Computer Associates Inc. Case Study - Communication Essay Example

            Computer Associates Inc., third largest independent software company have made major changes to their business model - Computer Associates Inc. Case Study introduction. New compensation policy for sales representatives was imposed new revenue recognition policy, and using the “pro forma” numbers to inform investors and external users of information of the present financial status of the company.  However, after the disclosure of reports showing a big reduction in revenue and earnings compared to previous years, the management was challenged by individuals and groups having particular interest to the business. In general, although some viewed the changes positively, others are throwing harsh criticism threatening the integrity of the company’s management.

However, the CEO and the management are confident that the changes were just the right decision for the business, and it did achieve the anticipated results. The objectives of this case analysis are to explore the changes made by the company, to try to understand why the company found it so difficult to get acceptance of the changes, and to recommend a course of action for the CEO, Sanjay Kumar.

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Problems

1.      Communicating the short-term and long-term benefits of the new business model.

Management finds it hard to convince the financial community of the effectiveness of the new business model, and that the changes made were right for the business. However, many individuals have remained in state of confusion and skepticism.

2.      Integrity of the accounting practice of the company in question.

Management is confronted by claims that financial reports reflecting higher revenues and earnings were manipulated, and that tightening of GAAP rules have leave the company out-of-option but to disguise its low performance by using the “pro forma” numbers for financial reporting.

Analysis

            The Computer Associates management’s decision to make changes in the business model, revenue recognition policy, pro forma disclosure, and the changes in the board of directors’ line up is an indication of the company’s effort to face the growing challenges in the business world. However, the changes have been challenged by negative criticism from investors and other parties having particular interest with the company. The “pro forma” accounting disclosure, and the GAAP based reporting have yield skeptical figures, thereby giving confusion to investors and the Wall Street analysts in comparing financial figures across years. Investors and external users having particular interest on financial reports disclosed by the company have wondered what difference did the new revenue recognition policy compared to the old revenue recognition policy, and wondered if company had overstated revenue in the past to reflect rapidly growing revenue and profits. In addition, this situation was further heightened by individuals and groups who are spreading rumors that the management has been using accounting gimmicks to disguise losses and malpractices. In general, the integrity of the company is at stake, as it is facing challenges of keeping existing, and potential investors’ confidence to invest with them. The best way to analyze the situation is to explore the impacts of the old and new business model to the overall performance of the business. Let’s set aside the negative criticism for now.

Understanding the impact of both the old and the new model to the operating expenses, and the profit generation of the business is of critical importance. It is by this approach that we can compare the performance of the old and the new model and its impact on the financial statements. These are the factors that the management has placed primary concerns: customer satisfaction and increasing sales in relation to sales representatives’ compensation policy, end-of-quarter flurry of deals and discounting in relation to revenue rate. First, customer satisfaction and sales is affected by sales representatives’ attitude, and sales representatives’ attitude is affected by compensation policy and license lives. Under the old compensation policy, commission rate based on the quarterly contracts sold. Sales representatives were inclined to focus on looking for new customers, attending those whose contracts are about to expire to deal for renewal, leaving other existing customers concerns. Losing customer satisfaction is truly a big threat to a business. A customer is a very important person to a business, because it is through this individual that a business makes profit. To solve the problem, the management has changed its compensation policy to variable rates. The management assured their sales representatives that under the new policy, their compensation will not go below their old compensation rates. The question here is that, does the management made correct estimates in setting up the variable rates for compensating their sales representatives? If it does, had the management explained the benefits well to their sales representatives? The variable rates will possibly lead to confusion and skepticism when sales representatives were unable to reach their sales quotas. Are the sales representatives satisfied with the new compensation policy? What if it had only put them in a no choice situation? It can possibly happen, especially if the setting of the new policy has failed to realize some factors that are present in the working environment. Motivating employees to work hard can be achieved by fair compensation and healthy working environment. In cases like these, the management should acquire feedbacks from their sales representatives regarding newly imposed compensation policy, and examine the impact on sales figure and salaries expense respectively. If the feedback were positive, then check if it did increase sales figures, and has it made profit, or has it only increased salaries expense. If it did increase sales figure and profit, it still should have to be observed over a period of time to check how it is consistent with the effort of achieving higher sales. If the average result is positive, then it is the time which the management can tell that the compensation policy is the right one to be imposed. Therefore, a compensation policy should offer mutual benefits between employers and employees. Another factor affecting the attitude of the sales representative is the license lives. As it was observed, under the old business model, revenue from license is affected by discount negotiations, and the obsolescence rate. Obsolescence rate is in effect when the license is multi-year. Although the licensing fee is incremental under the old system, it is subject to the obsolescence rate which in turn is decreasing the license fee as it aged. Let’s add up the “end-of-quarter flurry of deals” problem which engaged the customers and sales representatives in discount negotiations. Tricky customers who are taking advantage of the end of quarter rush of many companies to achieve targeted figures may benefit with the combination of obsolescence rate and the discounts. In result, license revenue decreases as the license aged. Multi year licenses may no longer be profitable to the business. To address this problem, the management has shortened the life of its licenses. This is beneficial to customers in the sense that shorter license life means more chances of trying new products. It offered them greater rate of satisfaction by giving them options to choose which could satisfy their needs. On the other side, the company benefits from reducing the rate of high discount problems. As discounts were reduced, it would generate bigger margin of profits to the business.

The effort toward achieving customer satisfaction is beneficial to the business. Because a satisfied customer lives with a network of people, it can be utilized by the business to expand its customer market. This type of practice is known as business networking. With proper utilization of this social network, a business can surely gain profit. But first, it should always aim at satisfying customer.

The worst situation that was presented in the case is the decline of revenue and earnings after the new model was applied. This event had captured the interest of the financial community. Many people are thinking that the company is no longer at its best compared to the previous years. Another very critical point is the skepticism that arose when information leaks that Securities and Exchange Commission has been reviewing the company’s previous financial records. Many investors in the financial community are skeptical whether the management had been honest in the past, or had it fooled them by disclosing manipulated revenues and earnings.

The claim that the company’s revenue stream is already slowing can be addressed by exploring common risk present in the economy. First, price fluctuation has greater impact. The company is acquiring some of its software from other producers instead of producing it as they found it less risk, and distribution to its market can be made as soon as the need arises. Once the price of the existing software which the company is acquiring from other software producer increases, resale pricing can be complicated. Let’s add up the pressure from competitors who are selling the same products at varying prices. Considering the qualities are identical, and only the price is making the difference, customers will always choose the one which they found less expensive. To avoid being caught up in a situation like this, pricing will be set based on the idea that it can compete among the varying price levels. This commonly results to lower profit generation. If the worst come, let’s say the prices are falling fast; it is more difficult for the management to determine at what price they would sell their software without incurring losses. Those were some concerns associated with price fluctuation which should also be given focus in measuring the performance of the business, especially with the new models and the changes made. Pricing will affect revenue, as the lower the profit made at every contract closed, means lower revenues and earnings. Therefore, we should not only look at the financial reports disclosed, let us also focus on the external forces that are affecting businesses. There are two possibilities which we can think about: First, we can think that the previous reports were manipulated and second, that it is honestly created. To think that it was honestly created is the same as accepting that the business flow in the previous years is easier to manage.

If we are to consider that the previous reports were indeed manipulated, well, that kind of case is not new. Therefore, people should not take it as a big deal when considering honesty. Information is always subject to manipulation. In the business context, we have what we call information asymmetry, where information processing is affected by information advantage. Insiders, who particularly have more knowledge due to the reason that they engage in day to day business operation, may be inclined with selecting information which they are about to disclose. We call this adverse selection. When information has negative impact on the business, it will not be disclosed, but instead replaced by information which will be beneficial to them. When a financial report is influenced by the insider, there is a tendency that information will be bias. In history, many companies in the past are reported to cases of disclosing financial reports that were manipulated. They believe it would be beneficial for them. But they failed to realize that someday it would be discovered, and will only put them in worst situation. Most of them have lost their investors confidence, and share prices have declined, others have filed for bankruptcy. One very important point we can get from their cases is that despite the fact that their financial reports were audited according to the GAAP and SEC guidelines, they were still able to manage their effort of manipulating their reports. This is always true, regulations and rules are not enough to control this type of attitude in the management. Let’s assume that the CA management indeed manipulated their previous financial reports, to what reason? Is it only CA who are doing that kind of trick? What about the other companies? CA is not the only case; there are others that were not yet discovered.

The change made in the line up of board of directors is a wise response. The number of insiders in the business is reduced, therefore, assuming that these independent members of the board will behave ethically; it is the company’s way of showing the integrity of its management. By limiting the number of insider, it reduces the rate of information bias. If the company can withstand these challenges, criticism regarding information bias in the future will be less. However, the company can’t assure itself that these independent members of the board will behave well. If in case they will be influenced by competitors, or by their own personal interest, that would be a very big threat to the company, and the investors as well. There is always the challenge of keeping the sincerity of these independent members. Another point to be considered here is the cost paid to these individuals service. Experts and professionals fees are high, thereby, it is additional cost.

Changing the revenue recognition policy is an excellent decision. Under the new business model, revenues are recognized according to the GAAP guidelines. Under the ratable recognition, quarterly revenue and earnings are transparent. However, the management was challenged by the earnings and revenue reports under the new revenue recognition policy. It showed lower license-fee revenue compared to the previous years, as the effect of multi year contracts were not reflected. This is the main reason why the financial community is questioning the credibility of the revenue and recognition policy employed in the previous years. The response should have been anticipated by the management. Before the changed was imposed, the management should have prepared necessary documents that could help explain the differences which the old and the new revenue recognition policy will bring. If the management did that, has it communicated the information well to the financial community? Managing change is very complex especially when you are about to change what was already generally accepted. The new system will of course reflect lower revenue compared to the old one. The management should explain how the new policy works, and what their impacts on the financial statements are. Let’s add the “pro forma” numbers, which had been found to be confusing to follow. Some critiques are alleging that the management is misleading the investors by attracting them with promising “pro forma” numbers. Stearns (2001) believed that it is hard to make comparison with pro forma reporting because it has no standard rules followed, and that it reflects mostly attractive figures rather than the actual ones. In this kind of reporting, financial reports reflects higher figures compared to GAAP based financial reports. In some cases, this confusion brought about by the differences is heightened when pro forma numbers are showing increases in revenues and earnings, while the GAAP based report is showing the opposite. The management should address this type of perception of the public by showing pro forma reports which are clear and easy to follow. Another the management should consider is explaining to the financial community about the purpose of their pro forma numbers are these reliable or not, and how they make sure it does adhere GAAP guidelines.

Recommendations

            There are options which the management could choose, and I am recommending these two options which I found suitable to the case.

The best way to solve the problem is to inform those who should be informed. Schedule an information campaign/open forum aiming to inform investors and external users of information about how the new business model works. Critical areas of importance are:
·         Short/ Long-Term Benefits of the Changes

·         Comparison of the Impact of the Changes in Financial Reports based on the old and new business model

·         Comparison of the Impact of the Changes in Overall Performance based on the old and new business model.

·         How the “pro forma” numbers are generated, and how it should be interpreted.

·         The accounting procedure employed by the business

The management may see this effort as time consuming, but it is of utmost importance to clear out the skepticism, and answer the questions that were playing up within the minds of the financial communities.

Conduct intensive review of the performance of the new model compared to the old model. This will serve as an opportunity to explore the strengths and weaknesses of the two models. The need for revision can also be traced by this step. This will also give the management additional proofs of the effectiveness of the system.
Pro Forma reports should be carefully done to avoid clashing with GAAP rules in the end. The company should assure the financial community that it will always maintain integrity in creating and maintaining their financial reports.
The management should review its accounting policy and check if other practices aside from revenue recognition are in line with the business model. The management should review other policies of how the business transactions are accounted, as some of them might have been affected and no longer suitable to newly adopted policies.
Press Releases should be regularly done to update the financial community of the most recent news, and areas of concern within the company. In all cases, the management should inform the public earlier. Competitors are there always looking for pitfalls which they could spread as a rumor. The management should be able to intercept rumors before it can spread.
The management should be open for innovation.
Conclusion

            In general, the case is showing us a clear picture of the challenges faced by top management. As the trends and patterns in the business world are shifting, the management needs to adapt to these changes at all cost, or else, the company will be left behind within the context of competition. I believe the biggest mistake the CA management committed is that they failed to communicate the benefits of the changes of their business model to the financial community. They may have tried, but the effort is lacking. The management was able to solve problems with their old business model. They were now confident that the customer satisfaction rating is high, get rid with the “end-of-quarter flurry of deals”, business economy is stable. The skepticism and confusion in the financial community can be addressed by informing the community effectively. From time to time, the company should answer inquiries, and should disclose reliable information to preserve its integrity, and gain the confidence of investors.

References:

Anderson, P., & Tushman, M. Managing Strategic Innovation and Change. 2nd Edition

Business Town.Com. Pro Forma Income Statements.Retrieved November 18, 2008 from http://www.businesstown.com/accounting/projections-statements.asp

Halsey B., & Soybel G. (2002). All AboutPro Forma Accounting In CPA Journal. Retrieved November 15, 2008 from http://www.nysscpa.org/cpajournal/2002/0402/nv/402nv4.htm

Miller, P.W.B., & Banson, P.R. Quality Financial Reporting. Why GAAP Aren’t Good Enough

(pp: 43-57)

Money Instructor.Com. Information Asymmetry.Retrieved November 16, 2008 from

http://www.moneyinstructor.com/art/infoasymmetry.asp

Tuccillo, J. New Business Model For a New Economy. Why Do We Need New Business Models? (pp: 43-45)

United States House of Representatives. The Problem of Pro Forma Accounting.

Retrieved November 17, 2008 from http://www.house.gov/stearns/Issues/Energy_Commitee/Enron/Proforma.html

Young, M. R. Accounting Irregularities and Financial Fraud. A Corporate Governance Guide. .  Initial Involvement of the Outside Auditor. (Pp: 61-79)

 

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