Location & Scale (A Level) (Cambridge International A-Level Business): Exam Questions

Define the term ‘scale of operation’.

[case-study] Quality Furniture (QF)

QF is a public limited company in country S. It manufactures furniture for cafés. The number of cafés in country S has increased by more than 50% over the last 5 years. This has meant that QF has been able to expand and achieve internal economies of scale. However, the growth of the café market has attracted new firms supplying café furniture and increased competition for QF.

An extract from QF’s income statement is shown in Table 1.1.

Table 1.1: Extract from QF’s income statement for 2020

	$m
Revenue	300
Cost of sales	120
Gross profit	180
Expenses	150

Although QF has been successful so far, Javid, the Managing Director, has identified two problem areas: inventory and human resources.

Inventory

QF’s inventory includes raw materials, work in progress and finished tables and chairs. QF buys 80% of its materials from country T and there is a long delivery lead time. This means that QF holds a high level of buffer inventory which has a high value.

Human resources

QF’s production employees are unhappy that they have not received any benefit from the company’s expansion. Profit has doubled over the past three years but employees have not received any pay increases or bonuses. The employees have all been trained by QF and have specialist skills which had ensured that customer expectations were met. However, customers are starting to complain about a fall in the quality of the furniture, which could be the result of the low morale of the employees. Some highly trained employees have left QF to work for competitor firms.

Explain the term ‘internal economies of scale’.

Define the term 'economies of scale'.

Define the term 'offshoring'.

Explain one reason why a business might decide to reshore its production.

Explain one way in which globalisation has affected businesses' location decisions.

Define the term 'diseconomies of scale'.

Explain one cause of diseconomies of scale.

Explain how economies of scale affect a business's unit costs.

Explain one factor a business should consider when choosing a location.

Analyse two factors that might determine the relocation of a business.

[case-study] Super Heroes (SH)

SH is a leisure (theme) park aimed at 10–18 year olds. It is owned by two companies, X and Y, which started SH as a joint venture. Company X owns many leisure centres and swimming pools. Company Y owns many brands based on superheroes.

SH employs 200 full-time workers and an extra 50 seasonal workers during the busiest times of the year. The park has 10 large rides which take up 2km² of land. There are also many smaller rides, restaurants, toilets and shops. The price of an entrance ticket is $11 per customer. Table 1.1 shows the costs for SH in 2019.

Table 1.1: SH costs for 2019

Total fixed costs (per year)	$12m
Variable costs (per customer)	$3
Total costs	$42m

One of the larger rides at SH is the Iron Blaster. The number of customers who use this ride has decreased each year for the last three years. This has led the management of SH to consider its options for internal growth.

Option 1 – A new virtual reality (VR) ride This option would involve developing the Iron Blaster into a VR ride. Most of the structure of the Iron Blaster could be used but customers would be given a VR headset to wear during the ride. The cost of developing the VR ride would be $2m. The Iron Blaster ride would be closed for a three month period during the off-peak season for the development to be carried out. No employees would be made redundant or dismissed.

*Option 2 – A new hotel * SH does not currently have a hotel. It could demolish the Iron Blaster to provide the space to build one. Many of the competitors of SH have a hotel near or within their leisure parks. Hotel customers would pay a high price for a room but have free access to the leisure park’s facilities. Market research suggests that the average hotel customer would spend twice as long in the leisure park than a non-hotel customer. The cost of developing the hotel would be $15m and take a year to build. All of the employees currently working on the Iron Blaster ride would face redundancy or dismissal.

Analyse two factors that may have determined the location of SH.

[case-study] Aashna’s Pies (AP)

AP produces and sells high quality pies. Aashna set up AP five years ago when she spotted a gap in the market. AP is a private limited company and Aashna is the majority shareholder. All of the pies use the AP branding which is growing in popularity.

AP owns a factory where all the pies are produced. Pies are packaged and sold individually. The range of pies produced by AP is shown in Table 1.1.

Table 1.1: AP’s product portfolio

Name of pie	Filling	Price per pie	Annual change in sales quantity (2018 to 2019)	Stage on the product life cycle
Meaty Marvel	Chicken and lamb	$2.80	+3%	Maturity
Vegetarian Victory	Broccoli, cheese and carrot	$2.50	–10%	Decline
Fishy Fortunes	Cod, prawns and cheese	$3.00	+20%	Growth

The pastry case of each pie is exactly the same no matter what filling is used. All of AP’s pastry is made using flow production. However each filling is made by specialist workers who use batch production.

Aashna is concerned about the sales of Vegetarian Victory pies and she is considering stopping production of this pie. However, the Operations Director has pointed out that AP might lose its economies of scale if the business reduces the total number of pies produced.

The Marketing Director would like Aashna to read his report about developing products in the future. He has done some market research (see Fig. 1.1).

- The price elasticity of demand for AP’s pies is price inelastic - Some consumers are worried about possible health risks of eating too much meat - The average family eats three pies per meal and chooses pies for a meal once every two weeks - The pies have a short ‘best before’ date – they must be eaten within two days of purchase - The average family has one member who does not eat meat.

Fig. 1.1: Market research to aid developing products in the future

Analyse two economies of scale that AP might lose if the business reduces the total number of pies produced.

[case-study] Merrow Cables

Merrow Cables manufactures electrical cable in country D for construction firms and equipment makers. Six years ago it offshored most of its production to country T, where wages were far lower, keeping only a small specialist plant in country D.

Table 1: Merrow Cables selected data

	2019	2025
Average factory wage, country T ($ per hour)	3.10	7.40
Average factory wage, country D ($ per hour)	16.20	18.90
Shipping cost per container ($)	1 900	4 300
Time from order to delivery (weeks)	9	11
Orders rejected for quality faults (%)	1.8	4.6

Merrow Cables' largest customers are construction firms working to fixed completion dates. Two have recently asked whether Merrow Cables can guarantee delivery within four weeks. It cannot.

The Finance Director, Anouk Baril, notes that wages in country T remain well under half those in country D, and that the offshored plant still produces at a lower cost per metre than the home site could.

The Production Director, Idris Kane, argues the gap has narrowed sharply, that quality faults have more than doubled, and that Merrow Cables is losing work it would win if it could deliver quickly. He has proposed reshoring around half of production.

The board will decide next quarter.

Analyse two impacts on Merrow Cables of having offshored its production to country T.

[case-study] Tarnwell

Tarnwell manufactures water pumps in country G for farms and small industrial users. Five years ago it operated from one site with 90 employees. After rapid growth it now runs four sites employing 620 people.

Table 1: Tarnwell selected data

	2020	2025
Number of sites	1	4
Employees	90	620
Pumps produced per year	41 000	139 000
Average cost per pump ($)	82	97
Layers of management	3	6
Employee absence rate (%)	3.1	8.7

Tarnwell now buys steel and motors in far greater quantities than in 2020 and qualifies for a 14% bulk discount it did not previously receive.

The Managing Director, Femi Adeyemi, is concerned that average cost per pump has risen even though the business produces nearly three and a half times as many.

The Operations Director, Clara Beitz, points to the six layers of management. A design change now takes eleven weeks to reach the factory floor, against two weeks in 2020. She also notes that each of the four sites orders its supplies separately.

Analyse two reasons why Tarnwell's average cost per pump has risen despite its growth.

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 following extract before answering

Recommend to Leff which location to choose for the new restaurant.

[case-study] Ockley

Ockley manufactures laboratory equipment in country B and needs a second production site. Two options are under consideration: a site 60 km from its existing factory in country B, or a site in country N.

Table 1: Comparison of the two sites

	Country B site	Country N site
Construction and set-up cost ($m)	8.4	5.1
Average annual wage per employee ($)	34 000	11 500
Distance from Ockley's main factory (km)	60	2 100
Corporation tax rate (%)	24	12
Time to obtain regulatory approval for medical-grade equipment (months)	4	19

Ockley's equipment must be certified before it can be sold in its main markets. Around 70% of its customers are in country B and neighbouring countries.

The Finance Director, Marta Olsen, favours country N. Set-up costs are $3.3m lower, wages are around a third, and the corporation tax rate is half.

The Technical Director, Sunil Raman, disagrees. Certification in country N would take 19 months against four, and engineers from the main factory can reach the country B site within an hour to resolve production problems.

A decision is needed within two months.

Evaluate whether Ockley should locate its second production site in country B or in country N.

[case-study] Fenwick Growers

Fenwick Growers operates greenhouses in country R, growing tomatoes for supermarkets and wholesalers. A large supermarket chain has offered it a three-year contract requiring roughly triple its current volume.

Table 1: Fenwick Growers, current and after proposed expansion

	Current	After expansion
Greenhouse area (hectares)	12	38
Annual output (tonnes)	4 200	13 400
Employees	55	160
Average cost per tonne ($)	610	540 (forecast)
Number of customers	9	4

The expansion would cost $14m, financed by a bank loan. The supermarket contract would account for 68% of Fenwick Growers' output and runs for three years, after which it is subject to renegotiation.

The Managing Director, Ines Duarte, points to the forecast fall in average cost per tonne from $610 to $540 and to the security of guaranteed volume.

The Operations Director, Kwame Boateng, is worried. Fenwick Growers would go from nine customers to four, and the loan repayments would continue for far longer than three years.

Evaluate whether Fenwick Growers should expand its scale of operations to take the supermarket contract.