Question
Willow Enterprises (WE)
Willow Enterprises (WE) was founded in 1989 originally as a small manufacturer of carpeting for high-end commercial and institutional office space. In 1997 the management made several strategic decisions:
change from the use of cheap man-made materials to more expensive natural fibres in its carpets
change legal status from a private to a public limited company
use profits to increase production capacity and expand the sales force
diversify by taking over other regional businesses, including a retail chain, and transform them into environmentally friendly businesses.
Because of its appeal to environmentally conscious customers, WE became the regional market leader and, by 2008, was an important carpet manufacturer at a national level.
At this time, Chief Executive Officer Simon Dee decided that WE would adopt a far-reaching programme of corporate social responsibility (CSR). Every year, WE committed more resources to various forms of corporate social responsibility (CSR), such as charitable contributions and fair payments to employees and suppliers. By 2018, WE had diverse revenue streams and a brand identity strongly associated with corporate social responsibility (CSR).
For the last few years, WE’s gross and net profit margins have been falling slightly but steadily. Simon has attributed the declining profitability to diseconomies of scale and one-off (one-time) expenses associated with each takeover. The Chief Financial Officer, Ruth Croft, disagreed. She gave Simon a copy of a 1970 article by the economist Milton Friedman entitled “The Social Responsibility of Business is to increase its Profits”.
a.Define the term revenue streams.[2]
b.Explain one advantage and one disadvantage of WE changing its legal status to a public limited company.[4]
c.With reference to WE, distinguish between internal and external growth.[4]
d.Discuss whether WE should retain its programme of corporate social responsibility (CSR).[10]
▶️Answer/Explanation
Ans:
a. Revenue streams refer to the different sources of sales revenue that a firm may have. Often, as firms grow, they attempt to diversify revenue streams as a way to find sales growth in saturated markets or as a way to offset risk (if sales revenue from one revenue stream declines, perhaps it can be offset by sales growth in another revenue stream).
Award [1] for a partial answer that conveys some understanding and [2] for a complete response that shows full understanding. Candidates do not have to word exactly as above. Simple exemplification is insufficient for a second mark. There must be some definition or description.
b.
Advantages of changing legal status to a public limited company include:
Access to greater sources of finance, either debt or equity, which WE may well want given its plan to grow externally through acquisition.
Greater prestige and name recognition, which may help WE as it approaches and acquires additional business.
Disadvantages of changing legal status to a public limited company include:
The initial and ongoing cost of being a public company, which requires extensive paperwork and filings with the government, as well as regular communication with shareholders. As WE is struggling to maintain margins, having additional expenses may further contribute to lower profitability.
Public disclosure to shareholders and media prevent WE from being more private in how it operates. Greater privacy with respect to strategy and direction could help WE more easily implement its strategies.
Accept any other relevant advantage or disadvantage.
Mark as 2 + 2.
For [2], candidates must identify an advantage or disadvantage, explain it, and apply it to the stimulus.
c.
Internal growth occurs when a business increases sales revenue through expansion of current operations, typically by building more capacity, hiring more sales people, or having more channels of distribution. WE’s growth, up until it decided on a programme of external growth, was always internal and in the carpet industry.
External growth occurs when business grows through some activity related to another business external to the original one. When WE decided to purchase additional companies, it was acquiring revenue streams and operations from other firms, which allowed for rapid growth.
Accept any other relevant advantage or disadvantage.
Mark as 2 + 2.
For [2], candidates must identify an advantage or disadvantage, explain it, and apply it to the stimulus.
d.
Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
Much debate exists around the question of CSR. Some companies advocate it, arguing that CSR is a way to balance corporate power with corporate responsibility despite the fact that having a programme of CSR increases costs in the short term and that there is no certainty that it will enhance business performance in the long run (though a slight positive correlation appears to exist).
Others argue that a company’s only responsibility, other than obeying the law, is increasing profits for shareholders. CSR makes a company less efficient. If all businesses in an economy are operating at less than optimal efficiency, the economy as a whole will suffer (just as each individual business will).
In the case of WE, the question of CSR is complicated. On the one hand, the brand identity of WE was built first on ecological sustainability and, later, on a full programme of CSR (thus economic and social sustainability as well). To suddenly change focus and adopt a totally profit-oriented mentality, as Milton Friedman argues, could hurt WE’s brand identity in the marketplace.
On the other hand, WE has experienced a steady erosion in margins (and, thus, profitability). Were the company to continue to allow this to occur, in the long run, WE would put itself at risk. Some disagreement internally exists, with the CEO believing the issue is the costs of expansion while the CFO has suggested that it is the costs of CSR.
WE should undertake a full marketing audit to determine the impact of CSR on its brand identity, as well as a thorough financial and managerial costing analysis to determine the true source of declining profitability. Without that investigation, WE will have difficulty knowing whether it should continue with CSR.
For a balanced argument, a candidate must have two arguments for and two arguments against CSR. At least one of the arguments for and against can be purely theoretical, while at least one argument for and one argument against must be based upon application to the stimulus. If the candidate does not make judgments on conclusions, maximum award: [6].
Marks should be allocated according to the paper 2 markbands for May 2016 forward.
Question
Dana’s Handbags (DH)
Dana’s Handbags (DH ) is a small manufacturer of women’s handbags. DH sells directly to large retail chains in Europe. The company is privately owned and has fifteen shareholders.
Table 1: Selected financial data for DH for 2016 and 2017 (figures in $000s)
Beginning in $2017, \mathrm{DH}$ adopted a programme of corporate social responsibility (CSR) by:
- donating money to charities
- encouraging employees to do three paid hours per week of community service during work hours
- using only biodegradable materials in its handbags.
This programme was expensive.
$D H$ ‘s management thought that a programme of corporate social responsibility (CSR) would strengthen $D H$ ‘s brand. During the first year of the corporate social responsibility (CSR) programme, employee morale improved and $D H$ received favourable media attention.
However, at the annual general meeting in January 2018, financial results from 2017 revealed that sales growth had not improved. Several influential shareholders complained about the high cost of the corporate social responsibility (CSR) programme. Other shareholders suggested that $D H$ should develop consumer awareness that it is a socially responsible company.
a. Identify two features of a private limited company.[2]
b.i. Calculate the net profit margins for $D H$ for 2016 and 2017.$[2]$
b.ii.Calculate net current assets (working capital) for $D H$ for 2016 and 2017.$[2]$
c. Explain one method of above-the-line promotion and one method of below-the-line promotion that $D H$ could use to raise consumer awareness
$[4]$ that it is a socially responsible company.
d. Discuss $D H$ ‘s decision to develop a policy of corporate social responsibility (CSR).[10]
▶️Answer/Explanation
Ans:
a.
Features of a private limited company include:
shareholders have limited liability.
ownership of shares is restricted to a small number of investors (varies from country to country but in general is a low number).
information does not have to be shared publicly.
it is less costly to manage shareholders because of lesser disclosure and other legal requirements.
it is a separate legal entity distinct from the owners of its shares.
Accept any other relevant feature. Award [1] for each feature identified up to [2].
b.i. 2016
2017
$\frac{1370}{28000}=4.89 \%$
$\frac{1300}{29000}=4.48 \%$
$=====$
$=====$
Award [1] for each correct answer. Showing working is not required.
Accept 4.9 % (2016) and 4.5 % (2017), but do not accept 5 % (2016) or 4 % or 5 % (2017).
b.ii. In 000s of dollars:
2016 2017
5000 − 3000 = $2000 5200 − 3500 = $1700
===== =====
Award [1] for each correct answer. Showing working is not required.
c.
Methods of above-the-line promotion that DH could use include:
- television advertising
- radio advertising
- advertising in newspapers, journals, magazines, or trade journals
- cinema advertising
- billboards.
Methods of below-the-line promotion that DH could use include:
- direct mailing
- exhibitions and trade fairs
- sponsorship
- public relations
- celebrity endorsement
- personal selling.
Do not accept word of mouth as a form of below-the-line promotion.
Accept any other appropriate form of above-the-line or below-the-line promotion.
Mark as a 2 + 2.
Award [1] for an appropriate above-the-line method identified and an additional [1] for development of the explanation illustrating the appropriateness of the method with respect to DH.
Award [1] for an appropriate below-the-line method identified and an additional [1] for development of the explanation illustrating the appropriateness of the method with respect to DH. Maximum award: [4].
If the answer has methods but no application (or just mentions the name of the business) then award a maximum of [2] overall.
d.
Refer to Paper 2 markbands for May 2016 forward, available under the “Your tests” tab > supplemental resources.
DH’s decision to develop a policy of corporate social responsibility (CSR) fits well with trends in business today, whereby many companies are doing so. Indeed, sometimes today stakeholder groups exert powerful pressure on companies to practice CSR. The pressure to follow triple-bottom line reporting is also influencing companies to act in a more socially responsible way (despite some criticism of CSR by certain economists).
DH has adopted several approaches that are popular today: giving profits, lending employees, and being more environmentally friendly. All these methods have garnered DH favourable media attention, though less clear is if DH’s brand identity has benefited. Sales growth has not improved. The gross profit margin decreased from 50 % to 48.28 %, and the net profit margin declined from 4.89 % to 4.48 %. The costs of donating profits, lending employees and presumably higher-priced biodegradable materials took a toll on profits. The situation also negatively affected the balance sheet, which saw a deteriorated working capital position, falling from $2 000 000 to $1 700 000.
One of the commonly cited reasons for practicing CSR is that it is a form of enlightened self-interest: doing good for others will in the long run lead to greater profits. In the case of DH, perhaps that was its intention. Employee morale improved, which can lead to greater productivity and loyalty (labour turnover would probably decline). CSR would enhance DH’s reputation, socially responsible consumers would find an additional reason to purchase DH products, and, over time, the company would make more profits than it otherwise would
have.
Some shareholders, however, are not satisfied with the results so far. At the annual general meeting, they complained about unimproved sales growth and lower margins, which they directly linked to the CSR programme. Several shareholders suggested that DH develop consumer awareness that it is a socially responsible company. The favourable media attention in the first year was insufficient to make an impact on the revenue side. Were DH to take this approach, reshape its brand identity and raise consumer awareness, it would have to invest in a promotional and public relations campaign, which might be costly. Profits and margins might go down before they go up, and possibly even more shareholders will be dissatisfied.
Accept any other relevant evaluation.
Marks should be allocated according to the Paper 2 markbands for May 2016 forward.
For a limited discussion of the financial situation (income statement only or balance sheet statement only), award up to [3]. For limited discussion of financial situation and one relevant non-quantitative consideration, award up to a maximum of [4].
If a candidate evaluates / addresses only the financial situation or only non-financial considerations, award a maximum of [5].
Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgement/conclusion.
Candidates cannot reach the [7–8] markband if they give judgement/conclusions that are not based on analysis/explanation already given in their answer.
