Strategic Management in Order Compile

Strategic Management

In order compile its annual budget, Verve Energy must estimate the amount of power that needs to be generated to meet public demand for the budget period. By forecasting demand, the company can make decisions about the scale of its operations. Once the demand is forecasted and decisions regarding operations made, Verve must make estimates with respect to the cost of goods sold for this power. Verve must then incorporate estimates of fixed costs into the budget.

However, as Verve is a public entity, adjustments must also be made for the impact of legislative changes such as new approvals and proposed funding changes. For example, the 2008-09 budget notes that the government is expected to introduce a new tariff to address Verve's ongoing shortfall.

Background: Verve's business performance has been poor in recent years. The company posted a loss of $171 million on revenues of $1.062 billion for fiscal 2009. The figures for fiscal 2008 were a loss of $132 million on revenues of $1.061 billion. This indicates that the company's revenues are stable, but their costs are not only too high but are increasing.

An analysis of the balance sheet reveals further problems. The company's equity declined in 2009 from $438 million to $266 million. For the past two years, Verve's current ratio has been poor. Cash and receivables do not cover trade payables must less interest-bearing liabilities. The company relies on borrowing in order to meet its operating needs and if it was not backed by the State Government it may have difficult finding funding.

Issues: Verve faces a number of challenges to its business. The first is that the company is mandated to produce power to meet the needs of the state. This is part of its "public good" mandate and must be met no matter what the cost. One of the ramifications of this is that Verve cannot truly be efficient in its operations -- it must always maintain the ability to increase capacity in order to meet this demand.

Another challenge to Verve's business is that they have supply contracts with Synergy, the electricity retailer in Western Australia. These contracts drive much of the revenue for Verve, but lock in electricity rates. The lack of change in revenues from 2008 to 2009 illustrates this, and the increasing costs illustrate the challenge of operating without the ability to increase rates to match input costs.

A further challenge is in the steady deregulation of the Western Australian electricity markets. With this deregulation, Verve's contracts with Synergy will be smaller going forward as the latter picks up supply from new entrants. This leaves Verve with a decreasing revenue stream but plants that they must continue to maintain. At some point, they may be able to decrease capacity to meet lower demand, or Verve will need to find new markets. The closest markets are other Australian states, but the long distance of transmission will put Verve at a competitive disadvantage to suppliers based in the eastern states.