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
Ace Industries (AI)
Ace Industries $(A l)$ manufactures plastic containers, mostly for the soft and fruit juice industries. The operations management department uses flow production for its standard-sized products and batch production for its customized products.
Al’s sales are growing rapidly. It currently has a $6 \%$ share of the plastic container market. However, it has recently struggled to meet customized orders on time. Some customers have complained about product quality. Currently, $A I$ is organized by region, which allows the company to have strong relationships with customers, who feel that $A /$ knows them and cares about their interests. The human resource department is proposing restructuring the organization by function. Not everyone at $A /$ agrees with this change. Many think that the problems of late delivery and poor quality could be solved through greater delegation.
Lloyd Rinnegrat, Chief Financial Officer, has suggested that $A /$ ‘s management think more deeply about their rapid growth. Except Lloyd, most people at Al believe that rapidly growing sales are good – that by increasing its market share $A /$ will, in the long run, benefit by being a large organization.
However, Lloyd argues that being a small organization has many merits, as shown by the changes in $A /$ ‘s recent gross profit margins and net profit margins.
Table 1: Selected financial data for $A I$
The marketing department has predicted that the soft and fruit juice industries are moving away from major mass-produced drinks and toward niche products, such as exotic fruit drinks and speciality beverages for very particular markets.
a. Outline two features of batch production.[2]
b. Draw a possible organizational chart for a manufacturing firm like $A l$ if it is organized by function.[2]
c.i. Calculate the total size of the plastic container market in 2019 (show all your working).[2]
c.ii.Calculate the difference in Al’s net profit before interest and tax between 2018 and 2019 (show all your working).[2]
d. Explain how delegation might help $A l$ improve its delivery times.[2]
e. With reference to $A l$, discuss Lloyd’s view that being a small organization has merits.$[10]$
▶️Answer/Explanation
Ans:
a.Features of batch production include:
Limited quantity produced according to specific specifications.
Non-continuous: batches are produced at intervals.
Batches more from stage to stage of production together (in other words, stage 1, one process occurs. Then, the batch moves to the next stage, where another process is done, etc).
Accept any other relevant feature.
Award [1] for each feature identified up to [2].
b.
The organizational chart does not have to appear exactly as above. Award [1] if the candidate demonstrates some understanding of an organizational chart. Award [2] if the candidate draws an organizational chart that is organized by function and has at least three functional areas labelled (operations, marketing, accounting and finance, HR, etc)
c.i. $\$ 421000000=0.06 \times($ total market size $)$
$
\frac{421000000}{0.06}=\$ 7016666666.67
$
Accept $\$ 7016666667$
Award [2] for correct answer and workings. Award [1] for correct process but with a mathematical error.
c.ii.PLEASE NOTE: Market size is not included in the syllabus for 2024 exams onward. Related parts of this multi-part question may be used.
$
\begin{aligned}
& 0.08 \times 376000000=30080000 \\
& 0.07 \times 421000000=\frac{29470000}{610000}
\end{aligned}
$
The difference between $A l$ ‘s profit in 2018 and 2019 was $-\$ 610000$.
Award [2] for correct answer and working. Award [1] for correct process but with a mathematical error.
d. PLEASE NOTE: Delegation is not included in the syllabus for 2024 exams onward. Related parts of this multi-part question may be used.
Delegation occurs when authority and responsibility are passed down the chain of command and subordinates are empowered to make decisions. When properly done, delegation leads to more effective decision making by subordinates, as they now feel the weight and bear the responsibility for their decisions. In the case of $A I$, if employees who deal with the customers’ orders and manage the operations line had greater authority, they could better align customized sales, which requires some reconfiguration of tooling for each batch, with capacity and availability.
Award [1] for some understanding of delegation and award an additional [1] for an explanation of how delegation could improve delivery time.
e.
Refer to Paper 2 markbands for May 2016 forward, available under the “Your tests” tab > supplemental materials.
Advantages of being a small business include:
can implement change quickly (flexibility)
can maintain relationships with customers and employees
can maintain consistency of brand identity
management can focus, including having tight control over operations
there are fewer risks associated with overtrading.
Disadvantages of being a small business include:
less recognition/awareness in the market place
fewer opportunities for economies of scale
less ability to compete on price
lesser access external sources of finance.
AI is transitioning into a large organization, but its growth affects the business. AI, for example, is not delivering orders on time, customers are complaining about product quality, and the company is not making the same margins it previously was. Unless AI can specifically pinpoint benefits from higher market share, which presumably explains the rapidly rising sales, the company may want to consider whether its sales growth is worth the problems.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.