External Influences on Business (A Level) (Cambridge International A-Level Business): Exam Questions

Define the term 'nationalisation'.

[case-study] Fold (FD)

Fold (FD) manufactures cardboard packaging in country M. It employs 190 people and supplies food producers and online retailers.

Three of FD's largest customers have told it that from 2028 they will buy only from suppliers whose packaging is made entirely from recycled material and who can show that their energy use is falling. Together these three customers provide 44% of FD's revenue.

FD currently uses 61% recycled material. Moving to 100% would cost around $2.8m in new equipment.

Country M's government has also announced a tax on packaging containing less than 70% recycled content, starting in 2027.

Explain one reason why sustainability is important to FD.

Define the term 'supply-side policy'.

Define the term 'pressure group'.

Explain one benefit to a business of a trade agreement between countries.

[case-study] Meadow (MW)

Meadow (MW) processes milk into cheese and yoghurt in country K. It employs 340 people at one large plant, where staff work with heavy machinery, hot liquids and refrigerated storage rooms.

New health and safety laws in country K require all food processing businesses to fit machine guards, provide protective clothing, and give every employee eight hours of safety training each year.

MW estimates that meeting the new requirements will cost $620,000 in the first year and $180,000 a year afterwards.

In the year before the new law, MW recorded 34 workplace injuries, nine of which required time off work.

Explain one way health and safety law affects MW.

Define the term 'migration'.

Define the term 'environmental audit'.

Explain one way a government might intervene to help businesses.

[case-study] Folio (FL)

Folio (FL) is a printing business in country W. It prints books, catalogues and packaging for around 200 customers, and employs 75 people.

Paper is FL's largest cost. FL buys all of its paper from just two mills, because only these two can supply the weights and finishes its customers require.

Last year one of the two mills raised its prices by 22% and reduced credit terms from 60 days to 30 days. FL had to pay more, and sooner, than it had planned.

FL's owner is now considering whether to hold larger stocks of paper or to look for a supplier in another country.

Explain one way FL's suppliers can influence its decisions.

Extract:

Pop Cool (PC) PC is a public limited company. Its head office is in Europe and it operates with centralised decision making. The company owns the Pop Cool brand name, logo and the distinctive bottle shape that is still used in some markets. PC operates its own bottling and canning factories in some countries. However, it also has joint venture agreements with packaging businesses in other countries. Much of the fruit and sugar used in producing the soft drinks is imported from African and Asian countries. 75% of PC’s sales and 90% of its profits are earned in the USA and Europe. The directors of PC are keen to develop other markets and other products so that the company becomes less dependent on a few key markets and products. Economic changes The economies of the USA and Europe have experienced very slow economic growth since 2008 – and some have even been hit by recession. Interest rates are very low as the monetary policy of these countries is aiming to boost demand. However, this has contributed to exchange rate depreciations of the US dollar and the European euro. Consumer spending has fallen due to declining real incomes. There are ageing populations in most of the countries where PC sells its products. A loss of competitiveness in many industrial sectors has resulted in rising unemployment. Statement of financial position valuations Since 2008 PC’s share price has fallen. This has been the trend for many public limited companies. PC’s Finance Director has been considering three changes that will affect PC’s accounts. He could make all three changes or just one or two of them. • When calculating depreciation of new production equipment bought last year for $25m, use an estimated life of 8 years not 5 years. The equipment would still have an estimated residual value of $3m. • Sell $10m of property assets and lease them back at an annual leasing cost of $1.5m. • Revalue the company’s intangible assets by 50%. He used an extract of PC’s most recent accounts to calculate what the impact of these changes might be on profit and gearing (see Appendix 1). Entering new markets – Africa and Asia Paul, PC’s Chief Executive Officer (CEO), has been discussing with the Marketing Director, Suzy, alternative marketing strategies the company could use to enter the rapidly expanding markets of Asia and Africa. They have different views. Paul stated that: ‘I think we should take over an existing soft drinks manufacturer in, for example, India or China. We would then have all of the production facilities and distribution channels through large supermarkets that we will need. The existing brand names could then be replaced with the Pop Cool brand which we would advertise very heavily for a short period. Consumers will be attracted to this because it is so popular elsewhere in the world.’ Suzy replied: ‘There could be local opposition to this globalised approach – although the marketing economies of scale will be substantial. I think we should develop a range of soft drinks to suit local tastes with brand names that reflect local language and culture. We could distribute these new drinks through small retail stores and street markets. This way we will slowly but steadily build up consumer awareness and loyalty.’

Workforce planning in country X Country X is one of PC’s biggest markets. The company fully owns all of the production facilities in this country and it has a large sales and marketing team too. PC employs 468 people in country X and labour costs are the company’s biggest expense in this country. The Human Resources department is under pressure from PC’s Head Office to reduce labour costs in country X by 15%. The Human Resources manager in country X, Bill, thinks that cutting labour costs might be risky. He told other senior managers: ‘We must maintain consistent and adequate production levels so that consumers can always buy the quantity they want. Production workers are sometimes reluctant to learn new skills and they are resistant to job flexibility. Should we cut back on sales and marketing staff? Perhaps we should employ more production workers on flexible contracts. Another option is to introduce even more automation at our main packaging plant.’ The other managers agreed with him that meeting this new company objective of reducing labour costs was going to need careful workforce planning. Special order in country X PC’s marketing team in country X has just received an enquiry from the country’s largest supermarket group – Superfood. The supermarket is asking PC to produce one large batch of soft drinks as a trial product to be sold under Superfood’s own brand name. The drinks would be similar to an existing Pop Cool product. PC’s Marketing manager in country X is not prepared to take this decision without the approval of Head Office. He consulted with the Operations manager in country X. They compiled data to present to PC’s senior management team in country X before asking Head Office for a final decision (see Appendix 2). Future options for PC’s growth PC’s Board of Directors has been criticised by the newspapers and by major shareholders for the company’s slow rate of growth in sales and profits since 2008. Apart from expansion into markets in Asia and Africa, the directors are investigating two other strategic options for growth and increasing long term profitability. Option A: Develop new flavours and distinctive names for a wider range of PC products. These could include: Pop Cool Energy aimed at the sports people market segment and Pop Cool Vital aimed at young people wanting to buy healthy drinks. The Marketing Director believes that much clearer market segmentation is the best strategy for achieving market penetration and higher profits. He said at a recent Board meeting: ‘This is a low risk strategy that could be implemented within two years’. Option B: Extend the Pop Cool brand name and image by organising a joint venture with a clothing designer. The plan would be to launch a range of modern clothes aimed at young consumers. With careful and extensive promotion, the CEO thinks that these consumers would quickly link the clothing range with Pop Cool’s positive image. He believes that the best way to expand profitably in the longer term is for PC to diversify into markets and products that could lead to higher profit margins than those achieved with soft drinks.

Appendix 1: Extract from Pop Cool’s latest published accounts (before any changes proposed by Finance Director) Statement of financial position extract as at 31 October 2013 $m Non-current assets: Land Buildings Production equipment Vehicles Intangible assets Total non-current assets 78 112 78 10 80 358 Net current assets 86 Non-current liabilities 156 Shareholders’ equity 288 Income statement extract for year ending 31 October 2013 Revenue 750 Profit after depreciation and interest 87 Appendix 2: Superfood’s special order – data produced by Marketing manager and Operations manager PC’s annual production capacity in country X 50m cans PC’s actual production level (2012) in country X 45m cans Superfood order 4m cans Unit material cost per can of drink $0.10 Unit direct labour cost per can of drink $0.15 Cost of new design of can for Superfood and product testing $0.5m Transport costs for Superfood order $0.1m PC factory overhead cost per can of drink (2012) $0.25 Price per can offered by Superfood to PC $0.50

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Analyse the likely impact on PC’s profitability of the economic changes referred to in lines 9–16.

Extract:

Thierry’s Kitchen (TK) Thierry’s Kitchen (TK) operates in four European countries with its head office in country H. TK was started by Thierry Radelet in 2017, after he gave up a senior management role in a food delivery company to start his own business. Thierry had observed the rise in popularity of delivery of cooked meals to offices and households. He identified a gap in the market for an efficient service, which would focus on high‑quality cooked meals for delivery only. TK grew quickly and converted to a public limited company in 2019. TK now has two kitchens in each of four European capital cities. The eight locations are outside the city centres and each kitchen has the capacity to produce 2200 meals each day. Meals are packaged and then delivered to customers by motorcycle. Thierry works at the company’s head office, attached to TK’s first kitchen location in country H. He visits the other kitchens once every month. Thierry and a team of directors make all the major decisions about the main menu items and new locations. Each kitchen has a manager who is responsible for decisions about inventory management and human resources. TK has financed its growth through retained profits and a loan of $15 million. Dividend payments to shareholders have been consistently above average for the catering industry. External environment The European countries in which TK operates experienced economic recessions during 2020. There has been economic growth since then. Governments have supported recovering economies with grants and loans to small and medium‑sized businesses, including TK. Social and technological changes have included fewer consumers eating at restaurants. Smartphone apps are increasingly used for online shopping and ordering meal deliveries. More employees are now working from home rather than in offices. The populations of European capital cities include significant numbers of young, professional individuals who earn above average incomes. Marketing TK differentiates its meal service from the increasing number of competitors on the basis of choice, quality and packaging. The menu is varied and includes daily special offers. Consumers are assured of the high‑quality of TK’s meals as it provides a complete service; from sourcing ingredients to cooking, packaging and delivery. TK’s Operations Director has worked closely with a packaging company to research, develop and patent a range of recyclable packaging containers that ensure meals arrive hot and in excellent condition. Marketing is mainly on its website and social media. However, TK’s Marketing Director believes that the monthly distribution of leaflets to businesses and households is a good use of the marketing budget. The average selling price of a meal is $8. The delivery charge is $5 per order and the average order is for 3 meals. Innovation Thierry has always ensured that TK is at the forefront of product and process innovations in the food delivery business. The majority of TK’s orders are received through its smartphone app. Thierry and the other TK directors are now interested in trialling automated (driverless) delivery vehicles (ADVs) in country H. The ADVs will be computer controlled and offer fast, low‑cost meal deliveries. ADVs may be ideal for deliveries in city locations. The capital cost of the ADV trial will be $1.5 million. This could be financed by further bank borrowing or a new share issue.Operations and human resources TK’s kitchen operations are labour‑intensive. Meals are produced using batch production, but demand for different meals is difficult to predict due to changing food trends. This makes it very difficult to control inventory. Frequently, too much of some menu items is produced leading to food wastage. Recently, following a social media review praising a TK vegan curry meal, demand increased so quickly that the kitchens failed to produce enough. Some customers were disappointed because their orders were not met. TK’s Operations Director is investigating the use of lean production techniques, such as Just in Time (JIT), which he believes could improve efficiency. Each kitchen employs a manager and a team of ten full‑time chefs on permanent employment contracts. There are also kitchen assistants, meal packers and delivery drivers who are employed on a range of part‑time and zero‑hours contracts. Workers are under pressure to constantly improve productivity while maintaining high quality. As Thierry always reminds employees ‘the quality of our food is our USP, because we do not see customers face‑to‑face or serve them their meals’. Most TK employees are shareholders in the company. Annual productivity bonuses are paid in TK shares. Kitchen 2 – a problem kitchen Kitchen 2 is one of TK’s kitchens in country J. Kitchen 2 is not performing well because sales have declined over the past six months. The reasons for this are unclear. Kitchen 2 sells TK’s main menu items and has a maximum capacity of 2200 meals per day. The average daily output is 1000 meals but Saturday is the only day when all the meals produced are sold. Kitchen 2 is located in a low‑income area and the average order value is lower than for other kitchens. Thierry has asked for further financial information about Kitchen 2. Details of this are shown in Table 1. Table 1: Financial data for Kitchen 2 for the last 6 months $m Revenue 1.40 Cost of sales (ingredients and packaging) 0.38 Variable labour costs 0.80 Variable delivery costs 0.01 Rent and fixed utility costs 0.20 Head office costs including marketing 0.02

Table 2 shows extracts from TK’s financial data for 2021. Table 2: Extracts from TK’s financial data 2021 $m Revenue 25.40 Operating profit 3.98 Profit for the year 3.18 Total annual dividends 1.50 Non‑current liabilities 15.00 Capital employed 30.00 $ Share price at year end 14.00 Dividend per share 1.20 Further developments The directors of TK would like to diversify the activities of the business. They are considering two possible options for this. They will need to make a strategic choice as it will not be possible to carry out both projects. Option 1 Start a chain of luxury TK restaurants in the European cities where the kitchens are located. The restaurants would offer new menu choices including local speciality dishes. Option 2 Extend the TK product range to include packaged vegetable snacks. This would involve the takeover of a small manufacturer of premium snacks. A summary of the strategic choice data is shown in Appendix 1.

Appendix 1: Strategic choice data for options 1 and 2 Option 1 TK luxury restaurant chain Option 2 Takeover of snack manufacturer Initial cost $4m $2.5m Estimated accounting rate of return (ARR) 9.1% 7.6% Main driving force Market for luxury restaurants may grow as economies recover from recession Can be sold and delivered with existing meal delivery service Main restraining force Ability to respond to high level of competition in the market No experience in packaged snack production Estimated chances of failure 35% 30% Estimated monetary value over five years $3.5m $2.2m

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Analyse two opportunities for TK resulting from changes in the external environment.

Extract:

Fashion Frames plc (FF) FF makes plastic frames for glasses (spectacles) in a factory in country W, in South East Asia. FF sells its plastic frames to wholesale businesses that market well-known brands of plastic frames which they sell globally. The wholesalers reject 7% of the frames supplied by FF because of substandard quality. The FF design team create dynamic styles based on the demands of the wholesalers. Meeting delivery times is very important. FF only delivers 85% of its sales on time. FF needs to improve this percentage. Improving quality Chang, the production manager, aims to reduce the high level of rejects by the wholesalers. He has identified a number of factors which make this difficult including: • employees know that rejected frames can be recycled • production targets are very difficult to meet • problems with suppliers of raw materials • breakdowns with machinery. Chang proposes introducing Total Quality Management (TQM). He thinks this will reduce the number of substandard frames and improve FF’s delivery times. Chang forecasts successful implementation of TQM will also increase output by 10% and average variable cost will fall by 5%. However, Chang is aware that there may be problems with TQM and forecasts can be inaccurate. Table 1 shows information on FF’s output, costs and prices, before TQM is implemented. Table 1: FF’s output, costs and prices Year ending September 2021 Maximum capacity 16 million frames Actual output 14 million frames Average variable cost $20 Average selling price $40 Communication challenges FF has a centralised organisational structure with a low degree of delegation. Directors make decisions, department managers plan how to implement these and supervisors give instructions. Employees have little responsibility or control. FF has provided good pay, good conditions of work and security of employment. However, employees are aware that the directors are considering significant changes to working conditions. All employees find it difficult to discuss this with their line managers. Many employees work alone so information is passed on informally and often inaccurately. This uncertainty has begun to lead to dissatisfaction, complaints, higher absence rates and lower productivity. Privatisation of electricity and water industries In country W, state-owned businesses supply all electricity and water. Prices of services in these industries have risen at above the rate of inflation for the last three years. Sometimes, electricity supply is interrupted and FF finds it difficult to obtain information about reconnection. Water quality is variable. The government has announced it intends to privatise these industries in the next three years, to improve these services.

Buying 3D printers 3D printers that make frames for glasses as part of a CAD/CAM process are becoming available. Chang is considering whether FF should invest in this rapidly developing technology. 3D printers have a guaranteed life span of four years but he believes they are probably usable for six years. There is no way of accurately estimating their value after four years. The directors have told Chang that an acceptable accounting rate of return (ARR) is 5%. Chang thinks new 3D printers will increase FF’s long-term profitability. The 3D printers will result in significant reductions in employee costs and waste and substandard reject costs. Maintenance and training costs will, however, increase. Table 2 and Table 3 show some of Chang’s research. Table 2: Investment appraisal for 3D printers: cash flow forecasts $m Year 0 Year 1 Year 2 Year 3 Year 4 Buy printers (10) Increased maintenance costs (0.1) (0.1) (0.1) (0.1) Increased training costs (0.2) (0.2) (0.2) (0.2) (0.2) Employee cost reductions 2.1 2.1 2.1 2.1 Waste and reject cost reductions 0.8 0.8 0.8 0.8 Net cash flow (10.2) 2.6 2.6 2.6 2.6 Table 3: Discount factors at 5% discount rate Year 0 Year 1 Year 2 Year 3 Year 4 Discount factors 1.000 0.952 0.907 0.864 0.823 There are risks that this technology might be replaced in future by even more advanced process innovations but Chang is keen to invest in 3D printers. He knows competitors are considering buying them. Product development and marketing The marketing manager is concerned that FF relies only on specific orders from wholesalers for plastic frames. He proposes that FF should use product development to design and manufacture metal glasses frames. These would be marketed to wholesalers and directly to businesses who sell glasses with globally recognised brands. FF would have to acquire new skills and equipment in order to design and manufacture metal frames. The marketing manager visited international trade fairs and found that several competitors have research and development (R&D) departments. Strategic choice: enter the Asia Pacific retail market The Chief Executive Officer (CEO) states: ‘My strategic analysis shows that FF must continue with the current business model but should take a new direction as well. My strategic choice is that FF should enter the retail glasses market in the Asia Pacific region. This will mean selling our own glasses in retail shops. We will need to work closely with lens manufacturers. Increased eye strain and higher disposable income are driving the increasing demand for higher value glasses. We could use the Ansoff Matrix to help analyse the link between this business strategy and risk. There are several approaches we could use to enter this new market.’

The CEO illustrates his proposal with Table 4 and Table 5. Table 4: Retail glasses market entry decision tree analysis Regional market Expected monetary value North America + $3m Europe +$4m Asia Pacific + $14m Table 5: Retail glasses sales data Total sales 2021 ($bn) Forecast sales growth 2021–2025 (%) North America 37 8 Europe 39 8 Asia Pacific 35 10 Rest of world 8 14 Managing a change to team working FF currently produces frames on production lines. There are nine stages in the production process, including cutting out plastic sheets, smoothing component parts, attaching them, and final shaping and polishing. Employees only carry out the one task they have been trained for in the production process. The Directors are considering a proposal from Chang to move to team working. A team would be responsible for the whole production of a product and would take all necessary decisions. If successful, FF could possibly reduce the lead-time from order to completion by 60%, inventory levels by 27% and increase productivity by 20%. A change to team working means greater delegation and less centralisation. Control, authority and trust involving directors, managers, supervisors and production employees will have to change. This strategic change must be managed effectively and directors are confident that Chang has the necessary theoretical knowledge. The benefits he identified will only be achieved if he applies the correct techniques to manage the introduction of team working.

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Analyse the advantages to FF of the privatisation of the electricity and water industries.

Extract:

World Spices Corporation (WSC) World Spices Corporation (WSC) is based in country X, which uses the dollar ($) as its currency. WSC was started 20 years ago by Max Cole. His daughters Suki and Dasha, together with a board of directors now manage the company. It converted to a public limited company in 2009. The Cole family has a controlling interest, owning 55% of the shares. WSC imports raw spices from many countries, including the US and India. WSC processes the raw spices into a range of products, including single and mixed spices for cooking and spiced sauces, dips and relishes. Recipes for these products are kept secret. The exact details are only known to Suki, Dasha and the Operations Director. These recipes are important intellectual property of the company. WSC markets its products as ‘fair trade’ and publicises that fair prices are paid to spice growers. WSC also claims to monitor working conditions and employment practices of its suppliers. This is difficult due to the fact that growers are in remote locations around the world. The WSC brand name is recognised globally. Products are sold globally to both food manufacturing businesses and retailers. WSC has grown very fast due to the increasing popularity of spicy food in developed countries. WSC built a new factory to meet this demand. The final stage of spice processing is highly automated, using computer aided machinery (CAM). Economic environment Country X’s economy is slowly recovering from recession. Economic growth is forecast to be 2% this year and unemployment is falling. The $ in country X has appreciated against other major currencies in recent years. The demand for WSC’s products from different countries fluctuates for many reasons, including changes in foreign exchange rates. Table 1: Annual changes in demand for WSC’s products (%) Area 2018 2019 2020 Europe +10 +8 +5 US +14 +9 –3 Asia +8 +5 –2 Others +5 +4 –1 Marketing WSC sells mainly to business customers and marketing communications are all online. WSC uses social media to keep in touch with business customers. Its website publicises products to both businesses and consumers. The website also has a range of recipes using WSC’s spices, which are updated regularly to encourage users to visit regularly.

The ready meals project WSC’s marketing department has investigated demand for ‘ready meals’. These are pre-cooked meals that are sold ready prepared and packaged. Customers will be able to heat the ready meals quickly using an oven or microwave. Demand for spicy ready meals is growing quickly, especially in Asian markets. Reaction to WSC’s new ready meals has been very positive in focus group tasting sessions. The factory extension and new production equipment necessary for the ready meals project will cost $1.5m. In addition, WSC’s Marketing Director has requested a launch marketing budget of $750000 to increase customers’ awareness of the new products. WSC plans to distribute these ready meals through supermarkets. A coordinated marketing strategy will be needed for the new ready meals. Table 2 shows investment appraisal data for the ready meals project. Table 2: Investment appraisal data for the ready meals project Year Net cash flow $m Discount factors at 6% 0 (1.5) 1 1 0.30 0.94 2 0.55 0.89 3 0.60 0.84 4 0.60 0.79 5 0.60 0.75

Finance WSC financed its growth with retained profits and a bank loan of $10m. Dividend payments to investors have remained stable and comparable to companies in the same industry. Suki and Dasha would like to finance the new ready meals project by offering new shares for sale to existing shareholders (a rights issue), instead of more bank borrowing. Financial data for WSC is shown in Table 3. Table 3: Financial data for WSC 2019 ($) 2020 ($) Revenue 21.5m 23.5m Cost of raw materials 10.0m 11.0m Direct labour costs 2.6m 2.8m Marketing and administration costs 1.6m 1.7m Other expenses 1.0m 1.1m Operating profit 6.3m 6.9m Profit after tax and interest 4.8m 5.9m Non-current liabilities 10.0m 10.0m Capital employed 24.0m 25.0m Total annual dividends 3.5m 3.4m Share price at year end 12.00 11.00 Dividend per share 1.50 1.45 Human resources and operations Production workers, who maintain the taste and quality of the spice products, are highly skilled and important to the business. They are able to detect small differences in the products by regular tasting. The directors are worried that labour turnover has increased recently. Some experienced employees have moved to companies that offer better chances of promotion. Suki and Dasha would like to increase employee involvement in order to widen employees’ roles and increase labour flexibility. This would be part of a move towards lean production with the aim of making factory operations more efficient. Raw spices lose flavour if inventory is kept for too long and a large amount of space is needed for storage. The current production system leads to high wastage rates of raw materials.

Further developments The directors of WSC would like to expand the company further. There are two possible options. They need to make a strategic choice as it will not be possible to carry out both projects. Option A Take over a small fast food restaurant chain in country X and rebrand it as ‘WSC street food cafés.’ WSC would need to recruit experienced senior staff to manage the street food cafés. They would retain existing fast food chain employees. Option B Extend the WSC product range into drinks for the first time. These would include exclusive recipe tea, coffee and chocolate drink mixes. WSC would need to find suppliers of raw materials and build a new production line. A summary of the information collected so far is shown in Appendix 1. Appendix 1: Research data for Options A and B Option A Take over a small fast food restaurant chain in country X Option B Extend the WSC product range into drinks Initial cost $3.5m $2m Estimated time for completion 9 months 1.5 years Main driving forces • WSC expertise in spice recipes • Growing demand for spicy foods • WSC expertise in processing spices • Recognised brand name Main restraining forces • Highly competitive fast food market in country X • WSC lack of knowledge and experience of running street food cafés • WSC lack of knowledge and experience in market for drinks • Need to find reliable suppliers Competitive rivalry • Low supplier power • High threat of substitutes • High supplier power • High threat of substitutes Estimated chances of success 65% 55% Estimated monetary value over five years $5m $4m

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Analyse one opportunity and one threat to WSC of the appreciation of its currency ($) against other major currencies.

Extract:

Pizza Adventure Company (PAC) PAC is a private limited company which owns restaurants. It was started ten years ago in a large city in country X, which is located in Asia. The business was set up by Paulo who had moved to country X from Italy with his parents to start a farm. Paulo soon decided to move to the city where he observed the growing popularity of international food. He decided that he could adapt traditional pizza recipes to appeal to the tastes of Asian customers. This would also attract the increasing numbers of tourists visiting the city. PAC has grown very fast and now owns 10 restaurants throughout country X, in major cities and tourist resorts. The restaurants are managed by local employees. Their performance is assessed by Paulo and his brother Gio, the directors of PAC. Planning and resource management is supported by enterprise resource planning (ERP) software throughout the company. Economic environment The economy of country X has grown in recent years and average incomes are rising by 5% per year. Annual inflation is steady at 4% and unemployment is falling, especially in the cities. Changes in government policy have led to the currency exchange rate of country X appreciating (increasing in value) against other major currencies. The government of country X sees overseas tourists as an economic benefit, so it has lifted travel restrictions and launched a worldwide advertising campaign to encourage visitors. Products and services PAC restaurants sell a wide range of pizzas and other foods, such as salads. Customers have a wide choice of ingredients and toppings for their pizza. Many of these ingredients and toppings are grown or produced at Paulo’s own family farm. This business model has proved very popular and the restaurants are full most lunchtimes and evenings. PAC also offers a takeaway service that enables customers to order by phone or online using an App. Food delivery is outsourced to a specialist company which uses motorbikes to avoid the problem of heavy traffic in the cities. Marketing Paulo’s daughter, Alice, is responsible for marketing. She has talked to Paulo about increasing the range of food available in the restaurants, as she believes that the market for pizza in country X is approaching the maturity stage. In addition, competition is increasing with several multi-national pizza companies starting up in country X. Alice would like PAC to serve a wider range of vegetarian options and many more salads, as well as the pizzas. She has noticed increasing numbers of online articles about the need to eat a healthy diet, with pizzas often mentioned as examples of unhealthy food items. Alice wants to launch a new ‘healthy life’ range of meals at two of the biggest restaurants to test the market. The target market for the new range will be young professionals trying to lead a healthy lifestyle. Alice has used her skills as an ICT graduate to build a website for PAC, which she now maintains on a daily basis, including news on new products, special offers and customer reviews. PAC restaurants have received many excellent reviews on travellers’ websites as well as in local newspaper articles and tourism guides.

Finance PAC’s profits have increased every year. Paulo has always reinvested most of the profit back into the company, after paying dividends to himself and other family shareholders. Paulo has also financed the purchase of some of PAC’s restaurants through loans from banks. Financial data for PAC is shown in Appendix 1. A new project Paulo has identified the rising popularity of ‘street food’ being sold by mobile vendors at events and markets. He would like to import four pizza vans in 2020, equipped with ovens. Pizzas can then be prepared and sold wherever the vans are taken. The total investment will be $50000 per van. Each van will cost $2000 per year to maintain. Paulo plans to purchase the vans using a bank loan. However, Gio is worried about PAC taking on further non-current liabilities. The data for the proposed pizza van project is shown in Appendix 2 and Appendix 3. Human resource and quality issues The restaurant managers have a wide range of delegated powers, including employee recruitment and food ordering, according to the individual restaurant sales. Paulo promotes teamwork in each location. All employees are provided with a uniform and given a free meal at the end of their duty hours. Restaurant opening times are long, requiring careful workforce planning. PAC employees have different employment contracts. Restaurant managers are full-time, permanent employees. Most waiting staff have flexible, part-time contracts. Labour turnover rates are high because restaurant work is demanding and pressurised, with some leavers saying they feel ‘undervalued’. Paulo and his management team try to ensure that food and quality service standards are consistently high in all PAC restaurants. All ingredients are stored carefully and used while still fresh. However, recently there have been an increasing number of customer complaints about the quality of service at two PAC restaurants. A customer has also complained that they became very ill after eating a pizza at a PAC restaurant. She claimed that the food had not been cooked thoroughly. The manager of the restaurant did not take this complaint seriously and she did not inform Gio and Paulo about it. Further expansion Paulo would like to expand PAC further with the aim of increasing return on capital employed. He is planning to meet with his management team to consider two opportunities. Only one strategy will be chosen. A summary of research data is shown in Appendix 4. Option 1: Purchase of ‘Healthy Juice’ bar business Take over ownership of a business which operates two ‘Healthy Juice’ bars in shopping malls in country X. Option 2: Sell franchises of PAC restaurants in countries Y and Z Sell franchises of the PAC restaurant model in neighbouring countries Y and Z. This would require the establishment of a central head office to administer the franchised outlets. Ingredients would be sourced from local suppliers.

Appendix 1: Financial data for PAC ($m) Actual data for 2019 Forecast for 2020 (without new pizza van investment) Revenue 5.2 5.3 Cost of sales 1.3 1.5 Labour costs 1.5 1.7 Marketing and administration costs 0.7 0.8 Other expenses 1.1 1.1 Non-current liabilities 4.9 4.8 Capital employed 10 10 Appendix 2: Financial data for pizza van project Year Net cash flow ($000) Discount factors at 8% 0 (200) 1 1 70 0.93 2 70 0.86 3 80 0.79 4 80 0.74 Appendix 3: Forecast data for each pizza van in 2021, prepared by Gio Forecasted number of customers 6000 Average spend per customer $7.00 Average variable cost per customer $2.50 Labour costs $12000 Van operating costs including maintenance $3500

Appendix 4: Research data for Options 1 and 2 Option 1 Purchase of ‘Healthy Juice’ bar business Option 2 Sell franchises of PAC restaurants in countries Y and Z Initial cost $0.75m $0.5m Timescale needed for implementation 3 months 1–2 years Probability of success 0.85 0.55 Main driving forces • Widen PAC product portfolio • Widen market and extend reach of PAC brand • Use of PAC core competency • Become an international company and brand name Main restraining force • Lack of familiarity with juice products and shopping mall environment • Increasing local and international competitors • Lack of familiarity with franchising and countries Y and Z • Difficult to control franchisees outside country X Position on Ansoff matrix New product, existing market Existing product, new market

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Analyse the advantages and disadvantages to PAC of country X’s exchange rate appreciating against other currencies.

Extract:

Normax Hotels (NH) NH is a public limited company that owns 32 hotels in country X. Jolin is the Chief Executive. NH has a centralised organisational structure. NH has three types of hotel: • Luxury hotels offer high quality accommodation at premium prices in city centres and exclusive beach resorts. They attract guests from all over the world as well as high‑income earners in country X. • Family hotels offer family rooms, children’s play areas, babysitting services and activities for children in rural and seaside locations. • Basic hotels offer clean, simple accommodation with basic food and facilities. The guests are low‑income travellers and students. They are located in city retail parks. Each hotel manager has limited authority to make decisions because they are told what to do by NH’s Head Office. NH is organised into the following functional departments: administration, operations, finance, marketing, human resources, IT and strategic planning. International expansion? Country Q is a low‑income country. It has a small but growing number of locally owned hotels. Jolin has held two meetings with the Minister for Tourism in country Q to discuss the possibility of opening three NH hotels in her country. These would be located in areas of outstanding natural beauty. Jolin told her that the three hotels would employ several hundred people and generate significant profits. However, the Minister expressed concern that country Q could lose more than it gained from such an investment from a large foreign company. She would have to consider the proposal in more detail. Operations issues Jolin is concerned that profits have recently decreased. He monitors key statistics and is considering introducing lean production principles. Table 1 shows some relevant information. NH holds high levels of inventory of supplies needed for the rooms. Each hotel can supply enough sheets, towels, soaps and cosmetics to every room every day, whether needed or not. The kitchens are expected to have enough food inventory for three days. A small but increasing number of employees have been dismissed for taking home food from the kitchen stores.

Table 1: NH capacity utilisation (room occupancy) and price data, 2019 Hotel type Total number of rooms Budgeted average number of rooms occupied per night Average number of rooms actually occupied per night Price per room per night Luxury 1600 1400 1300 $150 Family 1400 1100 1000 $110 Basic 2000 1800 1600 $40 Customer service Hotel managers claim that they follow company policy and insist that employees do the same. However, many customers complain about the difficulty of communicating with employees and managers who often claim that they are ‘too busy’. Another common complaint is that the hotels need modernising. Head Office has received some letters from employees with ideas for improvements but these have not been considered. Table 2 shows information about NH customers’ experience. Table 2: NH customers’ experience Hotel type Customer complaints 2019 Percentage change of customer complaints from 2018 Average customer satisfaction rating out of 10 Luxury 8560 +8 8.3 Family 6800 +7 7.1 Basic 9040 +9 8.1 Human resource issues Hotel employees are recruited by each hotel manager. Many employees have part time, flexible and temporary contracts. None of them are on zero hour contracts. All employees are trained to perform only one role in the hotel. The hotel managers are given strict labour cost budgets. Each manager has assistant managers who decide the allocation of tasks. Employees have worksheets that detail each task and how long it should take. No time is allowed to discuss these details. The Human Resource Director has just returned from a conference about Management by Objectives (MBO) and is now considering the information in Table 3.

Table 3: NH employee information 2018 2019 Employment costs as a percentage of total costs 68% 74% Employees average hourly wage rate $8 $8 Trade union membership as a percentage of employees 14% 18% Percentage of employees involved in disciplinary proceedings 3% 6% Labour turnover: non‑management employees 14% 26% Labour turnover: assistant managers 4% 15% Average job satisfaction rating out of 10: non‑management employees 6 5 Average job satisfaction rating out of 10: assistant managers 9 8 Marketing NH hotels Jolin is worried about room occupancy rates being below budget. Katie, the Marketing Director, told Jolin that: • the balance between the advertising media used (magazines, television and direct marketing) needed to be reviewed • economic and market conditions have not been favourable • room prices are fixed at the start of each year. Jolin insisted that Katie should revise the marketing plan to achieve the objectives of increased occupancy rates and increased revenue. A possible takeover Pitro, the Finance Director, has prepared the latest financial statements. See Table 4 and Table 5. Jolin recently told him: ‘I have been approached by the owners of EatBest, a restaurant chain, who want to sell the business. If NH takes over EatBest it could be completed in 2021. It would involve making a cash payment of $20m plus 0.5m NH shares. EatBest’s restaurants are valued at $40m.’ Jolin has forecast that this takeover would result in the following changes to NH’s accounts for the year ending 31 October 2021: • revenue would increase to $170m, cost of sales would increase to $46m and expenses would increase to $109m • additional borrowing of $50m at 5% interest per year • current assets and current liabilities increase by 10%.

Table 4: NH income statement year ended 31 October 2020 $m Revenue 140 Cost of sales 36 Gross profit 104 Expenses 84 Operating profit 20 Interest 4 Profit before tax 16 Profit after tax 8 Dividends 5 Retained earnings 3 Table 5: Extract from NH statement of financial position at 31 October 2020 $m Non‑current assets 80 Current assets 35 Total assets 115 Non‑current liabilities (60) Current liabilities (20) Total liabilities (80) Net assets 35 Directors’ meeting Jolin has just had a meeting with the directors. He started by reminding them that NH is recognised as having three core competencies which must provide the framework for any strategic decisions made. These are: • outstanding customer service • professional standards that focus on efficiency • clear leadership based on understanding the industry.

The directors discussed whether the organisational structure of NH should be changed. Jolin told the directors: ‘I am convinced that we need to change the organisational structure of NH. When the company started with just one hotel it was obvious that functional organisation was best. Now I think this is a barrier to success. Perhaps we should consider management theory including Chandler’s assertion that strategy and structure are linked. Maybe we also need to consider delayering NH’s organisational structure.’ Jolin finished the meeting by telling directors: ‘We also need a new strategy to avoid decline. We have to review our objectives and structure as part of producing a detailed strategic plan for success.’

Read the extract before answering

Analyse the possible disadvantages for country Q of NH opening hotels there.

Extract:

Garbanzo Restaurants (GR) Leff Alfa left school with no formal qualifications. However, he had a passion for food and started working for a fast food business in country F. Leff worked hard and within five years was promoted to restaurant manager. By 2010, he had become dissatisfied with not being able to make strategic decisions. He decided to start up his own business. Leff is now the Managing Director of GR, a medium-sized private limited company in country F. GR has a chain of 15 restaurants which sell high quality, healthy food using locally sourced produce (ingredients). GR has expanded slowly. However, Leff is now considering ambitious growth strategies requiring significant capital investment. Leff makes the decisions GR has an organisational structure with a tall hierarchy. Leff retains control of all key decisions aided by the Finance, Human Resource and Marketing Directors. These directors report directly to Leff and help him plan and decide on strategies, tactics and policies for GR and its restaurants. GR employs a manager for each restaurant with responsibility for implementing Leff’s policies, recruiting employees and sourcing local produce. Leff makes decisions about pricing and menus. He sets and monitors budgets for each restaurant. Restaurant managers have a small marketing budget. GR has a much larger central marketing budget to develop the GR brand. Restaurant 16 Leff has decided to open a new restaurant. He has identified two possible locations. Location X is an existing fast food outlet in a shopping mall near a city. There are three other restaurants in the shopping mall. Location Y is in a tourist resort and would require more work to convert the building to a suitable restaurant layout. Leff has gathered information about the two locations. This is shown in Table 1.

Table 1: Information on the two locations Location X Location Y Estimated time until opening of restaurant 2 months 6 months Target market Local community Tourists Capital cost of building work and equipment $30000 $100000 Monthly fixed costs (including leasing cost) $12000 $24000 Estimated average variable cost per customer $2 $2 Estimated average revenue per customer $8 $10 Expected average monthly number of customers 3000 5000 Number of customers per month needed to break even 2000 See Question 2(a)(i) Expected monthly profit $6000 See Question 2(a)(iii) Length of contract for leasing the building 1 year 3 years Human resource problems Suma, the Human Resource Director, is worried about the high level of labour turnover and absenteeism at many restaurants, particularly among kitchen employees. These problems add to GR’s recruitment and training costs. All new employees receive the minimum legally required training in food hygiene and health and safety. Most restaurant managers are recruited externally and Leff prefers individuals with strong personalities who ‘get things done’. The restaurant market is highly competitive. Consequently, Leff aims to keep labour costs low and maintain as much labour flexibility as possible. Many kitchen employees and waiters are paid the legal minimum wage. However, waiters can supplement their income through the tips that customers give for good service and food. Some employees have part-time contracts and some employees have full-time contracts. A small number of employees are on zero hour contracts even though the government is planning to make these illegal. Restaurant managers impose the rigid work practices developed by Leff and decide the weekly allocation of tasks. There is little consultation with employees about any changes introduced to the restaurants. Suma has conducted a survey of employees and leavers to provide feedback about GR. Tables 2 and 3 provide selected employee data and information from the survey.

Table 2: Employee data 2018 2019 Number of restaurant employees 200 200 Labour turnover 20% 22% Days lost through absenteeism 1400 1450 Table 3: Extract from surveys of employees and leavers Positive factors of working for GR • High level of tips (stated by some waiters) • Good working conditions Negative factors of working for GR • Lack of empowerment • Limited consultation Main reasons for leaving GR • Dissatisfaction with allocation of work tasks • Low pay • No opportunities for promotion • Variable working hours Increasing revenues GR’s objective for 2021 is to increase revenue by 10% and profit by 15% at its existing restaurants. Leff and Alec, the Marketing Director, are working on the marketing plan for 2021. Using past revenue data, market reports and primary research, Alec has considered how changes to price and promotion might affect demand. The price of a typical falafel meal at GR is $6 and in the last twelve months, 360000 of these meals were sold. He estimates that competitors in GR’s market segment will, on average, increase prices by 5% in 2021. If GR prices and other factors remain unchanged, Alec estimates additional sales of 14400 falafel meals. Alec has also estimated that promotional elasticity of demand is 0.2. GR’s current annual spend on above the line promotion is $150000. GR’s revenue was $5.76m during the last 12 months.

Budgeting for success Leff sets quarterly budgets for all restaurants. He uses an incremental budgeting approach. Every quarter he meets with individual restaurant managers to monitor performance and give them new budgets. Leff is unhappy with the performance of Restaurant 13, which has failed to meet budget targets for the last 18 months. See Table 4. At the most recent meeting, the manager of Restaurant 13 blamed the adverse variances on: • increased recruitment and training costs due to higher labour turnover • a new competitor opening a nearby restaurant 12 months ago • a reduction in tourist numbers caused by appreciation of country F’s currency exchange rate • an increase in costs of locally sourced food due to poor weather. The manager told Leff that: ‘Unrealistic budgets demotivate me and other employees and do not help with the allocation of resources.’ Table 4 shows recent budget data for Restaurant 13. Table 4: Restaurant 13 – Budget data for the 3 months to 30 September 2020 Budget ($) Actual ($) Revenue 120000 115000 Cost of sales 27000 28000 Restaurant overhead costs 60000 65000 Allocated Head Office overheads 15000 15000 Profit 18000 7000 Strategic options for growth Leff has decided to expand GR. He has conducted a thorough strategic analysis of his business and as a result is considering two strategic options. Strategy 1: Manufacture chilled meals. GR restaurants already sell a range of chilled meals, produced and packaged in each restaurant, for customers to purchase and reheat later. A national supermarket is interested in selling these GR meals throughout country F. GR would need to establish a manufacturing site to meet the potential demand for these meals. Leff estimates a capital cost of $3m. Strategy 2: Takeover of Abila. Abila is a group of 10 restaurants in country F. The owners want to sell the business for $1.5m. If GR purchased Abila it would have to rebrand the group and update the restaurants. This would cost a further $0.5m. Leff believes that he can improve profitability of these restaurants through rationalisation. There would be many redundancies. Appendix 1 and Appendix 2, on the next page, give further information about Leff’s strategic analysis.

Appendix 1: SWOT analysis for GR Strengths • Strong brand image • Quality meals • Low gearing Opportunities • Market growth in restaurant market of 3% per annum • Increasing sales of chilled meals of 10% per annum Weaknesses • Labour turnover • Demotivated employees Threats • Competitors with greater economies of scale • New entrants to the market • Changes in the legal environment Appendix 2: Porter’s Five Forces – Country F chilled meal market Threat of new entrants • Low consumer brand loyalty in market Buyer power • Three supermarkets control 80% of the market Threat of substitutes • Many substitutes available Supplier power • Few manufacturers of chilled meals

Read the extract before answering

Analyse how any two changes in the legal environment might affect GR.

Extract:

MERIDIAN TECHNOLOGIES (MT)

Background

Meridian Technologies (MT) is a private limited company based in country K. It designs and manufactures smart home devices, including wireless speakers, smart thermostats, and home security systems.

MT was founded 12 years ago by entrepreneur Hana Park and has grown to employ 850 workers across two manufacturing facilities in country K.

MT sells its products domestically and exports to several countries in Asia and Europe. Competition in the smart home device market is intense. MT faces growing pressure from several large multinational companies (MNCs) that compete aggressively on price and brand recognition.

Organisational Change

Until two years ago, MT operated with a flat organisational structure in which considerable authority was delegated to regional managers. Following a period of rapid growth, Hana decided to restructure the business, reducing the number of management levels and centralising all major decision-making at head office.

The restructuring has not been universally welcomed. A recent internal employee survey found that 64% of workers felt less motivated since the change was introduced. Three experienced regional managers left the business within six months of the restructuring being implemented.

Expansion Plans

MT is planning to expand its production capacity and is evaluating two investment projects. Table 1 shows data for Project A. Table 2 shows the projected annual net cash flows for Project B.

Table 1: Project A — Automated Production Line

Table 2: Project B — Expansion of Existing Facility

Export Markets and Exchange Rates

MT currently generates 40% of its revenue from exports. Approximately 60% of MT's export revenue is earned in euros (€). In the past 12 months, country K's currency has strengthened significantly against the euro, rising in value by 15%.

Table 3 shows MT's revenue by market for the year ended December 2023.

Table 3: MT Revenue by Market (year ended December 2023)

Pricing Strategy

MT's Finance Director has suggested reducing the selling price of the smart thermostat in order to increase market share and compete more effectively against MNC rivals. Table 4 shows the relevant pricing and demand data.

Table 4: Smart Thermostat — Pricing and Demand Data

Corporate Social Responsibility

MT sources many of its components from suppliers based in country L, where labour costs are significantly lower than in country K. A pressure group called EthicsWatch has recently published a report claiming that some of MT's suppliers in country L use poor working conditions and pay employees below the minimum wage. The report has received widespread media coverage in country K and has been shared extensively on social media.

Hana is considering whether to introduce a formal corporate social responsibility (CSR) strategy. This would include auditing all of MT's suppliers in country L and switching to certified ethical suppliers where necessary. MT's operations director estimates that this would increase raw material costs by approximately 12%.

Read the insert before answering this question.

Analyse two ways in which the strengthening of country K's currency might affect MT's business.

Analyse two ways in which a business could respond to an increase in competition in its market.

Extract:

KOPARA BEVERAGES (KB)

Background

Kopara Beverages (KB) is a private limited company based in country P. It manufactures and sells premium fruit juices and plant-based drinks, including cold-pressed juices, coconut water blends, and protein smoothies. Founded 15 years ago by entrepreneur Lily Sato, KB now employs 400 workers in one large production facility in country P.

KB sells its products domestically and has recently begun exporting to country Q, where demand for healthy, natural drinks is growing rapidly. KB's mission is 'to bring nutritious, sustainably produced beverages to customers across the world'.

Organisational Structure

Two years ago, KB moved from a centralised management structure to a decentralised one, giving production and marketing managers greater autonomy over day-to-day decisions. Lily believes the change has increased innovation and improved employee morale.

However, KB's Finance Director has raised concerns about inconsistent financial decisions being made across departments and a lack of coordinated budgeting.

Investment Projects

To meet growing demand from country Q, KB is evaluating two investment projects. Table 1 shows data for Project A. Table 2 shows projected annual net cash flows and discount factors for Project B.

Table 1: Project A — New Production Line

Table 2: Project B — Automated Bottling System

Financial Performance

KB's Finance Director has produced financial data for 2022 and 2023 to allow comparison of the business's performance. Table 3 shows selected financial data.

Table 3: KB selected financial data

Competitive Pressures

The domestic market for beverages in country P has become increasingly competitive. Several large multinational companies (MNCs) have entered the market with similar healthy drink products, often at significantly lower prices than KB. KB's share of the domestic market has fallen from 18% to 14% over the past two years.

KB's Marketing Director is recommending that KB invests in product innovation — developing new flavours, new formats, and stronger branding — to differentiate its products from MNC rivals and justify its premium price.

The Finance Director disagrees, believing that KB must reduce prices to remain competitive and maintain market share.

KB's export revenue from country Q has grown by 35% in the past year. Country Q has a growing middle-class population with rising health awareness and disposable income. Lily is considering whether KB should seek additional long-term finance to accelerate its expansion into country Q.

Read the insert before answering this question.

Analyse two ways in which the growing middle-class population in country Q might affect KB's marketing strategy.

Extract:

AerCore (AC) Omar is the founder and Chief Executive Officer (CEO) of AC, a private limited company. AC was founded in 2000 and manufactures fitness equipment in country K. Membership of fitness centres is increasing in country K as a result of rising incomes and greater awareness of the benefits of exercise. AC sells and leases fitness equipment such as treadmills and rowing machines to fitness centres, hotels and large corporations. AC does not currently sell directly to consumers. AC exports to a neighbouring country though sales have declined there in the past two years. Foreign manufacturers have begun to sell their fitness equipment in country K due to the growth of the market. Control from the centre Omar and six other family members own all the shares of AC and they are the only directors. Omar keeps control of all aspects of the business. Organisation is hierarchical and centralised. Managers have only limited authority. AC has expanded gradually over the years, financed by retained profits and bank loans. AC has made sufficient profit to give shareholders a good return. Table 1 shows selected data from AC’s latest annual accounts. Table 1: Selected data from AC’s annual accounts as at 30 September 2021 ($m) Revenue 84 Cost of sales 44 Expenses 36 Total dividends 2 Current assets 3 Current liabilities 2 Non-current liabilities 40 Shareholder equity 25 Omar has plans to significantly expand AC in the next three years. Omar believes this requires the board to consider two key questions: • Should AC convert to a public limited company (plc)? • Would decentralisation benefit AC? Consumer fitness equipment market AC currently focuses on the industrial sector of the fitness market. Marketing relies on promotion at trade fairs, advertising in industry magazines and direct selling to hotels, gyms and corporate offices. Omar’s brother Khalil is the Marketing Director. He has identified that there is rapid growth in the consumer equipment fitness market. In this market people purchase fitness equipment to use in their own homes. Khalil believes that price is important to these consumers. The equipment does not need to be as durable as for the industrial sector.

His research suggests the increasing number of people who are overweight is a driving factor for growth in the use of fitness products at home. The Board of Directors has agreed to his proposal to develop products more suitable for entering the consumer market in 2022. Khalil has researched the consumer fitness equipment market in country K. Table 2 gives a summary of his research. Table 2: The consumer fitness equipment market in country K in 2020 Market share of the three biggest suppliers of fitness equipment 60% Number of suppliers of fitness equipment 50 Change in advertising expenditure by the market leading brand +30% Average spend on fitness equipment $550 Growth of consumer market 3% Proportion of households with fitness equipment 5% Proportion of consumers buying fitness equipment online 75% Khalil will outline his proposed marketing strategy to the Board of Directors next week. He will recommend an objective of achieving a market share of 5% within 2 years. Manufacturing problems AC’s employees are skilled and there is a production line for each product. Quality control inspectors are employed to ensure that fitness equipment conforms to the quality standards set by AC. However, Omar is concerned about the increase in the proportion of substandard output. The operations manager estimates that the average cost to AC of correcting substandard output is $70 per unit. The operations manager has also reported that production of treadmills was recently stopped for two days due to late delivery of an important component. Table 3 contains factory data. Table 3: Factory data for 2020 Number of employees 80 Number of days lost through absenteeism 600 Average monthly output (units of equipment) 5100 Percentage of substandard output 3% Omar asked the operations manager to investigate the problems and make a recommendation for change. The operations manager reported the following: • Production line workers are paid approximately 90% of the industry average. • Labour turnover in 2020 was 15%. • Workers feel that they are not valued by AC. • Workers do not feel that they are trusted. The operations manager has recommended that AC should introduce Total Quality Management (TQM). He has also told Omar that he has insufficient authority to make the necessary decisions to manage operations effectively.

Growth strategies Competitive rivalry in the fitness industry is high. Existing businesses aim to maintain market share. Growth is mainly driven by entering new markets. Research and development focuses on product development. As well as entering the consumer market in country K, Omar will present two other strategies for growth at the next Board meeting. These are outlined below: Option 1: market development. Enter the fitness market in country P. Initially this would target the industrial sector. Option 2: diversification. Diversify into the tertiary sector by opening a chain of fitness centres in country K. These would target the premium segment of the market. Omar has researched both options and estimated sales and costs to help make the decision. Extracts from his research are shown in Appendix 2. Appendix 1: Forecast economic data for country K 2022 2023 2024 Annual growth in real GDP (%) 3 5 3.5 Inflation rate (%) 6 9 10 Indirect tax rate (sales tax) (%) 10 12 12 Direct tax rate (income tax) (%) 24 26 26 Unemployment rate (%) 9 7.8 7.4 Interest rate (%) 6 8 8

Appendix 2: Strategic choice techniques for the potential growth strategies capital cost ($15m) option 1 success 0.6 $26m $12m $26m $22m failure 0.4 success 0.8 failure 0.2 option 2 capital cost ($20m) Option 1: market development Option 2: diversification Payback 4 years 5 years Accounting rate of return (ARR) first ten years 10% 13% Key driving forces • Strong economic growth in country P • Growth in fitness centre membership • Stable growing market in country K • Opportunity for increased sales of AC’s equipment • Develop branding Key restraining forces • Existing competition • Foreign exchange rate risks • Capacity constraints • Lack of managerial expertise in tertiary sector • Cost

Read the extract before answering

Evaluate the likely impact on AC’s future profitability of the forecast economic changes in Appendix 1.

Extract:

Urban Bee Hive (UBH) Co-working After Amit Menda graduated from university, he started work for a business in the US. The business specialised in designing workplace environments that aim to improve productivity. Whilst working in the US, Amit observed the growth of co-working. Co-working provides office space and support services for businesses. It offers a flexible solution for businesses which need an alternative to traditional long-term leasing or ownership of office space. In 2018, using his knowledge and experience, Amit founded UBH, a private limited company. It is based in country W, where co-working is still a relatively new idea. UBH focuses on providing office space to entrepreneurs and small businesses as and when they demand it. UBH calls its co-working centres ‘beehives’. There are three shareholders in UBH, all of whom are directors. Amit owns 50% of the shares while the other two shareholders own 25% each. A difficult economic climate Until 2020, UBH’s expansion was rapid. This internal growth was mainly financed by bank loans. However, in 2020 UBH came close to failing. There was a recession in country W when economic output fell by 10%. Many of UBH’s small business customers became insolvent during the recession. UBH was left with significant unused capacity and almost no working capital. The government responded quickly to the recession and made the following changes to its economic policies: • increased investment in infrastructure including road and rail transport • reduced income tax • reduced central bank interest rates • delayed payment of business and property taxes. Amit believes that without these changes to economic policies UBH would have failed. Marketing strategy UBH’s marketing strategy has targeted entrepreneurs starting new businesses and small, established businesses. Each UBH co-working centre (beehive) provides customers with shared kitchen facilities and snack vending machines. Customers are offered flexible contracts from 1 day to 1 year. They can either lease a hot desk (any desk available that day), a dedicated desk (the same desk for the duration of the contract) or a private office. Customers can also rent meeting rooms of various sizes by the hour. All customers benefit from unlimited internet access and printing facilities.

The Marketing Director has produced a situational analysis for the Board of Directors to consider. Selected details are given below. • In 2020, capacity utilisation fell to a low of 50%. • During 2021, following the recession, UBH opened 3 new beehives. UBH now has 10 beehives in country W. • In 2021, two international corporations entered the market in direct competition with UBH. • Customer feedback shows a high level of satisfaction with UBH’s facilities. • Customer feedback rates price, flexible contracts and distance from key transport hubs as the three most important factors in choosing a co-working centre. • Price elasticity of demand for leasing desks is estimated to be –0.5. • Most new business start-ups are unaware of the benefits of co-working. • Social media advertising has been the most cost-effective method of attracting customers. • Some larger businesses, including multinationals, make use of co-working centres in country W. However, they demand premium facilities and more space per desk than UBH currently provide. • Forecast market growth for co-working in country W in 2023 is 10%. Table 1: Price per month for leasing desks at UBH and market leader UBH ($) Market leader ($) Hot desk 150 140 Dedicated desk 300 280 Private office 2500 2300 Amit is concerned that capacity utilisation across UBH’s 10 beehives averages 80% compared to the target of 100%. He has asked the marketing department to propose changes to the marketing strategy to increase sales and reach target capacity. Managing co-working centres and Human Resource Management (HRM) Amit has delegated authority to centre managers to make decisions about local advertising, day-to-day operational issues and hiring of employees such as cleaners, IT technicians and security. Each UBH beehive also has a customer relationship manager. UBH encourages its beehives to hold special events to promote their facilities and increase customer interaction. Recent events include educational talks and business advice sessions. UBH employees have flexible employment contracts. Employees can spend 5% of their time working on individual projects of interest. All new recruits receive extensive training. UBH’s vision includes ‘Our people are our greatest strength and we are committed to providing opportunities for each individual to fulfil their potential. Our team is energetic with an entrepreneurial spirit, ready to face challenges.’Beehive 811 UBH is scheduled to open its new centre, Beehive 811, very soon. The Operations Director prepared a network analysis at the start of this project and predicted it would finish within Amit’s deadline of 45 days. Table 2 and Fig. 1 provide details of the network analysis and diagram. Table 2: Network analysis Activity Activity detail Preceding activities Duration (days) A Agree and sign lease with landlord None 5 B Draft building plans None 3 C Order and delivery of building materials A & B 5 D Building work and inspection C 20 E Order and delivery of office equipment A & B 10 F Installation of office equipment D & E 8 G Employee recruitment A 24 H Employee training G 10 J Initial marketing of centre A & B 30 K Fire inspection and certificate F 5 2 5 5 1 0 0 3 5 5 4 10 10 5 A B 3 C 5 D 20 J 30 F 8 K 5 E 10 G 24 H 10 5 6 30 30 7 38 38 8 43 43 Fig. 1: Network diagram The project started 10 days ago. The delivery of office equipment is delayed by 12 days. Amit is concerned that any delay in opening will lead to a loss of income if prospective customers decide to go elsewhere.

Going public? After making a loss in 2020, UBH returned to profit in 2021. UBH has ambitious expansion plans for the next 18 months. As well as opening Beehive 811, UBH is aiming to open 3 more centres in 2022 and 10 more in 2023. Office buildings are expensive in country W so UBH uses a combination of long-term leases and joint investments with landlords to reduce cash outflows. UBH will need to invest $16m to finance this expansion. Amit is in favour of changing UBH to a public limited company (plc). UBH could offer its shares for sale to the public by early 2023. The other two shareholders warned Amit that the cost of a stock exchange flotation is likely to be very high. The Finance Director predicts that interest rates in country W will increase from 2% to 4% by 2023. Table 3 provides data from UBH’s latest financial statements. Table 3: Extracts from UBH’s financial statements 2021 ($m) 2020 ($m) Income statement Revenue 14.4 6 Profit/loss for the year 1.5 (3) Dividends paid 0.5 0.2 Statement of financial position (at end of year) Non-current liabilities 12 9 Share capital 2 2 Retained earnings 3.5 2.5 Trade receivables 1.1 0.7 Cash and cash equivalents 0.7 0.1 Current liabilities 3 4.5

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Evaluate the likely impact on UBH of the changes the government made to its economic policies in response to the recession.

Extract:

Waste To Zero (WTZ) Making use of waste As a young boy Amandi Said supplemented his family’s income by finding waste materials and products and making new products to sell. Later, he employed other teenagers to collect waste such as card and plastics in the capital city of country R. Amandi sold these waste materials to recycling companies. In 2015, Amandi set up WTZ as a private limited company and a summary of its rapid growth is provided below. 2015 WTZ gains contract from local government to collect recyclable waste. This is sorted at the new WTZ recycling centre and then sold to local manufacturers. 2017 WTZ opens its first factory producing the innovative Hydrocamel – a water barrel made from recycled plastic waste. The Hydrocamel is sold to local communities and charities to improve access to clean water in low‑income countries. 2019 WTZ converts to a public limited company. Operations expand to other major cities in country R. Additional waste recycling centres and factories open. One centre in country R burns waste products to generate electricity. 2020 WTZ patents a process for creating bricks from waste plastic and rubber. These bricks can be used to build durable and affordable houses. 2021 WTZ takes over MR, a company that recycles metal. 2022 WTZ’s market share for collecting and recycling plastic waste in country R reaches 60%. Ownership and finance Amandi retains a controlling stake in WTZ. He has always been motivated by profit and the desire to secure a future for his children. Amandi is willing to take risks. WTZ has entered new markets and invested in research and development. Business expansion has been financed by bank borrowing and by the public offer of shares on the stock market in 2019. Table 1 and Table 2 provide selected information from the financial statements of WTZ. Table 1: Extracts from WTZ’s income statement (year ending 30 April) 2022 ($m) 2021 ($m) Revenue 60.0 50.0 Profit for the year 5.6 6.4 Dividends 4.8 4.4

Table 2: Extracts from WTZ’s statement of financial position (at 30 April) 2022 ($m) 2021 ($m) Non‑current liabilities 14.0 10.0 Share capital 4.0 4.0 Retained profit reserves 4.0 3.8 Inventories 4.0 3.2 Trade receivables 1.6 1.5 Cash 0.2 0.4 Current liabilities 4.2 3.6 Notes: Authorised share capital – 20 million shares @ $0.5 Number of shares issued – 8 million Current share price – $3 Operational efficiency Amandi’s focus has always been on minimising costs to maximise profit margins. Many factory employees are on flexible contracts and are paid the minimum wage for unskilled work. Many employees work long hours. Working conditions in WTZ’s factories are difficult with poor ventilation and a lack of facilities for employees to take breaks. Employees have demanded the right to join a trade union. However, unemployment in country R is high, so WTZ has refused to recognise trade unions. The new operations manager at the Hydrocamel factory, Khalid, reported the following problems to the directors: • employee absenteeism is increasing • productivity is not increasing • quality standards are below expectations with 5% of output rejected • inefficient collection of recycled materials • high inventory levels. Khalid recommends a lean approach to production including the introduction of Kaizen (continuous improvement). To be effective this change would require investment in employee training.

Marketing Hydrocamel has been a very successful product since its launch in 2017. The Hydrocamel helps families reduce the time needed to collect and transport water. The Hydrocamel can store 100 litres of water and is designed to be rolled so that it is easily movable. In 2019 a competitor brand, the Hippo Barrel, was launched and WTZ’s sales growth slowed. The marketing manager, Kofi, is planning a marketing strategy to increase sales to 50000 units per year which is the maximum capacity of the factory. He collected the following information as part of his situational analysis: • price of the Hydrocamel is $140 • price of the competitor’s Hippo Barrel was reduced by 20% to $120 in 2020 • this resulted in an 8% decrease in demand for the Hydrocamel to 40000 units in 2021 • estimated price elasticity of demand for the Hydrocamel is –1.2 • WTZ promotes the Hydrocamel through adverts in specialist magazines and by contacting charities directly • the promotional budget in 2021 was $10000 • targeted marketing spending is estimated to have promotional elasticity of demand of 1.3. Organisational structure Amandi has not changed the organisational structure of WTZ as the business expanded. The business has a hierarchical structure with functional areas of operations, human resources, marketing and finance. The business has been successful and continues to expand. Continued expansion has made it more difficult for Amandi to have effective control over the business. He thinks that managers focus too much on their functional responsibilities and this prevents them from planning strategically. Amandi considers the current organisational structure to be a weakness that is constraining growth. In discussion with other directors, Amandi commented ‘WTZ is increasingly diversified and we need a structure that can support growth and drive innovation. Changes will also be needed if we expand into other countries to process waste and generate electricity.’ An increased focus on corporate social responsibility (CSR) Kofi recommends that WTZ engages more with the local community. He reported to Amandi that ‘WTZ should be a leading supporter of sustainable development. We could use our expertise in recycling to develop a positive brand image and promote the company as protecting the future for all. Ambitious environmental objectives could be set. However, there is likely to be an impact on the costs of the business. There are, for example, operational and human resource issues we need to overcome as we focus on CSR.’ Growth strategies for the future Amandi used strategic analysis techniques to consider the strategic direction of WTZ’s continued expansion. An extract from his external environment analysis (PEST) is shown in Appendix 1. He identified two potential strategic options. Amandi plans to proceed with only one of the options. However, the Finance Director is concerned about the capital cost and the potential impact on working capital.

Option 1: Purchase a small business called Lacpac Takeover Lacpac which produces recyclable non‑plastic packaging for the food industry. It is an innovative company and a market leader in country R. Option 2: Expansion to country S Country S is a high‑income country with a large population. WTZ would build a factory for processing plastic waste. WTZ would use its core competencies to gain contracts from the government of country S. Appendix 2 provides further data on each option. Appendix 1: External environment analysis (PEST) Political • Some low‑income countries have banned processing of plastic waste from high‑income countries • There is proposed regulation in country R to reduce the use of plastics in food packaging Economic • Economic growth in country R is forecast to be 5% per year on average over the next 5 years • Global interest rates forecast to decrease in 2023 Social • Increasing environmental awareness in country R and country S • Global environmental pressure groups propose consumer boycotts against businesses which operate unsustainably Technological • Increasing use of computer controlled machinery for collecting and sorting recycled material • Innovations in processing of waste materials Appendix 2: Summary of data from strategic choice techniques over 5‑year period Option 1: Takeover of Lacpac Option 2: Expansion into country S Driving forces Rapid market growth in use of recyclable non‑plastic packaging in the food industry Builds on core competencies of WTZ Restraining forces High cost Competitive market in country S Capital cost $20m $10m Accounting Rate of Return (ARR) 15% 10% Decision tree: Expected monetary value Probability of success $9m 60% $4m 70%

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Evaluate the likely impact on WTZ’s future profitability of increased focus on corporate social responsibility (CSR).