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
Buzza
Jo and Demi Straus established Buzza, a partnership, in 1999. Buzza manufactures women’s fashion accessories, such as handbags and scarves. Jo, a gifted designer, directs the design team. Demi, a business graduate, organized the business by function. She manages most of those functions.
In 2012, they converted Buzza to a private limited company to help obtain finance for the business’s expansion. Jo and Demi retained 60 % ownership between them.
Because of the brand’s reputation, Buzza can recruit creative graduates from design universities. Graduates receive 12-month contracts, which are renewed only if Buzza accepts their designs. Buzza tells graduates that, generally, only half of all contracts are renewed. The average age in the design team is 26. Labour turnover in the design team is much higher than in similar exclusive brands.
Wealthy consumers interested in the latest fashions find Buzza a highly desirable and exclusive brand. Only approved retail outlets sell Buzza products. New collections are produced four times a year. At the end of each season, retailers return unsold products to Buzza. Last year, these unsold products were valued at $15 million. At present, Buzza sends returned products to an incinerator plant to be destroyed. A recent television documentary revealed that Buzza incinerates perfectly good products, which led to damaging social media comments.
In response to the negative publicity, Jo and Demi are considering two options:
Option 1: Sell surplus products at greatly reduced prices on its website.
Option 2: Break down returned products to recover raw materials for re-use in future products. This process of breaking down returned products will be time consuming and costly.
a.State three of Buzza’s main business functions.[2]
b.Explain one advantage and one disadvantage to Buzza of operating as a partnership.[4]
c.Explain one advantage and one disadvantage of the high labour turnover of designers at Buzza.[4]
d.Discuss the two options that Jo and Demi are considering.[10]
▶️Answer/Explanation
Ans:
PLEASE NOTE: This content is not included in the syllabus for 2024 exams onward. Related parts of this multi-part question may be used.
Possible answers include:
human resources
finance (and accounts)
marketing
operations
management
Candidates must use the traditional business functions, such as those noted above (or others which are traditionally listed in textbooks). Do not accept terms inspired by the stimulus itself (R & D, for example).
For [2], candidates must state 3 (or more) of the above.
For [1], candidates must state 2 of the above.
If a candidate states only one business function, award [0].
Advantages include:
Partners can each have different skills, which benefits the business. In this case, Jo is a gifted designer and therefore brought key sills to the design side of the business, whilst Demi is a business graduate and will know much more about how to run a business.
More capital is available for the business than when set up as a sole trader.
Disadvantages include:
There is a risk of disagreements amongst partners.
The amount of capital that can be raised is limited unless additional partners are taken on and in this case the partnership lacked the finance needed for expansion.
The liability of the partners for the debts of the business is unlimited.
Each partner is liable for actions by other partners.
Accept any other relevant advantage or disadvantage.
Mark as 2 + 2.
For [2], candidates must identify an advantage or a disadvantage, explain it, and apply it to the stimulus.
Advantages and disadvantages can apply to Buzza OR to the designers themselves.
Advantages include:
Buzza has a constant supply of new designers with fresh ideas, which is good for the business. The fact that the average age of the design team is 26 is evidence of the constant supply of new designers.
The “threat” of not having a contract renewed may act as a motivator for designers, a situation that benefits Buzza as they will have a very focused team of designers – only 50 % of designers on average gets contracts renewed so they know they are under pressure to perform.
Buzza does not have to deal with the problem of under-performing designers in the long-term as they can simply not renew designers’ 12-month contracts. This situation also allows Buzza to avoid the need for redundancy payments.
Disadvantages include:
Buzza will need to continually recruit new designers, which can be expensive and time consuming as 50 % of new recruits on average do not have their contracts renewed.
Labour turnover figures, with 50 % not having contracts renewed, may act to discourage some potential good designers from applying and Buzza may lose out on potentially gifted designers as other exclusive brands have a lower labour turnover figures and may attract applications from such graduates.
The high labour turnover figures may cause insecurity amongst the workforce and demotivate designers who feel under pressure particularly if after three seasons they have not had a design accepted.
Accept any other relevant advantage or disadvantage.
Mark as 2 + 2.
For [2], candidates must identify ad advantage or a 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.
Option 1: Sell surplus products at greatly reduced prices via its website.
- This option has the advantage of increasing revenue as out of season stock is sold and at least raises some revenue, even though it will be far less than the original price charged.
- It also avoids the need to destroy stock in an incinerator and may improve the business’s image amongst consumers who dislike the idea of perfectly good products being burnt, which is a waste of resources and potentially damaging to the environment.
- However, Option 1 can seriously affect the brand’s image amongst wealthy consumers– Buzza a highly desirable and exclusive brand bought by wealthy consumers – who may take issue with their ‘status symbol’ fashion items being sold to less affluent consumers. Desertion of the brand by current customers to could seriously undermine the brand image and lead to lost sales at high prices charged in approved outlets.
- The approved retail outlets that sell Buzza products may also object as they may lose sales as some wealthy customers may delay purchasing until the products they want are sold at much lower prices on the Buzza website. These outlets may no longer wish to stock Buzza products, affecting Buzza sales, profits and reputation.
Option 2: Break down returned products to recover raw materials to re-use in future products. This process will be costly.
- This option avoids the need to burn products and therefore will impress those who see burning stock as a waste of resources and damaging to the environment and will therefore answer social media critics.
- This option is better for Buzza’s brand reputation amongst the wealthy consumers as they will not face the prospects of having their exclusive products also being worn by those on less in reputation as perfectly good products will not be broken up.
- However, this option is a costly method. Not all materials that are recovered may be suitable for use in new season products and so there may still be considerable waste.
No details are provided as to the actual costs of incineration or of breaking down products to re-use in future season products. Candidates in the 7+ mark range would be expected to refer to this and the need for more information before coming to a final decision.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.