owned five acres housing its executive offices and main maintenance

facility. It was serviced by KTC’s oldest boat with a seating capacity of up to

eighty. Company management insisted that the Rangitoto vessel was well maintained,

but conceded that its fuel efficiency was far below that of the more modern vessels serving

AD. The company ran four one-way trips per day on the route. The steady decline

in traffic was difficult for management to explain, but one assumption was that in

today’s fast-paced, “time poor” world, travelers were not interested in seeing the lava

rock island more than once. Additionally, a competitor ferry service went to Rangitoto

Island and serviced the nearby Motutapu Island with more frequency.

Great Spotted Kiwi Tourist Cruises

KTC built the Great Spotted Kiwi cruise ship in 2002, in order to enter the “cruise and

event” market. The vessel offered daily lunch cruises, narrated afternoon tours around

Auckland Harbor and the Islands, weekend brunch cruises, wine and olive oil tasting

cruises, dinner cruises with musical and comedy entertainment, and space for private

events such as weddings, parties, and corporate functions. The Great Spotted Kiwi

could host 150 guests and accommodate full-service food and beverage needs. Since its

launch in 2002, the vessel’s revenue stream was about 70 percent cruise revenue and 30

percent private events. Cruises and events represented less than 13 percent of total KTC

revenues as of 2007. Although more tourists were booking harbor cruises and more

events were chartering the ship, the Great Spotted Kiwi had seen its profitability slide

in 2007 due to rising fuel and food expenses.

COMPETITION

Almost 4,000,000 passengers used the various ferry lines into and out of downtown

Auckland in 2007.1 By virtue of its strength on the AD crossing, KTC was one of the

leaders in the market. KTC’s main local competition was Kiwi Kat, an Auckland-based

ferry operator owned by a local private equity firm, Pencarrow. Kiwi Kat served several

routes in the Auckland area under the brand names 360 Discovery and SeaLink. Its

main operation was a car ferry on the forty-five minute route to Waiheke Island, with

up to fourteen return sailings a day leaving from the Half Moon Bay docks in eastern

Auckland. On weekends, the company also offered service leaving from the Jellicoe

Street wharf in downtown Auckland. Kiwi Kat was known to price aggressively on this

route, offering discounted fares for senior citizens, families, multi-trip users and residents

of Waiheke Island, and promotions such as waiver of the NZ$30 driver’s fee during

designated summer promotion periods. SeaLink also targeted the freight market on

the Waiheke Island route, with a specially fitted ship, the Seamaster, designed to carry

heavy shipments of fuel, goods, and heavy trucks and machinery to the Island.

In terms of longer crossings, SeaLink served the Great Barrier Island with service six

days a week in summer and three days a week in winter. This four-and-a-half hour trip

carried residents of the Island and tourists, as well as their cars and freight. SeaLink’s vessel

on this route, the Island Navigator, offered onboard dining, two movie theatres, and

outdoor observation seating.

Pencarrow served the market for Auckland Harbor excursions for tourists and corporate

charters under the 360 Discovery brand with a range of smaller boats that Kiwi

Kat owned. Since 2006, 360 Discovery held a license to run a once-a-day ferry service

to the town of Coromandel (see Exhibit 1) via Waiheke Island. This service had been

moderately successful, carrying about 2,000 passengers per month for its first two years.

However, Pencarrow spokespeople had stated that this figure was about 10–12 percent

below the level needed for the route to be “viable” over the long term.2

The Aurora, another independent cruise ship in Auckland Harbor giving service

tours, was close to the Auckland operations of KTC and had made the cruise industry

their sole business. They had many ties to tourism operators, including several exclusive

contracts, and busloads of tourists would be delivered to the Aurora dock for scenic tours

of the Harbor. The Aurora was a seemingly successful competitor to KTC’s Great Spotted

Kiwi cruise ship.

Broadly speaking, the automobile provided another source of competition for KTC.

For example, instead of taking KTC’s twelve-minute crossing to Davenport, commuters

in Auckland could use NZ Route 1, driving across a bridge spanning the harbor, to

Northcote Point. This route could take up to thirty minutes depending on traffic conditions.

Another important influence on commuters’ decisions was fuel prices. As fuel

prices rose beginning in early 2007, increasing numbers of commuters opted to reduce

their commuting cost by using the ferries. In fact, the year-ended March 30, 2007, had

been a record year for Auckland commuter ferry services.3

Belaire Ferries, although not a direct competitor to KTC, ran ferry operations in the

Auckland market. The company operated two boats connecting Auckland with

Waitemata Harbor and the town of Hobsonville, to the west of downtown. Belaire had

been successful on this route since beginning the service, carrying over 3,000 passengers

a month and running eight return trips a day at practically full capacity. The crossing,

which took about thirty-five minutes, was targeted almost exclusively at commuters in

the area, who faced a drive of up to an hour in rush hour.4 Bellaire’s service received a

small subsidy from the Auckland Regional Transport Authority.

STRATEGIC OPPORTUNITIES

Consolidating Operations to Fewer Crossings

One possible change that Bobby was considering was a pruning of the company’s offerings,

with a refocus on the lucrative AD crossing. Closing or selling Rangitoto and consolidating

ferry operations at AD would result in a significant increase in overall margins.

With rising fuel prices, the Rangitoto crossing had seen its profitability seriously

eroded, to the point where it lost money in 2007.

However, this option also came with serious consequences. One would be the reduction

of between forty-five and seventy full-time employees. The reduction in jobs and

impact on employees who had been with the company for years would be difficult for

all concerned. The firm’s lawyers estimated that severance payments to the laid-off

employees could be as much as NZ$10,000 per full-time employee, though only about

two-thirds of the employees working on Rangitoto were actually full-time. The perception

and image of the company would also be affected as customers and the various

communities served by KTC’s ferries assessed the changes in operation.

Expansion of Cruise Operations

Bobby Allen felt that the tourist cruise and events portion of KTC’s business had been

under-exploited. One possibility to expand the cruise business would be to acquire a

Kiwi Transportation Company 5

cruise ship that gave ninety-minute scenic tours of Auckland Harbor. Management had

been considering attempting to purchase the Aurora, a cruise boat that had been operating

from an adjacent downtown Auckland dock for more than twenty-five years. The

Aurora had several advantages that made it an attractive takeover target. It launched from

a very visible and accessible location and it had developed extensive connections with area

bus touring companies over the years. KTC management felt synergies could be found

in the maintenance area since the company could service Aurora from its own dry dock.

The purchase would make KTC the largest provider of tourism in Auckland Harbor. It

was unclear if the Aurora’s owners were interested in a sale, but if they were, the vessel

could probably not be purchased for less than NZ$8 million. Of course, another option

to expanding the cruise operations was to mimic what Aurora was doing. KTC could

attempt to get the bus touring companies to drop passengers at the KTC dock instead of

at Aurora’s dock or market to corporations to take the Pencarrow corporate charter tours.

Breaking into the bus tour and corporate charter markets would take some serious contacts

and time, as these have long gone to Aurora and Pencarrow, respectively.

Price Increases

KTC ticket prices had increased modestly since 2005. However, in light of dramatic

increases in fuel prices from 2006 and 2007, Bobby Allen wondered if additional significant

increases in ticket prices would be necessary.

KTC management had only a general idea of the price elasticity for their products.

For commuters, the only alternative to the AD crossing was to drive around the bay,

resulting in considerably more driving (which would also be expensive given gasoline

price increases) and time. As for tourists, KTC management felt they were fairly insensitive

to price increases since their irregular use of the company’s products meant they

had no pricing benchmark to evaluate higher ticket prices. Bobby Allen felt that a 7–9

percent across-the-board price increase would partially offset the increases in fuel prices

over the previous two years and would be about the most he could expect. However,

in reviewing KTC’s latest financials (see Exhibit 3), Bobby began to suspect that the

cost structure on Rangitoto might be so out of line that even a substantial price

increase would not reverse some of the negative trends of the past few years. In contrast,

on the AD route, even a modest (3–5 percent) price increase would go directly

to the company’s bottom line.

PERSONNEL AND HUMAN RESOURCES POLICIES

The ferry business is a labor-intensive operation, and managing employees can be a

challenge. As of 2007, the company employed 120 full-time staff members in a variety

of roles, including management, ship captains, and deckhands. The number of employees

increased to 230 during the summer months so that average annual employment was

about 200. The senior staff managed their departments on a daily basis and created an

environment under Bob’s leadership where a positive attitude was the norm and

employees continued to be thought of as family. The financial impact of a laborintensive

operation was, however, a major concern, with 52 percent of gross sales allocated

to salaries and benefits. Bob Allen’s goal had long been to keep labor costs well

below 50 percent of gross sales. Reducing these costs would be advantageous to the

company, but Bob had decided that such reductions could only occur if they did not

6 Case Research Journal • Volume 31 • Issue 4 • Fall 2011

negatively impact customer-service levels and employee morale. After twenty plus years

leading KTC, Bob had not shown any desire to make these changes.

A significant undertaking in the ferry business was hiring, training, and maintaining

a qualified staff in seasonal areas of operations. Seasonal employment patterns had challenged

the company for many years. The summer ferry season ran from November to

April and relied on many students to fill positions. However, students were not available

for the whole summer season due to school schedules. Filling these student-held

positions so that customer service was maintained was an annual concern.

Deckhand positions were filled by a varied group of employees with different backgrounds,

experiences, and goals. Some deckhands were older people, who had worked

for the company through college, had entered and finished careers, and had now

returned to the Kiwi Transportation Company to work in retirement. Others were

younger and more ambitious. They began their employment as deckhands but were

looking to move up quickly and obtain their captain’s licenses. The requirements for

gaining a captain’s license included 365 days of working on deck, which took the average

person approximately one and a half years to complete. Once this requirement had

been met, however, even if the employee obtained his/her license, there was a waiting

list at KTC to obtain a ship to captain. It was anticipated that in the coming ten years

a significant number of captains would be retiring, which would lead to a new generation

of captains who had been on the waiting list. Captains who wished to upgrade from

a 100-ton captain’s license to a 500-ton captain’s license also needed 365 captain days.

This was difficult to achieve due to the seasonal nature of a captain’s employment. The

captains employed by the Kiwi Transportation Company worked year-round, even

though several of the ferry crossings were seasonal. In the slower off-seasons, they continued

to work for the company and focused on facility maintenance.

Factors, such as shift work, long hours, and work on holidays and weekends,

impacted the Kiwi Transportation Company’s ability to hire and retain employees to

perform specific functions. For example, ticket booths operated on the AD boats for

twenty hours per day and the third shift was generally unpopular among employees.

Hiring and retaining third shift employees was challenging and required a night shift

bonus to attract applicants.

The average wage at KTC was about NZ$20 per hour, considered reasonable by

Auckland standards. Employee benefits had been relatively modest over the years, due

to New Zealand’s publicly funded health care and retirement systems (the latter similar

to Social Security in the U.S.). However, in 2007, New Zealand’s government established

KiwiSaver, a voluntary retirement savings program with incentives to encourage

employee participation. Initially, employers were not required to offer their own company-

specific KiwiSaver plan, but had to take on some administrative tasks, such as providing

information on the program and forwarding employee contributions. However,

there were rumblings in parliament during 2007 of a change to the program so that

employers might be required to match contributions employees made. Among the proposals

being floated was one that would require companies to make contributions to

employees’ KiwiSaver accounts starting at 1 percent of gross salary or wages and increasing

each year by 1 percent until reaching 4 percent by 2011. Depending on the rate of

participation of a KTC’s employees, this new mandate was a potentially a significant

new burden on the firm.

KTC’s vacation policy was also a potential financial burden. In 1997, KTC introduced

a policy allowing two weeks of paid vacation to employees who had worked for

Kiwi Transportation Company 7

the company for ten years. After twenty-five years with the firm, vacation increased to

four weeks. Given the long tenure of most of KTC’s employees, KTC had a significant

number of employees who had sizeable vacation breaks. Coverage for these breaks

meant either hiring temporary employees or paying overtime to existing staff.

FLEET MANAGEMENT OPTIONS

Like all boat companies, the Kiwi Transportation Company had to consider when to

replace its boats. Fleet management decisions were governed by a number of factors,

such as volume of traffic and demand on specific routes. Overall volume of traffic, route

demand, and fuel prices influenced the need to replace boats. Older boats used more

fuel and required additional maintenance. New boats tended to be more dependable

and consistent, and had lower operating costs. Since rejoining KTC, Bobby had raised

the issue of new boat acquisition with his father, Bob Allen. Each time, Bob expressed

wariness about acquisitions, insisting that “our customers, especially the daily commuters,

wouldn’t notice or be willing to pay for the supposed benefits of a new boat.

Meanwhile, tourists on the longer, scenic crossings are more concerned about food and

beverage provisions onboard than the actual layout and look of the boat.” From the

employee perspective, however, new boats were always better. Even Bob Allen conceded

that from the employees’ perspective “it’s exciting to be steering or working on the latest

and greatest.”

The company had to decide if aging boats should be replaced or upgraded.

Specifically, as of the end of 2007, Bobby Allen was considering whether or not to

replace the Islander, which had been in the fleet for eighteen years. This ferry was capable

of carrying up to 220 passengers and could be sold for approximately NZ$2.4 million.

A replacement ferry of up to 216 feet in length with a capacity to carry up to 350

passengers would cost about NZ$4.8 million for the shell, NZ$250,000 for motors and

gears, and NZ$200,000–250,000 for the cabin additions/amenities. Additional costs

associated with the purchase would bring the total price tag to about NZ$6 million. A

newer vessel would be up to 10 percent more fuel efficient than the Islander and up to

15 percent more efficient than the smaller boats currently running the AD crossing,

with a state-of-the-art fuel usage monitoring system. If KTC acquired the new vessel