Question
Standard level Paper 2 (21)
KapTan
KapTan (KT ), which manufactures rechargeable batteries for cordless consumer products like vacuum cleaners, began five years ago as a business with a product orientation. It sells business to business (B2B). Multinational companies dominate the rechargeable battery industry, and KT suffered from cash-flow problems in its first year of trading. Its profits are small and, in the last two years, have fallen.
KT has now developed an innovative battery that is small and lightweight. This battery is an emergency power source allowing electric cars to reach a charging station. However, the battery can only be used ten times before it runs out. KT has insufficient finance to create a battery that can be recharged an unlimited number of times.
Through market research, KT has discovered that:
- no other emergency batteries for electric cars exist
- owners of electric cars fear running out of power
- KT ’s new battery could be obsolete in five years.
KT has the capacity to produce 90 000 of these new batteries each year. The average cost is $200 per unit. KT has insufficient funds to invest in additional capacity.
KT is considering two options:
Option 1: Market and sell directly to existing car owners through business to consumer (B2C) at a retail price of $400. KT will need to borrow significant capital to finance this option.
Option 2: Accept an offer of a five-year strategic alliance with a manufacturer of electric cars. KT would provide its product exclusively at $250 per unit. Sales are guaranteed.
Table 2: KT’s forecasted and guaranteed worldwide unit sales (in 000s) for the two options
a. Define the term product orientation. [2]
b. With reference to Option 1, for $K T$, explain the relationship between the product life cycle, investment, profit and cash flow. $[4]$
c. With reference to $K T$, explain two problems that a new business may face. [4]
d. Recommend whether $K T$ should choose Option 1 or Option 2. $[10]$
▶️Answer/Explanation
Ans:
a. A company following a production orientation chooses to ignore their customers’ needs and to focus only on efficiently building a quality product. They do not undertake market research identifying customer reactions to their proposed product before commencing production. This type of company believes that if they can make the best product their customers will come.
Candidates are not expected to word their responses exactly as above.
If the candidate says something to the effect of “The company focuses on the product,” award [1]. A second mark can be awarded if the candidate then offers a contradistinction such as “ignores the market,” “does not do market research,” “does not appeal to the market,” etc.
Award [1] for identification of one characteristic of a product-orientated business.
Award [2] for a full, clear description.
b. Initial research and development costs plus the costs involved in launching a product usually means a product will be a loss maker in its early years. Cash flows may be negative. As sales grow and the product moves into the growth phase, profits are likely to be positive but the company will require additional working capital Not until the product reaches the maturity phases of the life cycle are cash flows and profits likely to be positive. In the decline phase, cash flows and profits are likely to remain positive. The cash flows especially should be solid with the contraction of necessary working capital. For KT, the investment in R&D for the new battery will have had a negative effect on cash flow and profits. Once the product is launched, Option 1 forecasts see quite large sales and therefore large cash inflows. However, we do not know about the marketing costs, which will increase cash outflows. Sometime in year 2, further investment would be needed if sales targets in years 3 and 4 are to be fulfilled as projected sales exceed capacity. This investment would increase fixed costs and reduce profits.
If a candidate shows some understanding the relationship between the product life cycle, investment, profit and cash flow, but with no application to the stimulus, award [1].
If the candidate shows clear understanding of the relationship between the product life cycle, investment, profit and cash flow, but with no application to the stimulus, award [2].
If the candidate shows some understanding of the relationship between the product life cycle, investment, profit and cash flow and has some application to the stimulus, award [2].
If the candidate shows clear understanding of the relationship between the product life cycle, investment, profit and cash flow and has some application to the stimulus, award [3].
If the candidate shows clear understanding of the relationship between the product life cycle, investment, profit and cash flow and has detailed application to the stimulus, award [4].
If a candidate writes or draws some sort of table (such as exist in several of the textbooks IB students use) listing the stages of the product life cycle and showing the relationship between stages of the life cycle and their relationship to investment, cash flow and profit, accept and award [2] marks if well executed with no application to the stimulus and award [1] if poorly executed with no application to the stimulus.
If the candidate applies to the stimulus, either by making inserts into the table or with commentary before or after it, award an additional [1 to 2] according to the depth and quality of the application.
c. Problems any new business may face include:
- Competition – KT faces stiff competition in the market for batteries for consumer products from multinationals.
- Cash flow problems – KT suffered from cash flow problems in its first year of trading.
- Human resources issues, particularly finding the right staff.
- Insufficient marketing.
- Market research – KT is product orientated and therefore will not have undertaken market research before developing is products.
- Poor planning.
- Insufficient start-up capital.
Accept any other relevant problems that a new business may face.
Mark as 2 + 2.
For [2], candidates must identify a problem, explain it, and apply it to the stimulus.
N.B. If the candidate addresses an issue at the end of the time period specified in the stimulus and notes a problem that KT may face then, do not accept (as the business will no longer be new).
Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
Option 1: Selling car batteries directly to car owners. They currently sell B2B rather than B2C.
Advantages:
- Higher initial revenues per unit – KT will receive $400 per unit by selling directly to consumers, compared to only $250 per unit if sold to a car manufacturer.
- Sales are higher in option 1 for the first 2 years and at 410 000 over 5 years are 95 000 higher.
- Total revenues are higher at $164 000 000 compared with $78 750 000.
Disadvantages:
- KT has no experience of selling directly to consumers as it is currently a B2B business. It will need to decide HOW it will allow customers to order its products – via its website or by phone – both solutions will require additional spending.
- KT will need to undertake a marketing campaign to raise awareness of its new products. As a B2B business, KT has no experience of engaging consumers. Funds will need to be found to finance a marketing campaign to raise awareness of its product and to persuade consumers to buy the product.
- The data in Table 1 is only a forecast and therefore may exaggerate its potential. KT may sell much less than forecast which affects its profitability.
- Further investment would be needed to meet demand as full capacity is exceeded in years 3 and 4. The cost of this investment is unknown. KT has insufficient funds to invest in new capacity.
Option 2: Form a five-year strategic alliance with a manufacturer of electric cars.
Advantages:
- Sales are guaranteed as the partner in the strategic alliance has agreed to buy a set number for 5 years. This alliance provides the business with certainty.
- KT avoids capacity issues as maximum annual sales are 85 000 units (batteries), which is below KT’s capacity of 90 000 units.
- No additional marketing costs.
Disadvantages:
- Sales are lower than option 1 for years 1,2,3,4 and 5.
- Unit revenues are lower at $250 rather than $400 per unit.
- Total sales and sales revenue are lower at 315 000 units with a total revenue of $78 750 000.
Balance in the context of this question means having at least one advantage and one disadvantage for each option (and, thus, addressing both options).
Accept any other relevant evaluation.
These mark awards in the table below should be viewed as maximums.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.
Question
Las Migas
Carolina plans to set up a bakery, Las Migas, in a small town. Competition from established bakeries is strong. Carolina has asked for a bank loan because her personal savings are insufficient. The bank manager requested the following information:
a business plan
a cash flow forecast for the first four months of operations.
Carolina has no experience with financial forecasts but she estimated the figures for Las Migas for the first four months of operations. These figures are shown in Table 1.
Table 1: Estimated figures for Las Migas for the first four months of operations
a. State two elements, other than a cash flow forecast, of a business plan.[2]
b. Prepare a cash flow forecast for Las Migas for the first four months of operations.$[6]$
c. Explain one problem that Las Migas may experience as a new business.[2]
▶️Answer/Explanation
Ans:
- An executive summary
- A business description
- A market analysis
- Financial forecasts
- Marketing strategies
- Organization strategies
- Business objectives
- Mission/vision statement
- Human resources plan
- Type of organization
- Analysis, provided the candidate gives some specifics (PESTLE, SWOT, ratio, etc)
- Forecasted: profit and loss and balance sheet
Accept any other relevant, meaningful element (eg product portfolio).
N.B. If a candidate states mission and vision statements, award [1]. If a candidate states either vision or mission statement, award [1]. If a candidate states forecasted profit and loss account or forecasted balance sheet, award [1]. If a candidate states both forecasted profit and loss account and forecasted balance sheet, award [1].
Do not award a mark for information such as table of contents, name and address of business, index, etc. Also, do not accept executive personnel introduction, as in this case that would be totally irrelevant.
Award [1] for stating an appropriate element of a business plan (application not required), up to a maximum of [2].
a.
All figures in $
Accept slightly different headings / format.
N.B. Allow candidate own figure rule (OFR): if a candidate makes an error in one row and carries it through the remainder of the forecast that is only one error. This provision includes both mathematical errors and conceptual errors (for example, if a candidate has the interest in the incorrect month then candidates should only lose [1] for that error.
If a candidate misclassifies an item, like salary, as an inflow, consider that one error. Award [1] if the candidate conveys some understanding of what a cash flow forecast is, but otherwise the forecast is largely inaccurate, incomplete, or illegible.
If the candidate produces a cash flow as below
Award a maximum of [5] if otherwise fully correct. Deduct any further marks according to the guidance above for mathematical and conceptual errors.
Award [2–3] if a cash flow forecast is drawn, but either it is not in a generally accepted format or it is untidy, and/or the forecast contains three or more errors, which could include, in addition to number placement problems and mathematical errors, conceptual errors (using the word “profit” rather than “net cash flow”) or omissions, such as not having a line like “closing balance” or totals.
Award [4–5] if the cash flow forecast is drawn essentially correctly and neatly in a generally accepted format, but there is one error for [5] or two errors for [4].
Award [6] if the cash flow forecast is drawn accurately and neatly in a generally accepted format, and is error free. If the candidate provides a heading of total inflow/outflow without using another heading above of inflow or outflow – do not penalise as an omission.
If the candidate omitted both headings of outflow/inflow = one error substituting the term “net profit in the cash flow forecast for “net cash flow” is inaccurate and [1] should be deducted. If the candidate has only one row for all cash outflows, deduct [1] from the total mark awarded.
Full working is not expected.
c.
Banks and suppliers are sometimes reluctant to give credit to new businesses with no trading records. The local bank may not lend Carolina the money she needs to set up the bakery, especially if the market is already very competitive. Her personal savings, as for many start-up owners, are insufficient.
Many start-up owners may lack management skills, leadership skills, etc. Carolina has no experience with financial records, account and estimates, which are vital for business survival. Carolina’s lack of managerial skills can be risky and jeopardize Las Migas’ survival.
Las Migas will have to face competition from established bakeries. In a small town, will demand be enough for another bakery? As a start-up, Las Migas will have to find a USP to survive and build its own customer base.
One problem that Las Migas could face is that the salary expected is low relative to her rent as she tries to establish her business. She might have a personal cash flow issue.
N.B. Accept cash flow problems/a need for finance, referring to the cash flow forecast constructed.
Do not accept “legal issues”, as it is a reasonable assumption that Carolina is operating within the law.
Award [1] for a relevant generic problem identified or described and [1] for any additional explanation in context.
[2] cannot be awarded for the problem if the response lacks either explanation and / or application.
For example: for identification or a description of the problem with or without application [1].
For explanation of the problem with no application [1].
For explanation of the problem and application [2].