IB DP Business Management Unit 5: Operations management -: 5.6 Production planning SL Paper 1

Ans:

a. Market share can be defined as a percentage of an organization’s total sales revenue in relation to the total market sales revenue within a specific industry.

Accept any other relevant definition.

N.B. no application required. Do not credit examples.

Award [1] for a basic definition that conveys partial knowledge and understanding.

Award [2] for a full definition that conveys knowledge and understanding similar to the answer above. A candidate must demonstrate an understanding that the market share is measured as a percentage for [2].

Accept the formula as an indication of percentage.
b.

Referring to the 98% capacity utilization as mentioned in the stimulus should not be treated as application.
Some of the advantages of working at almost full capacity utilization:

• Almost full capacity utilization indicates that there is sufficient demand for SD. All resources are nearly fully utilized, in this case the delivery people, so it is likely that their financial rewards are higher, especially if paid by meals delivered. Even if a fixed salary is paid, high demand at near full capacity utilization may provide opportunities for working overtime.
• Constant work could also increase the motivation of the delivery people due to job security.
• If a fixed salary is paid, SD does not pay its workers for idle time. Better financial management is evident as can be seen by the high 20% GPM.
• Due to satisfying the assumed high demand the profit is likely to increase. See figures presented.

Disadvantages:
• SD flexibility might be reduced if a new organization approaches it to act as a subcontractor. SD will lose out on potential new clients in the currently growing market and growing competition for home delivered, freshly cooked meals.
• The cyclists/delivery people may be overworked and unmotivated. Accidents are more likely to occur when the cyclists are rushed to deliver.
• Quality compromised and SD might lose some contracts, especially as more competitors are entering the markets. There is evidence in the stimulus of some late deliveries, which reduced the quality of the meals delivered.
• The bicycles are more likely to break down, leading to increased costs and further delay of the arrival of the meals to customers. SD will lose many contracts, especially as a stronger competitor is entering the market. SD‘s highest market share/ power will be eroded.

Accept any other relevant and applicable advantage/disadvantage.

Mark as 2 + 2.

Award [1] for identifying or describing the advantage/disadvantage for working at full capacity and a further [1] for a development with respect/ application to SD. Award a maximum of [2].

[2] cannot be awarded per advantage/disadvantage if the response lacks either explanation and/or application.

For example:
• for an identification or a description of an advantage/disadvantage with or without application [1]
• for explanation of an advantage/disadvantage with no application [1]
• for explanation of an advantage/disadvantage and application [2].
c.

Internal growth strategy is proposed. It is expected that candidates describe the nature/meaning of this type of growth where the company grows from within using their own resources and capabilities to expand and grow in size/market share by investing in scooters and employing more staff to deliver the meals.

Advantages:
• The management of SD will have full control of the process of growth in terms of speed, priorities and the amount of capital spent. As the stimulus outlines a large amount of finance is needed and the management could decide on the number of scooters etc. There will be no need for consultation and discussion with another organization be it through merger/takeover, joint venture or strategic alliance. Therefore, SD can react quickly to the current problem of late deliveries.
• It appears that SD is a successful company given the profit margins and perhaps operating within a successful organizational culture. SD will not lose its independence and/or culture. Nor will it experience any cultural clashes with the management and employees of a different organisation. Less change management is required/ less disruption to SD.
• Internal growth is likely to be cheaper than the external growth option of takeover. However, the stimulus outlines that a lot of capital has to be raised, so this option is theoretical rather than applicable. Nevertheless, the 6% return on the investment in scooters is relatively high and the investment is profitable.
• The proposed internal growth strategy will make the working life of the staff easier and more efficient. Motivation is likely to increase.

Disadvantages:
• This method of growth is considerably slower compared to external growth. SD might not be able to compete with the newly merged competitors who are likely to be stronger. SD is likely to struggle against the new competitor and lose its current market leader position. SD will not be able to take immediate advantage of the growing market as the CEO plans.
• Some shareholders are against this option perhaps due to a large sum of finance being required. Shareholders tends to expect short term, quick results/dividends and are likely to block the proposal. The proposed option is against the current trend of consolidation. SD might not be able to compete with the newly created powerful competitor.

Please note that while some text books may say that internal growth is cheaper, there is an indication in the stimulus that this particular option may pose a financial challenge to SD. Options such as a strategic alliance or franchising could be cheaper.

Accept any other relevant/applicable advantage / disadvantage.

Mark as 2 + 2.

Award [1] for identifying or describing the advantage / disadvantage of internal growth and a further [1] for a development with respect to SD. Award a maximum of [2].

[2] cannot be awarded per advantage / disadvantage if the response lacks either explanation and/or application.

For example:
• for an identification or a description of an advantage / disadvantage with or without application [1]
• for explanation of an advantage / disadvantage with no application [1]
• for explanation of an advantage / disadvantage and application [2].
d.

Some of the possible sources of finance:

Issuing more shares – as a private limited company, SD can definitely issue more shares. Currently, SD is highly geared = 65 % so the option of shares might be an appropriate one, especially if the banks will not offer finance. Issuing shares will not require any payback of the loans and will not subject SD to vulnerability of interest rate fluctuations. GPM (20%)/NPM (9 %)are healthy in this industry, so dividends are likely to be paid. The payback is relatively short and the ARR is quite high / reasonable. If the current shareholders buy extra shares, ownership will not be diluted; if other friends and family buy the shares, the current shareholders’ control might be diluted and they may raise objections. However, the current shareholders still control who buys the shares. Control will be not lost.

Going public (IPO) – an expensive and very time consuming source of finance that may not be judged as suitable for SD as a quick reaction to the competitors is needed. However, SD can raise a significant amount of finance needed to purchase the scooters which is much needed as stated in the stimulus. Ownership may be diluted with a risk of losing control.
However, a very low current ratio of 0.9 indicates liquidity problems which might deter investors.

Long term bank loans – If agreed, the money can be given quickly / quicker than issuing shares, this is a very significant advantage for SD given the urgent need for action. However, the banks will be worried about SD being highly geared with its current obligation to pay interest as well as to pay back the loan. Moreover, given the low current ratio, it is likely that the bank’s financial manager will refuse the loan due to liquidity problems. Also, SD does not manage its short term liquidly- see debtors and creditors hence the bank may be worried of insolvency.

Leasing the scooters – could provide a good solution for SD. The scooters can be leased quickly and maintained by the leased company. This fits the managers’ objectives of a quick response. SD will pay a relatively small amount every month, which mitigates the problem of raising a large sum pf money. However, while, if bought, the scooters will become SD fixed assets after 3.2 years (payback), if leased, they will never be SD’s. Still, one may judge this issue as less significant as the need for a quick reaction is vital

Venture capitalists/business angel – As SD is highly geared, coupled with the likelihood that the banks refuse a loan, the use of the above might seem highly suitable especially if there is potential to make a quick /significant profit as seen given the GPM 20% and NPM 9 %. However, venture capitalists/business angels might be reluctant to join SD due to the merger between competitors and some discord with shareholders re: the methods of growth.
However, a very low current ratio of 0.9 indicates liquidity problems which might deter investors.

Accept different arguments for the above option if fully justified.

Using retained profit – SD is profitable. GPM is 20 % and NPM is 4%. While we do not know the industry norm, one may judge this option as highly suitable as SD will not be subject to fluctuating interest rates and repayments. It is also likely that being Ltd, the shareholders will agree to have less dividends to pursue the strategic option of internal finance.
However, some shareholders might object to this option. Despite the percentage given of the profit margin, it might not be sufficient to generate the large sum of finance required and SD might have to opt for external source of finance.

Sell fixed assets – The main assets are bicycles. Selling these assets can generate some finance. However, it might be judged as a limited source /method to raise finance, as the bikes will not generate the cash needed, if any.
Another possibility is to sell some fixed assets like the office.

Accept different arguments for the above option if fully justified.

Please note:
• Long-term or medium-term sources of finance only should be considered.
• Do not accept some short-term sources of finance such as an overdraft, short term loan or creditors.
• Accept debtors or debt factoring if the candidate comments on their unsuitability given the liquidity problem.
• Accept ‘loan’
• If the candidate wrote ‘short term loan’ instead of just ‘loan’ but the arguments for /against are relevant /applicable give some credit.
• It is expected that the candidates suggest the suitability or otherwise of two different sources of finance. Within the above categories, candidates can suggest any source of finance, including some, which might not be highly appropriate, as long as they evaluate the appropriateness of their chosen sources. Candidates are expected to use the financial information provided as part of their evaluation. Not using any quantitative information reduces the quality of application and makes the response rather generic, therefore award up to 5 marks.
• Candidates should not divert into a solution to some cash-flow problem given the debtor and creditors ratios
• It is not expected that the candidate incorporate all of the above arguments.
• Accept any other relevant issue.
• Accept any other relevant discussion.
• A conclusion with judgment is expected.

A balanced response is one that covers at least one issue/argument for and at least one argument against each option.

Marks should be allocated according to the paper 2 markbands for May 2016 forwards with further guidance below.

For one relevant issue that is one-sided, award up to [3]. For more than one relevant issue that is one-sided, award up to a maximum of [4].

Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgment/conclusion.

Candidates cannot reach the [7–8] markband if they give judgment/conclusions that are not based on analysis/explanation already given in their answer.