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
FrioAire Appliances (FA)
FrioAire Appliances $(F A)$ manufactures medium-priced and medium-quality refrigerators. It is a multinational public limited company. Its factory is located in a less economically developed country that has high unemployment, a tradition of autocratic leadership and labour costs lower than FA’s home country. The factory is profitable, and FA pays consistently good dividends. Market growth for medium-priced and medium-quality refrigerators is limited.
As part of a strategic objective to increase productivity and to enter a fast-growing market for high-priced and high-quality refrigerators, $F A$ is considering building a new factory in and relocating production to Germany. This would require closing the factory in the less economically developed country. The new factory will:
- use innovative technologies, including advanced robotics and 3D processes
- require fewer employees, but those it does require will need to have better skills and qualifications.
Germany has a highly skilled, qualified and productive workforce. The new factory would allow FA to reposition its products. However, FA would need to raise significant finance to build and equip the new factory.
FA’s leadership style at the factory in the less economically developed country is autocratic. Members of FA’s board wonder whether this style would be suitable for the new factory in Germany, where workers have more bargaining power because of their high skill level and the labour-friendly cultural traditions. In Germany, FA would have to follow more regulations regarding the environment, health and safety, and employee rights.
$F A$ workers in the less economically developed country are very loyal to $F A$, which has continued operation through a civil war at significant cost to itself (for security). If $F A$ were to close in the less economically developed country, the workers would not find such good jobs.
a. Describe one disadvantage of operating as a public limited company.[2]
b. Explain one benefit and one cost to FA of using an autocratic leadership style.[4]
c. Explain one positive and one negative impact of $F A$ on the developing country.$[4]$
d. Evaluate the option of building a factory in, and relocating, to Germany.[10]
▶️Answer/Explanation
Ans:
a. Disadvantages of operating as a public limited company include:
The expense of going public and the ongoing expenses of reporting to the government or shareholders.
Loss of privacy, as the company must report to the public and to shareholders.
Strategic decisions can take longer, as management has responsibility to communicate with the board, shareholders, and, often, other stakeholders.
Risk of takeover.
Unless candidates otherwise have elements in their response deserving marks, do not award any marks for statements such as “dilution of control” or “the owner will not have full control.” Answers such as these two show a significant misunderstanding.
Award [1] for an identification of a disadvantage and another [1] for sufficient description thereof.
b.
In the stimulus it is indicated that FA has an autocratic leadership style. This style appears to dovetail with the culture of the less economically developed country. Also, the factory is profitable and has been efficient through lower costs. It is possible that the leadership style fosters loyalty in this country because of the cultural fit.
The costs to FA include that autocratic leadership may stifle creativity and innovation, which could be available in a more democratic system. Productivity in Germany could be higher than in a less economically developed country. The fact that FA’s leadership is thinking of relocating to Germany indicates that they see problems in moving to a new higher-price segment.
Mark as 2 + 2.
Award [1] for each relevant benefit / cost explained and [1] with application to FA. Award up to a maximum of [2] per benefit/cost explained.
[2] cannot be awarded per benefit / cost if the response lacks either explanation and / or application.
For example: For an identification/description of a benefit / cost with or without application [1]. For explanation of a benefit / cost with no application [1].
c.
Positive impacts of FA on the developing country include:
Provides employment at wages better than those available in the less economically developed country.
Was loyal during the civil war.
Theoretically possible other positive impacts include:
Technology and skill transfers from FA’s host country to the less economically developed country.
Negative impacts of FA on the less economically developed country include:
FA relies on an autocratic leadership style.
FA does not use the most advanced technology in the less economically developed country.
FA could leave the country, leaving many people who are currently dependent on the company out of work.
FA does not provide the same employee rights provisions or health and safety provisions that it would in a less economically developed country.
Theoretically possible other negative impacts include:
FA may pollute to a level in the less economically developed country that it would not in Germany.
Mark as [2 + 2]. For [2], candidates must identify a positive and a negative impact, explain it, and apply to the less economically developed country.
Award [2] for a positive impact with application to the less economically developed country.
Award [2] for a negative impact with application to the less economically developed country.
If there is no application to the less economically developed country at all then the maximum mark per impact is [1].
d.
Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
The option of building a factory in and relocating to Germany is a major strategic decision. In certain respects, FA would be an entirely different company: new products, new processes, new types of workers and new leadership styles, as well as a wholly new cultural context. Going into highly sophisticated high-tech manufacturing with robots has the potential to position FA for a future of highly automated manufacturing. Without making these changes, FA runs some risk of remaining stuck in much lower value-added processes, which in the long run are less profitable. The risks are very high. The potential rewards are high as well.
Perhaps a strategy for FA would be not to sell the older factory but to continue to operate it and rely on those profits to support the new factory as it gets started. Whether FA’s balance sheet is strong enough to operate both factories is an open question, as is the question of whether its management has sufficient depth to operate two major plants.
Balance in this context means having two arguments for opening the plant in Germany and two arguments against, which could be partially couched in a discussion of leaving the old plant open.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.