Question
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.