Question
ReVolve Ltd (RV)
ReVolve Ltd (RV ) manufactures and sells high-quality, high-priced bicycles to high-income earners. Operating in a niche market, its advertising slogan and unique selling point/proposition (USP) is “hand made to order, in the USA, delivered within seven days”. Brand loyalty is strong, but brand recognition outside of its customer base is weak. 98 % of its sales are to customers living within 50 miles of the business.
Prior to 2017, RV received an increasing number of customer complaints that phone lines were often engaged and calls not returned. As such, it adopted e-commerce. Its website now allows customers to:
customize their choice of bicycle
place orders
pay for purchases
have their questions answered.
RV employs 20 highly paid, skilled employees using job production. To retain these workers, RV has raised their wages significantly since 2016.
Increasing competition from imports of hand-made high-quality bikes has forced down prices in this niche market. RV has been making increasingly larger losses since 2017. In 2020, its sales fell by 15 %. Inflation is forecasted at between 2 % and 3 % for the next three years. As such, RV’s directors are considering two options to enable it to lower the prices of its bicycles.
Option 1: Offshore production to China, where production costs are significantly lower. The bicycles would be manufactured using batch production. RV would focus only on the design and marketing of its bicycles.
Option 2: Invest in new job production techniques that enable parts to be glued rather than welded, which only requires unskilled labour. Investment would cost $3 500 000 and the forecasted annual net cash flow is $600 000.
a. Define the term niche market.[2]
b. Explain two benefits to $R V$ of the decision to adopt e-commerce.$[4]$
c.i. Calculate the payback period if $R V$ chooses Option 2 (show all your working).[2]
c.ii.Explain one disadvantage to $R V$ of using the payback period method of investment appraisal.[2]
d. Recommend whether RV’s directors should choose Option 1 or Option 2.$[10]$
▶️Answer/Explanation
Ans:
a.A niche market is a small market segment. The products are usually specialised, aimed at satisfying specific market needs for a well-defined segment of the population.
Candidates are not expected to word their responses exactly as above. If a candidate uses the word smaller rather than small, accept.
Award [1] for some understanding.
Award [2] for a clear definition.
b.
PLEASE NOTE: This content is not included in the syllabus for 2024 exams onward. Related parts of this multi-part question may be used.
Benefits must be to RV not just to customers – a benefit to a customer can only be rewarded if the answers goes on to explain how this benefit also helps the business.
For example, stating that a website allows the customer to view the business products 24×7 (or to place orders from the comfort of their own home) is on its own not rewardable. The candidate would need to go on to state that this situation may lead to increased orders for RV bicycles for the response to be rewardable.
Benefits may include:
Lowering costs – RV can reduce the need for employing staff to handle orders or take phone calls.
Providing abundant information – There are limitations to the amount of information that can be displayed in a physical store. It is difficult to equip employees to respond to customers who require information across product lines. E-commerce websites can make additional information easily available to customers. Most of this information is provided by vendors and does not cost anything to create or maintain. Will also help overcome problems that RV faced e.g. RV received an increasing number of customer complaints that phone lines were often engaged and calls not returned.
Being open 24×7, which may increase orders as customers can order anytime.
Making the business more visible – currently 98 % of customers are within 5 miles of RV’s business.
Accept any other relevant benefit.
Award [1] for stating a benefit to RV from adopting e-commerce and an additional [1]for its explanation with reference to RV. Award a maximum of [2] per benefit.
Mark as 2 + 2. Maximum award: [4].
c.i. The payback is:
Payback formula $=\frac{\text { initial investment }}{\text { net cash flow per year }}$
$=\frac{\$ 3500000}{\$ 600000}$
$=5$ years and 10 months OR 5.833 years
OR
$\frac{\$ 3.5}{\$ 0.6}$
$=5$ years and 10 months OR 5.833 years
Award [1] for correct formula (with or without figures)
OR
Award [1] for correct figures but incorrect final answer
(e.g. $\frac{\$ 3.5}{\$ 0.6}=5.5$ years) .
Award [2] for correct answer with working.
c.ii. One disadvantage is that the payback method fails to take into account the time value of money and adjust the cash inflows accordingly. [1]
Though the forecasted net returns each year are $600 000, the inflation in the country is forecast to remain in the 2–3 % range for the next three years. Therefore, the real value of the annual $600 000 will be less in years 1 to 3, thus overstating the return on the investment.
Also, the payback analysis fails to consider inflows of cash that occur beyond the payback period [1] – in this case we are not told the life of the investment so we cannot see how much the net returns will be for the life of the investment [1].
Award [1] for a disadvantage of the payback method and [1] for its application to RV.
d.
Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
Option 1 advantages:
RV will have lower production costs as production costs are lower in China. This option will help the business deal with the low-priced imports.
It will allow RV to concentrate on design and marketing, which may enable it to improve its designs and marketing and, thus, increase sales.
Option 1 disadvantages:
The Chinese factory uses batch production, which will affect RV’s ability to produce bicycles that fit their customer’s demands. Currently, RV can meet customer demands because the business uses job production.
RV will no longer have control over production and quality standards may deteriorate.
Transport issues from China will mean that RV will not be able to deliver bicycles to customers within 7 days of receipt of their orders. RV’s advertising slogan will need to change as the business will no longer hand make orders in the USA.
Option 2 advantages:
RV will have lower production costs because it will no longer need expensive, skilled labour. Lower costs will help the business deal with the low-priced imports.
Production will remain in the USA and it can retain job production.
RV will likely not have delivery time issues.
Option 2 disadvantages:
Will need to make existing skilled employees redundant which will incur redundancy costs.
Require an investment of $3.5m at a time when the business is making losses (since 2017) – this may require external finance which will, incur interest charges, raising unit costs.
The payback period is also more than 5 years which is relatively long.
Will their customer base trust the new production technique which uses glue rather than welding?
Candidates may assume that using glue rather than welding means lower quality. Accept that assumption.
Accept any other relevant evaluation.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.
The table below should be followed (along with the markbands on page 3). These mark awards in the table below should be viewed as maximums. That is, just because a candidate has one argument for Option 1 and one argument against does not mean that they will automatically get a 4. One strong argument for one side and merely a weak or nominal argument for the other side might result in a 3.
Question
Daytona Go-Carts
In 2020, Ron James aims to open Daytona Go-Carts, a race track where individuals as young as twelve can rent go-carts and participate in races. Through primary market research, Ron has discovered that many teenagers would enjoy participating in go-cart races.
Ron has two options for locations for the go-cart race track:
Option 1: The cost of the site would be $1.2 million
Option 2: The cost of the site would be $1.8 million.
Forecasted profits for Option 1 are:
Forecasted profits for Option 2 are $\$ 300000$ in the first year, with profits growing by $20 \%$ per year for the next four years.
a. State two methods of primary market research.[2]
b.i. Calculate, for Option 1 the average rate of return (ARR) (show all your working).[2]
b.ii.Calculate, for Option 1 the payback period (show all your working).[2]
c. Calculate, for Option 2, the average rate of return (ARR) (show all your working).[2]
d. Explain one reason why Option 1 may be a less risky investment than Option 2.[2]
▶️Answer/Explanation
Ans:
a. Types of primary market research include:
- questionnaire/surveys (postal, online, face-to-face)
- focus groups
- interviews (telephone or face-to-face)
- observation.
Award [1] for each type of market research method identified, up to a maximum of [2]. If a candidate names two types of the same method (for example, postal survey and online survey), award a maximum of [1].
Do not accept “Data collected from a business” (or something similar), as this wording is insufficiently precise. Many types of data collected from a business would be secondary.
b.i.ARR:
$
\begin{aligned}
& \frac{\text { Profit from investment }- \text { Cost of investment }}{\text { Number of years }}=\frac{\$ 1400000-\$ 1200000}{5}=\frac{\$ 200000}{5} \\
& =\$ 40000 \text { average profit per year } \\
& \frac{\text { Average per annum profit }}{\text { Cost of investment }}=\frac{\$ 40000}{\$ 1200000}=\mathbf{3 . 3 \%}
\end{aligned}
$
Award [1] for working or formula and [1] for the correct answer. Award up to a maximum of [2].
If a candidate has the workings shown (40 000/1 200 000) and has the answer written out as 3.33, 3.3333, etc, award [2].
If a candidate has the workings shown (40 000/1 200 000) and has the answer written out as 3.3, award [2].
If a candidate has the workings shown (40 000/1 200000$)$ and has the answer written out as 3.4, or has a maths error, award [1].
b.ii.Payback period:
Profit after the first four years is $\$ 1000000$, which means that $\$ 100$ remains going into the fifth year, which has anticipated profits of $\$ 300$.
$
\frac{\$ 100}{\$ 300}=\frac{1}{3}=\text { four months. }
$
The payback period is 4 years and 4 months.
Award [1] for working or formula and [1] for the correct answer. Award up to a maximum of [2].
c. ARR:
$$
\begin{aligned}
& \frac{\text { Profit from investment }- \text { Cost of investment }}{\text { Number of years }}=\frac{\$ 2232480-\$ 1800000}{5}=\frac{\$ 432480}{5} \\
& =\$ 86496 \text { average profit per year } \\
& \frac{\text { Average per annum profit }}{\text { Cost of investment }}=\frac{\$ 86496}{\$ 1800000}=\mathbf{4 . 8 1 \%}
\end{aligned}
$$
If a candidate has the workings shown (86 496/ 1800 000) and has the answer written out as 4.8053, 4.80533, etc., award [2].
If a candidate has the workings shown (86 496/ 1800 000) and has the answer written out as 4.81 or 4.8 , award [2].
If a candidate has the workings shown (86 496/ 1800 000) and has any other answer than those above or has a maths error, award [1]
d. Reasons that Option 1 may be the less risky of the two investments include:
- Lesser capital outlay. The success of Option 2 relies heavily on strong and growing demand year on year. Were that demand not to materialize, the returns on the investment would fall and it would take longer to recoup the investment cost.
- In the early years, Option 1 has higher profits as a percentage of investment than Option 2. Forecasts become more problematic the further out they go in years. Option 1 will see a fairly significant recovery of investment in the early years, whereas Option 2 is very dependent on demand of $20 \%$ growth through five years. Profit of $\$ 622080$ is crucial to the success of Option 2.
Accept any other relevant response.
Award [1] for identification of a reason why Option 1 may be safer and award [2] for an explanation of why Option 1 may be safer. Application is largely built into the question.