Question
Standard level Paper 2(21)
Trestle Z PLC (TZ)
Trestle Z PLC (TZ), a specialist coffee roaster, operates in the secondary sector. Its instant coffees are sold worldwide in a very competitive market. Consumers in this market have strong brand loyalty.
Although demand for instant coffee has not grown in many richer countries, it is growing in emerging markets and Eastern Europe. TZ has no control over the price of its raw material (coffee beans), as prices are determined by world markets.
The directors of TZ want to increase the company’s gross profit margin and net profit margin and grow the business. Table 5 gives selected financial information for the company for 2019 and 2020.
TZ’s directors are considering two options.
Option 1: Take over a specialist coffee business
TZ is considering taking over Green Glass (GG) for $600 million. GG owns 1000 cafés in the USA that sell speciality products at high prices. It also has an e-commerce subscription service that sells its coffee beans to consumers. In 2020, GG’s net profits were $120 million. GG has a well-organized distribution channel and strong brand awareness in the USA. TZ would operate the cafés using the GG branding.
Option 2: Launch its own chain of cafés
These cafés would compete against established chains of cafés serving the mass market. Initially, the launch would be in three EU countries but would then, if successful, be launched across the world. TZ would produce a range of freshly ground coffees for sale in the cafés.
a. Define the term secondary sector.
b. Explain two factors that might prevent $T Z$ from increasing its gross profit margin.
c. Explain, using the Ansoff Matrix, TZ’s proposed takeover of GG.
d. Recommend whether TZ’s directors should choose Option 1 or Option 2.
▶️Answer/Explanation
Ans:
a. This sector includes both construction and manufacturing. It uses resources from the primary sector to manufacture finished goods or process raw materials to be used for other secondary sector business. The secondary sector supports both the primary and tertiary sector.
Award [1] for some understanding.
Award [2] for a clear definition.
Providing examples of secondary sector business alone is insufficient to receive marks. However, exemplification can strengthen a definition and be a basis for a second mark (if the definition was not fully complete).
b. $T Z$ will find it very difficult to reduce its cost of sales as raw material prices are dependent on the world price of coffee beans and $T Z$ has no control over these prices (it is a price taker).
$T Z$ will find it very difficult to raise prices as $T Z$ operates in a “very competitive market”.
To increase its gross profit margin $T Z$ would need to either
- raise its price OR
- reduce its costs of sales.
Mark as [2+2].
Award [1] for stating a reason why $T Z$ might not be able to increase its gross profit margin and an additional [1] for its explanation with reference to TZ. Award a maximum of [2].
c. Candidates can be awarded up to 2 marks for demonstrating a knowledge of the Ansoff Matrix and a further 2 marks for applying it the stimulus.
Candidates do NOT need to draw the Ansoff Matrix, but marks can be awarded if they do and place the takeover of GG in an appropriate sector. However, such an answer without any commentary is restricted to a maximum of 2 marks.
There is no single correct answer.
Candidates can be rewarded application marks if they suggest the takeover is either:
- product development as coffee retailers look at their existing market and seek to gain their customers’ loyalty with new and more exciting products, or
- market development as they take their existing product, coffee, and aim to extend to new niche markets (of their own creation) by educating their consumers to seek a new experience or
- market penetration – It is a good example of a product extension strategy, adding value to a product for the consumer.
- diversification – From a certain perspective, TZ’s proposed takeover of GG is a form of diversification, related diversification (though candidates are not required to use the word related).
Award [1] if the answer demonstrates a weak grasp of the Ansoff Matrix.
Award [2] if the answer demonstrates a sound grasp of the Ansoff Matrix.
Award [3] if the answer demonstrates a sound grasp of the Ansoff Matrix and the candidate explains why it might be considered to be either PD, MD or MP using the stimulus.
Award [4] if the answer demonstrates a sound grasp of the Ansoff Matrix and the candidate explains why it might be considered to be more than just one classification i.e. either PD or MD or PD or MP, MD or MP using the stimulus.
d Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
Option 1 Advantages
- Speed – once the deal is struck TZ will have expanded quickly.
- Proven profitability GG made a profit of $120m in 2021 – is therefore less risky than Option 2.
- This business has a well organised distribution channel and strong brand awareness in the USA and therefore is already well established.
Option 1 Disadvantages
- TZ only has $400m in cash and the takeover price is $600m and therefore TZ will need external finance the purchase.
- TZ will have to raise external finance, which means that its debt (and interest expense) will increase or some dilution of ownership will occur.
- This option is only based in US – will the concept transfer to other countries and how much cost will be incurred to establish its brand overseas?
Option 2 Advantages
- This can be seen as diversification, reducing risks as the market of jars of coffee has stagnated in many richer countries.
- It already has experience of purchasing coffee beans on a large scale and can use the same suppliers for its new chain of cafes.
- It has great potential as demand is growing in eastern Europe. Demand is also growing in emerging markets so the prospects for sales may be good.
Option 2 Disadvantages
- TZ has no experience of running cafes selling coffee.
- It will have to go head on with established brands (students are likely to name them e.g. Starbucks, Dunkin Donuts etc.) and may find it hard to compete with the brand loyalties already established.
- Will not have the economies of scale that existing chains have.
- Will take much longer – is only trialling this in 3 countries in EU.
- If successful in these countries will it work worldwide? – cannot be certain as consumers in these countries may have different tastes or attitudes to rest of the world.
In order to reach the top bands of the markscheme candidates must have a balanced view, made a judgement AND also used the data in Table 3 effectively.
Accept any other relevant evaluation.
The table below should be followed (along with the paper 2 markbands).
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.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.
Question Standard level Paper 1 2021
Refer to the Megamin Mining case study (SL/HL paper 1 Nov 2021).
MM is reviewing its hotel and mining operations.
To understand customer opinions about its hotels, MM will distribute questionnaires at two of its hotels and use a convenience sampling method. MM is also considering introducing flexitime for hotel employees.
For its gold mining operations, MM wants to increase its market share worldwide to 1 % by 2030. In 2020, MM produced 17 tonnes of the global production of 3200 tonnes.
In another development, MM wants to enter the rapidly growing lithium market. MM has rejected the idea of buying an existing lithium producer and is considering two options: opening its own lithium mine in Australia or entering a joint venture with a lithium mining company.
Option 1: Open a lithium mine in Australia
MM has identified a site in Australia, and the Australian government, which is keen to develop its country’s lithium mining industry, will approve a mining license for it. Development of the mine would take three years and cost $100 million. Table 2 shows the forecasted net returns for the first six years.
Table 2: Forecasted net returns for the lithium mine (in millions of $)
MM will sell the lithium to battery manufacturers in China, a market familiar to the Australian mining industry. Transport costs would be high. Environmental pressure groups oppose the mine because of the water and air pollution they think it would create.
Option 2: A joint venture with CanLith (CL)
CL, a lithium mining company, is seeking expansion with a new mine and needs finance. A joint venture with MM would bring MM’s expertise and corporate values to the expansion. MM and CL would have equal ownership of the new mine and jointly manage it. CL would appoint a board of directors. However, CL has attracted bad publicity because of its poor environmental record, and local people oppose the new mine. Information on the joint venture is shown in Table 3.
Table 3: Information on setting up the joint venture
a. Define the term flexitime.[2]
b.i. Calculate for MM: its market share worldwide in gold in 2020 (show all your working).
b.ii.Calculate for $M M$ : the average rate of return (ARR) for the lithium mine (show all your working).[2]
c. Explain one advantage and one disadvantage for $M M$ of using convenience sampling for its market research.$[4]$
d. Using the case study and additional information from Section B, recommend whether MM should choose Option 1 or Option 2.$[10]$
▶️Answer/Explanation
Ans:
a. A system of working a set number of hours with the starting and finishing times chosen within agreed limits by the employee and employer.
Candidates are not expected to word their responses exactly as above.
Award [2] for a clear, complete definition.
Award [1] for a partial definition that shows some understanding.
b.i. MM’s sales: 17 tonnes
Total market 3200 tonnes
Market share $=\frac{17}{3200} \times 100=0.53 \%$ (allow rounding)
Award [2] if correct answer and working shown.
Award [1] if correct answer but no working, or no \%.
$
\begin{aligned}
& \text { b.iiAverage rate of return }(\mathrm{ARR})=\frac{\text { (total returns }- \text { capital cost) } \div \text { years of use }}{\text { capital cost }} \times 100 \\
& =\frac{(190 \mathrm{~m}-100 \mathrm{~m}) \div 5}{100 \mathrm{~m}} \times 100=18 \% \\
& \text { Total return }=\$(-70-20-10+30+60+100) \mathrm{m}=\$ 90 \mathrm{~m}=\$ 18 \mathrm{~m} \text { per year } \\
& \text { Investment }=\$ 100 \mathrm{~m} \\
& \text { ARR }=\frac{18}{100 \mathrm{~m}} \times 100 \%=18 \% \text { per year }
\end{aligned}
$
Total return $=\$(-70-20-10+30+60+100) \mathrm{m}=\$ 90 \mathrm{~m}=\$ 18 \mathrm{~m}$ per year Investment $=\$ 100 \mathrm{~m}$
$A R R=\frac{18}{100 \mathrm{~m}} \times 100 \%=18 \%$ per year
(alternative method: $\$ 190 \mathrm{~m}$ return from $\$ 100 \mathrm{~m}$ investment = net $\$ 90 \mathrm{~m}=$
$\frac{90 \mathrm{~m}}{100 \mathrm{~m}} \times 100 \%=90 \%$ over 5 years $=18 \%$ average per year)
Award [2] if correct answer and working shown.
Award [1] if correct answer but no working, or no $\%$.
c.Advantage
Easy to identify: hotel guests, who know about the hotel and its problems
Does not involve people not interested in MM’s hotels
Cheap to administer
It can be used to intervene to satisfy dissatisfied customers
Disadvantage
Does not sample potential hotel customers
Not random so there could be bias – existing customers may have different views than the general population
Award [1] for each advantage/disadvantage up to a total of [2].
Award [1] for putting each advantage/disadvantage into context up to a total of [2].
d.
NOTE FOR EXAMS 2024 ONWARD: Option 1 is not a good fit for the new syllabus as it is effectively internal growth and this is not assessed at AO3. Related parts of this multi-part question may be used.
Refer to Paper 1 markbands for May 2016 forward, available under the “Your tests” tab > supplemental materials.
Arguments for Option 1
Australian government is keen – license might be straightforward
Higher ARR
Cost spread over several years
MM in complete control – make all the decisions
Net returns suggest more after year 5. How long does the mine last?
Chinese have trade deals with Australia for minerals
Organic (internal) growth, so safer and less risky than external growth
Arguments for Option 2
Lower investment ($40m, total cost $80m versus $100m)
Equal ownership so equal say – not dominated by CL. Joint management – CL will have expertise
Existing mine so problems sorted
CL will benefit so chances of a symbiotic relationship
But: Lower ARR, opposition
Less time to complete/develop (6 months compared to 3 years)
External growth, so faster than internal growth
Recommendation needed. But rewardable only if supported by analysis.
Accept reasonable alternative answers.
Marks should be allocated according to the paper 1 markbands for May 2016 forward section B.
Award a maximum of [4] for a purely theoretical answer or with no effective use of case (e.g. only repeating case material without development.)
Award a maximum of [5] if only one option is considered.
Award a maximum of [8] if both options are considered and there is good use of data but there are no significant judgements.