Question
Smith’s Foods Ltd (SF)
Charles Smith and seven friends started a private limited company, Smith’s Foods Ltd (SF), to produce ready-made healthy meals for people with diabetes*. Using a cost-plus (mark‑up) pricing strategy, SF’s mission is to make inexpensive, widely available meals that help diabetics manage their carbohydrate intake accurately.
Despite reliance on inexpensive social media marketing, SF grew rapidly. Due to this rapid growth, however, the quality of its products deteriorated, and a number of its meals were found to contain different quantities of carbohydrate than those stated on the packaging. Negative comments appeared on SF’s Instagram page. Charles responded quickly to reassure customers and offered refunds. SF’s response led to the company receiving an industry award for ethical behaviour.
Charles introduced flow production to reduce the cost of SF’s meals, which changed SF’s scale of operations and increased its gearing ratio. However, Charles had little business experience of using flow production and problems emerged.
External stakeholders began to look into SF’s operations. One supermarket chain, Good Foods (GF), contacted Charles and offered to take over SF, keeping Charles on the board of directors. This takeover would allow SF’s meals to be produced at a lower cost and reach a wider target market. GF would also finance research and development into new meals with more carefully controlled carbohydrate levels.
However, SF would close. Negative publicity would be considerable. The remaining shareholders have threatened to launch a new business, creating their own brand of meals for people with diabetes in direct competition with GF.
* diabetes: a medical condition that causes a person’s blood sugar level to become too high. People with diabetes need to be mindful of the amount of carbohydrates (which includes sugar) they include in their diet.
a.Define the term cost-plus (mark-up) pricing strategy.[2]
b.Explain two benefits for SF of using social media marketing.[4]
c.Explain one benefit and one cost to SF of using a flow production method.[4]
d.Discuss whether Charles should accept GF’s offer of a takeover.[10]
▶️Answer/Explanation
Ans:
a. Cost-plus pricing is a pricing method where the total cost of producing is calculated which includes variable costs (direct costs) and a fixed cost component (or part of the overhead). Then a profit margin per unit is added to obtain the selling price.
Award 1 mark for a partial definition where the candidate has mentioned costs and a small profit margin being added to achieve the selling price
Award 2 marks for a full clearer definition which includes reference to both variable and fixed costs being calculated with a profit margin being added to achieve the selling price.
b.
Social media marketing allows accurate targeting through social media. Below the line could allow targeting to families who have a strong interest in purchasing diabetic meals though Facebook or Reddit groups.
Cheap and quick to set up and very wide reach. Evidence that SF has grown fast indicating that below the line promotion has exceeded expectations.
The speed of response of social media may be instant. Charles’ quick response on social media managed to reduce the impact of the negative publicity after the quality issue.
Below the line promotion allows SF to create customer loyalty programmes which can be managed online and have continued direct links to current and potential customers looking for diabetic meals.
Award [1] for a benefit of social media marketing with an additional [1] for application to SF.
Mark as [2+2].
c. The benefits of a flow production method to SF could include:
- It is likely to lead to SF meeting the growing demand for its meals quickly and in the process reducing the unit costs of production.
- This may allow SF to reduce the price of its meals as they use cost-plus pricing.
- The benefits of flow production imply that SF will be true to its mission statement.
- Enables SF to control quality more effectively and avoid the mis-labelling issues.
The costs allude to an increase in complexity of the business and the stimulus indicates that some problems are emerging. Hence some costs could include:
- Charles’ management style will also come under increased pressure as he does not have experience of transitioning to and using this new technology.
- Communication and coordination issues may arise leading to higher unit costs effectively a diseconomy of scale.
- Investment in flow production involves high capital costs resulting in possible borrowing and higher gearing.
- Pausing production e.g. for changing recipes, can be expensive.
- If flow production creates too many additional meals even with growing demand, SF could be left with meals it cannot sell.
Award [1] for a benefit of flow production with an additional [1] for application to SF.
Mark as [2+2].
Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
SF is clearly a successful business although struggling to maintain control. The offer of a takeover comes at a critical time.
There are a number of arguments against the takeover:
- The move to flow production has reduced costs and prices and this factor may lead to even higher sales and by assumption profits.
- Although Charles has limited experience of using flow production the future growth of SF could be considerable.
- The company will thrive, and they possibly do not wish to accept the offer. By not accepting the offer Charles will eliminate the possibility of a rival company as the remaining shareholders will not create one.
- This will cause great resentment among the shareholders and given that SF has already survived one episode of poor publicity through the quality control issue, Charles can ill afford any more. There is evidence from the stimulus that this negative publicity could grow considerably.
- The creation of a direct competitor run by the remaining shareholders under albeit a new brand could confuse their loyal customers.
However, there are a number of arguments for takeover:
- The distribution channels offered by the supermarket will boost SF’s profile further and allow them to work with a business with greater levels of experience in the same area.
- The takeover will also allow SF to develop its mission and expand the range of meals offered given that there is finance for research and development into new nutritional meals.
- Finally, after the success of diabetic meals how long will it be before other large supermarket chains come up with their own branded diabetic meals. SF could be outmaneuvered and undercut by future competition. SF’s
market value would appear to be high but will this be the case in 2–3 years?
The decision is difficult. The other shareholders do not want this move and can ill afford the additional negative publicity. A conflict carried out on social media could become damaging to the brand which relies on positive social media word of mouth. The offer is tempting but SF is in fair financial shape despite the higher gearing ratio. Charles has limited experience and perhaps needs more time. It might be sensible for Charles to wait and discuss further with the other shareholders since a majority agreement is required to sell.
Marks to be awarded using the paper 2 mark bands for May 2016 forward and the following is to be noted.
Candidates are expected to provide a conclusion with a substantiated judgment.
For one relevant argument for acceptance of the takeover that is one-sided, award a maximum of [3].
For two relevant arguments, but the discussion of both is one-sided, award a maximum of [4].
For two relevant arguments, one treated in a balanced way and another in an unbalanced way, award a maximum of [5].
For two relevant arguments, both treated in balanced ways, but no real conclusion, award a maximum of [6]. Conclusions must be more than nominal (for example, when a candidate opens a final paragraph with “In conclusion . . . “ but then has no real conclusion, award a maximum of [6].
Question
Sharon’s Super Lunches (SSL)
Sharon’s Super Lunches (SSL) is a cooperative that provides healthy school lunches. The lunches are delivered daily to students, who order them online. SSL aims for a minimum order size of 50 lunches to deliver to a school.
Table 2: Sales and other financial information for SSL for one week
SSL is considering a new promotional strategy for healthy school lunches: they will donate a free school lunch to a student in a lower-income area for each lunch purchased in a higher-income area.
a. Describe one feature of a cooperative.[2]
b. Using total contribution, calculate the forecasted total profit for SSL before the introduction of the new promotional strategy (show all your working).[2]
c. Construct a fully labelled break-even chart for SSL for before the new promotional strategy is introduced (show all your working).[4]
d. Explain one advantage to $S S L$ from implementing the new promotional strategy.[2]
▶️Answer/Explanation
Ans:
a.One feature of a cooperative:
decision making is usually shared by all members
any profits (or surpluses) and losses arising from this decision are also shared
decision making is regarded as more democratic
membership is voluntary
although a for-profit business there is usually some sort of social improvement goal.
Award [1] for a partial description of a cooperative.
Award [2] for a fuller description which may include an element of profit (surplus) or loss sharing.
b.
Unit contribution is $10.20 − $6.40 = $3.80
Total contribution = 3200 × $3.80 = $12 160
Total profit = $12 160 − $7980 = $4180
Award [1] for a correct calculation for both total contribution and one mark for total profit similar to the working shown above.
If the candidate correctly calculates total profit but does not make any reference to contribution, then award [1] only.
If candidate incorrectly calculates contribution but applies correctly to Total Profit then OFR and 1 mark.
Do not penalize lack of $ sign.
c.
Award [1] for correct labelling of both x and y axis − total costs and revenue (y) and output or units produced (x).
Award [1] for accurate total cost curve.
Award [1] for accurate total revenue curve.
Award [1] for identifying the break-even point = Do Not reward calculations of BE quantity when not accompanied by chart.
Candidates are NOT required to produce Fixed Costs FC or show the B/E Revenue line.
Accuracy of TC and TR is based on the ability to approximate the B/E quantity based on the scale chosen for the x and y axes (this allows for the cases where graph paper has not been used).
If B/E not accurate but identified DO NOT penalize if either TR and/or TC already penalized. Hence OFR applied.
d.
The new promotional strategy will allow SSL to generate considerable goodwill, publicity and social responsibility. This will boost output from the current level of 3200 to the maximum of 4000. SSL may be able to reduce costs through greater bulk buying of ingredients and this could lead to an increase in profits.
As SSL has a minimum order size of 50, the promotional offer is likely to encourage more schools to order.
Award [1] for an advantage and an additional [1] for clear application to SSL.