–4–
2.
M10/3/BUSMT/HP2/ENG/TZ0/XX+
The Berkeley
The Berkeley is a movie theatre owned by Ed Andrews. It shows old movies and recent independently
financed films. The movies appeal to niche1 audiences, which would not be shown at the multi-screen
cinema complex called The Max located five kilometres away.
As a sole trader, Ed’s financial position is deteriorating. Only 40 % of films shown at The Berkeley
return a small profit. The manager of The Max phoned Ed two months ago and offered to takeover
The Berkeley. Ed politely refused.
Cinema attendance has declined and Ed is aware that technology is changing people’s viewing
habits. Recent releases of old movies on DVD and the lower price of home cinema systems to
show these movies have led evening attendances to fall dramatically. Ed has calculated the
cross-elasticity of demand for movie tickets, in relation to the price of these DVDs. He found that
movie attendance at The Berkeley and DVD releases were very close substitutes.
Ed has just been offered a chance to be the first cinema in the region to show the second film
“Film X”, of a young filmmaker called Judd Peterson. Judd’s previous movie had been a
huge success. The potential demand for his “Film X” is so high that it would be shown twice at
this premiere but Ed must guarantee a target profit of US$10 000. Ed anticipates selling all tickets
at both showings.
Ed has prepared some figures for his break-even analysis if he shows “Film X”:
• capacity of The Berkeley = 1200 per showing
• price of movie ticket = US$12
• fixed costs = US$12 000 (this includes target profit of US$10 000) to be split equally over the
2 showings
• variable costs per ticket sold = US$6.
Ed has a dilemma: if “Film X” is successful, The Berkeley will receive a substantial revenue
boost as well as free publicity. This could also help Ed bring more diverse films to The Berkeley,
especially little known international films, which would fulfil a long-held ambition of his.
However, if he shows “Film X”, Ed risks changing the perception of customers that The Berkeley
provides films for a niche market to a perception that it provides films for a mass-market2. He is
concerned that customers would expect similar movies in the future.
1
2
niche: a much more focused segment of the market with a smaller potential customer base classified perhaps by income levels,
age or other demographic factors
mass-market: an attempt by a company to produce goods and services which try to satisfy the needs of as many consumers in a
market as possible
(This question continues on the following page)
2210-5012
–5–
M10/3/BUSMT/HP2/ENG/TZ0/XX+
(Question 2 continued)
(a)
Identify two characteristics of a sole trader.
[2 marks]
(ii) Define the term cross-elasticity of demand.
[2 marks]
(i)
Prepare a fully labelled break-even chart for The Berkeley for one showing
of “Film X” at the premiere.
[6 marks]
(ii) Calculate the total profit of The Berkeley if it shows “Film X” twice and
comment on your results.
[3 marks]
(iii) Using The Boston Consulting Group (BCG) matrix, explain two reasons
for the manager of The Max’s decision to offer to takeover The Berkeley.
[6 marks]
Analyse the relative importance of driving and restraining forces on
The Berkeley if Ed decides to show “Film X”.
[6 marks]
(b) (i)
(c)
2210-5012
Turn over
–9–
2.
(a)
(i)
M10/3/BUSMT/HP2/ENG/TZ0/XX/M+
Identify two characteristics of a sole trader.
[2 marks]
These include but are not limited to:
unlimited liability – a firm’s finances are not separate from the owner’s
owned by one person but may have a number of employees
limited capital for expansion
any other relevant characteristic.
Award [1 mark] for each appropriate, correct characteristic identified, up to
a maximum of [2 marks].
(ii)
Define the term cross-elasticity of demand.
Cross-elasticity of demand measures the responsiveness of demand for one
product, when the price of another product changes. The term is used to
help define substitutional and complementary relationships between
products.
Candidates are not expected to word their definition exactly as above.
As the formula is given award [0 marks] if the candidate merely writes the
expression down.
Award [1 mark] for a basic definition that conveys partial knowledge and
understanding.
Award [2 marks] for a full, clear definition that conveys knowledge and
understanding similar to the answer above.
For only a relevant: example or application to the stimulus award
[1 mark].
[2 marks]
– 10 –
(b)
(i)
M10/3/BUSMT/HP2/ENG/TZ0/XX/M+
Prepare a fully labelled break-even chart for The Berkeley for one
showing of “Film X” at the premiere.
[6 marks]
Break-even chart for The Berkeley for one
showing of “Film X”
Costs
Revenue
(US$000s)
Break-even
point
Total revenue
Profit
Total costs
14
12
10
8
Loss
Fixed costs +
target profit
6
4
Margin of safety
2
0
1
2
3
4
5
6
7
8
9
10
11
Cinema tickets
12 sold (00s)
Break-even output seats sold
Calculations:
Fixed costs (includes target profit) = US$6000
12 000
2
Contribution = 12 6 = 6
6000
Break-even point =
= 1000 for one showing
6
Variable costs: US$6 per unit: ticket sold
Total costs = US$6000 + US$6 per ticket sold
Margin of safety = 1200 1000 200 per showing
– 11 –
M10/3/BUSMT/HP2/ENG/TZ0/XX/M+
Award marks as follows:
[1 mark] for appropriately labelled axes.
[1 mark] for an accurately drawn and labelled total revenue curve.
[1 mark] for an accurately drawn and labelled total costs curve. Own Figure
Rule (OFR) applies.
[1 mark] for an accurately drawn fixed costs and target profit curve.
[1 mark] for the identification of the break-even level of output (whatever the
value) and [1 mark] for showing the correct value of the break-even level of
output.
[6 marks] in total.
The margin of safety is not expected to be identified (despite the diagram).
If the break-even chart is accurately drawn but not neatly, using a ruler or
straight-edge, or out of proportion, award a maximum of [3 marks].
If the candidate produces a table rather than a chart, award [0 marks].
(ii)
Calculate the total profit of The Berkeley if it shows “Film X” twice and
comment on your results.
[3 marks]
Total profit for The Berkeley if both showings sell out
TR = 2400 12 = 28 800
TC = FC + VC
= 12 000 + (6 2400)
= 12 000 + 14 400
= 26 400
Total profit = 28 800 – 26 400 = US$2400
[1 mark] only for correct answer.
The break-even point is 1000 tickets sold for one showing with a margin of
safety of 200 tickets. After satisfying the target profit of US$10 000, Ed will
be left with a cash boost of US$2400.
Award [1 mark] if comments only refer to the fact that Ed will be making a
profit compared to the current loss making situation.
Award [2 marks] for a further development of the magnitude of the profit.
Also, possibly but not necessarily comments on the break-even point or on
any other information in the stimulus material.
– 12 –
M10/3/BUSMT/HP2/ENG/TZ0/XX/M+
(iii) Using The Boston Consulting Group (BCG) matrix, explain two reasons
for the manager of The Max’s decision to offer to takeover
The Berkeley.
[6 marks]
The BCG matrix need not be written in full although a number of
candidates will do so. The key is to be able to apply elements of the matrix
to The Berkeley as being part of The Max’s portfolio. There is no correct
classification here. Marks will be awarded for appropriate explanations
relevant to the stimulus.
Possible applications:
If The Max sees itself as a cash cow with limited potential for growth
given the technological/social external environment then The Berkeley could
be perceived as:
A problem child (question mark) with The Max seeing the potential to
develop it further as it complements the mass market audience of
The Max.
As a dog blocking out potential competition – defensive reasons for
acquisition.
One could argue that the manager of The Max may regard The Berkeley
as a potential star that can be moved into the cash cow position with a
new marketing plan and appropriate financial investment. This can be
seen as a defensive move of the proposed acquisition.
Alternatively, The Max might see itself as a cash cow with limited
potential growth, looking at a takeover as an extension strategy.
There is no exact information in the stimulus material in order to identify
the exact position of The Berkeley’s product therefore accept any reasonable
explanation in context.
Accept any other relevant explanation.
Mark as 3+3.
Award [1 mark] for a brief and general answer (possibly just a list) with no
development/explanation.
Award [2 marks] for an adequate explanation of the reasons for the manager
of The Max’s decision to offer to takeover The Berkeley, though the
response may be lacking in clarity or detail. For [2 marks] there should be
some use of the BCG matrix.
Award [3 marks] for a clear and detailed explanation of the reasons for the
manager of The Max’s decision to offer to takeover The Berkeley.
Reference is made to the stimulus material and accurate use is made of the
BCG matrix.
– 13 –
(c)
M10/3/BUSMT/HP2/ENG/TZ0/XX/M+
Analyse the relative importance of driving and restraining forces on
The Berkeley if Ed decides to show “Film X”.
[6 marks]
A full force field analysis is not required but some candidates may wish to
highlight the key forces in a diagram. This would constitute part of the analysis as
long as the relative importance of each constituent part is analysed afterwards as a
separate section. If the candidate only provides a Lewin type analysis but no
examination, then the candidate should not proceed to [3 to 4 marks].
Key driving forces:
Ed’s determination to achieve his ambition for his niche audience
the ability to spread his passion for “world cinema” or “festival” movies
a fear of consenting to the takeover bid by The Max as Ed, the sole trader,
is facing difficulties
the fragile state of the finances of The Berkeley with the majority of films
shown not breaking even
use of technology at home affecting the nature of demand for The Berkeley’s
films
Judd’s previous success and anticipated demand for the premiere of “Film X”.
Key restraining forces:
fear of irrevocably changing the perception of The Berkeley away from
Ed’s ambition
fear of imitation or me-too aspect with respect to The Max, which might
damage The Berkeley as they do not have the economies of scale or financial
muscle to compete with The Max
fear of alienating existing customers.
The key driver would seem to be finance and the change in home viewing habits
situation. Most of the restraining forces will be weakened if The Berkeley is
threatened with closure due to external factors. We do not know the extent of the
financial position but clearly with only 40 % of films returning a small profit,
Ed must show “Film X” and generate a revenue boost to stave off extinction
before he can think about satisfying his loyal customers and fulfilling his
ambition.
Accept any other relevant analysis.
For one relevant issue that is one sided, award up to [3 marks].
If the response is a one-sided relevant approach with no analysis, award a
maximum of [4 marks]. If only the driving forces or the restraining forces are
analysed, award a maximum of [4 marks].
Marks should be allocated according to the markbands on page 3.
–2–
N10/3/BUSMT/HP2/ENG/TZ0/XX
SECTION A
Answer one question from this section.
1.
Dan Electro
Dan Bowen is a sole trader who sells digital cameras directly to consumers. He owns an online
business and all sales are processed electronically under the business name Dan Electro. The office,
storage place and call centre are located together in an expensive and desirable city centre location.
Dan started the business three years ago by borrowing a considerable amount of money from a bank.
He used his residential property as collateral* for the loan.
The cameras are bought and shipped from a reputable and reliable overseas supplier who charges
a high price for good quality cameras and prompt transportation. Dan has to pay in advance for
the cameras. Dan Electro’s customers are very loyal and see their purchase as good value
for money. Repeat purchases comprise a large percentage of Dan Electro’s sales. Some customers
have even indicated that they would pay a higher price for the cameras because of their quality
and the good service he provides.
Dan is now worried about the forecasted rise in interest rates, inflation and an increase in
online competition. Dan Electro may face some cash flow difficulties in the coming years. He is
considering various strategies in order to prevent such possible cash flow difficulties.
Financial information for 2010 (all figures in US$)
Fixed costs per year
Rent
20 000
Marketing
4000
Administration
5000
Interest payments
1000
Variable costs per camera
Camera
135
Transportation
45
Direct labour
20
Price per camera
250
Dan is expected to sell 700 cameras in 2010.
*
collateral: the borrower’s property is offered to the lender as security if the loan is not paid back
(This question continues on the following page)
8810-5012
–3–
N10/3/BUSMT/HP2/ENG/TZ0/XX
(Question 1 continued)
(a)
(i)
Define the term variable costs.
(ii) Identify two advantages for Dan of operating as a sole trader.
[2 marks]
[2 marks]
Construct a fully labelled break-even chart for Dan Electro for 2010.
Calculate and indicate the break-even point, the margin of safety and the
projected profit at 700 cameras (show all your working).
[7 marks]
(ii) Calculate the number of cameras Dan Electro must sell in order to double
the projected profit (show all your working).
[2 marks]
(iii) Calculate the price per camera that needs to be charged (at expected
sales of 700 cameras) in order to double the projected profit (show all
your working).
[2 marks]
(iv) Explain two possible limitations of the break-even model as a decision
tool for Dan Electro.
[4 marks]
Examine two possible strategies for Dan Electro to prevent cash flow
difficulties.
[6 marks]
(b) (i)
(c)
8810-5012
Turn over
–5–
N10/3/BUSMT/HP2/ENG/TZ0/XX/M
SECTION A
1.
(a)
(i)
Define the term variable costs.
[2 marks]
Variable costs are costs that vary in “direct proportion” to change in
output/level of production.
Candidates are not expected to word their definition exactly as above.
Award [1 mark] for a basic definition that conveys partial knowledge and
understanding.
Award [2 marks] for a full, clear definition that conveys knowledge and
understanding similar to the answer above.
For only a relevant: example or application to the stimulus award [1 mark].
(ii)
Identify two advantages for Dan of operating as a sole trader.
Possible advantages could include:
 Dan as a sole trader has complete creative and management freedom
 Dan can be more customer focused due to constant interaction and
communication with the customers
 Dan does not have to share the profit with anyone else
 accept any other relevant advantage.
Award [1 mark] for each relevant and appropriate advantage identified
up to a maximum of [2 marks].
[2 marks]
–6–
(b)
(i)
N10/3/BUSMT/HP2/ENG/TZ0/XX/M
Construct a fully labelled break-even chart for Dan Electro for 2010.
Calculate and indicate the break-even point, the margin of safety and
the projected profit at 700 cameras (show all your working).
[7 marks]
The break-even point is:
Fixed cost
US$30 000

 600 cameras
Contribution US$250  US$200
Cost/revenue
(US$000s)
180
Total revenue
Profit
Total costs
Break-even
point
160
140
120
100
80
60
40
Margin of
safety
20
0
100
200
300
400
500
600
700
Fixed costs
Cameras
The margin of safety is:
700  600  100 units
The projected profit at 700 units is:
Margin of safety  contribution per unit  100 units  US$50  US$5000
Or:
Total revenue – total cost  US$175 000  US$30 000   200  700   US$5000
–7–
N10/3/BUSMT/HP2/ENG/TZ0/XX/M
Do not double penalize candidates.
Award marks as follows:
[1 mark] for appropriately labelled axes.
[1 mark] for an accurately drawn and labelled total revenue curve.
[1 mark] for an accurately drawn and labelled total costs curve.
[1 mark] for identification of the break-even point and [1 mark] for
showing calculation at the correct value of 600.
[1 mark] for identification of the margin of safety.
[1 mark] for correct calculation of the projected profit.
If the candidate produces a table rather than a chart, award [0 marks].
(ii)
Calculate the number of cameras Dan Electro must sell in order to
double the projected profit (show all your working).
[2 marks]
The doubled level of profit is:
Target: US$5000  2  US$10 000
Fixed cost  target profit US$30 000  US$10 000

 800 cameras
Contribution
US$50
Do not double penalize for a mistake carried forward.
Award [1 mark] for the correct workings and [1 mark] for the correct
calculation/figure.
–8–
N10/3/BUSMT/HP2/ENG/TZ0/XX/M
(iii) Calculate the price per camera that needs to be charged (at expected
sales of 700 cameras) in order to double the projected profit (show all
your working).
[2 marks]
target profit + total costs US$10 000  (US$30 000  US$140 000)

output
700
= US$257.14 (2 d.p.)
Price 
Do not double penalize for a mistake carried forward.
Award [1 mark] for the correct workings and [1 mark] for the correct
calculation/figure.
(iv) Explain two possible limitations of the break-even model as a decision
tool for Dan Electro.
[4 marks]
The possible limitations/drawbacks of the break-even model are:
The model assumes that all cameras are sold.
Dan Electro might not be able to sell all of its cameras and, therefore,
the total revenue curve might not be as high/accurate as the model assumes:
 The model is also used under the assumption of unchanging conditions.
Inflation and interest rates might indeed increase (forecasted) which
could affect the demand for the camera.
 Also, the effectiveness of the model depends on the accuracy of
the data. Dan might not have computed all the costs/revenue accurately.
 The model assumes a linear relationship, which is quite unlikely in
real life. Dan might decide to reduce the price of the cameras to
stimulate sales.
Given the above, the use of the model can become less effective as a
decision tool for Dan.
Accept any other relevant explanation.
Mark as 2+2.
Award [1 mark] for identifying each relevant and correct limitation of the
break-even model and [1 mark] for each explanation of the limitation with
application to the stimulus material.
Award a maximum of [2 marks] overall if there is no application to the
stimulus material.
–9–
(c)
N10/3/BUSMT/HP2/ENG/TZ0/XX/M
Examine two possible strategies for Dan Electro to prevent cash flow
difficulties.
[6 marks]
Some of the possible strategies that are available for Dan Electro in order to
overcome the forecasted cash flow difficulties are:
Increase inflow of money:
Dan can look for a partner. Forming a partnership can inject cash quickly with the
added benefits of knowledge and expertise. The responsibilities of running the
business can also be shared. However, Dan will lose the benefits of being a sole
trader – benefits such as complete freedom in decision-making and the retaining
of all profit.
Dan could increase the price of the cameras. Dan has very loyal and, therefore,
price inelastic customers. Some customers indicated that they would be willing to
pay a higher price. This enables him to increase the price and at the same time to
increase Dan Electro’s total revenue. However, given the increase of online
competition and the current customers’ perception of the camera being good value
for money, this option is somewhat risky. Dan Electro might end up with fewer
customers and less total revenue.
Dan Electro’s marketing expenses are relatively small. Dan might want to
consider a marketing drive to promote the product so as to increase sales and then
sell more than 700 cameras – which is rather a small amount. However, care has
to be taken that the extra marketing expenditure does not outweigh the extra
revenue. Perhaps it is a risk worth taking given the increased competition.
Taking another loan from the bank might inject immediate cash, but may not be
seen as a wise move as Dan is still paying back US$1000 in interest on the
previous loan and the interest rate is predicted to rise.
Decrease outflow of money:
The main problem that can be seen from the data is the transportation cost per
camera, which is a significant 22.5 % of the variable costs. Dan could negotiate a
reduction in such costs with the current supplier. Perhaps a bulk buying deal can
be agreed upon. However, Dan will have to take the risk of being left with
unsold stock, which is risky given the fast changing technology in this market.
Rent is currently extremely expensive. The costs for an “expensive and desirable”
location are unnecessary given the fact that Dan operates an online business.
A move to a cheaper and non-central location could provide a good solution.
The service quality should not be harmed by this change.
Also, Dan should ask for some credit facilities with the current supplier rather
than continue with the current agreement of paying in advance. This will alleviate
the cash flow difficulties. However, the supplier may not agree and may decide to
supply to other retailers given the increase in online competition.
Another possibility is to look for a cheaper local supplier. However, the quality of
the cameras may be compromised and Dan Electro may lose its competitive
advantage.
– 10 –
N10/3/BUSMT/HP2/ENG/TZ0/XX/M
Accept any other relevant examination.
To achieve the top markband candidates must give a balanced examination of two
possible strategies.
For one relevant issue that is one-sided, award up to [3 marks]. If the response is
a one-sided relevant approach with no balanced examination, award a maximum
of [4 marks].
Marks should be allocated according to the markbands on page 3.
––
M07/3/BUSMT/HP2/ENG/TZ0/XX
6.
Paolo’s Pasta
Paolo Cabrini runs a small pasta-making business, called Paolo’s Pasta. He has borrowed funds
to purchase a property, leased machines and employed two staff. His main competitor is called
Fasta Pasta but there are also a number of general food shops selling fresh pasta as a small part of
their product range. Paolo sells his pasta for a premium price of $7 per kilogram. Full capacity is
12 000 kilograms of pasta per year. He incurred the following expenses in 2007.
Lease costs
Mortgage payment Paolo’s salary
Raw materials
Wages
Electricity/gas/water
Paolo’s Pasta is currently producing an output of 10 000 kilogram per year. A large hotel chain
has approached Paolo and offered to purchase 4000 kilograms per year of pasta at a price of
$4.50 per kilogram. Paolo is considering the offer and believes that it may be worthwhile as he is
concerned about sales falling in the future.
(a)
With reference to Paolo’s Pasta, distinguish between fixed costs and
variable costs.
[3 marks]
(b) Construct a break-even graph showing the break-even level of output,
the margin of safety and the amount of profit at current output level. (Show any
relevant workings)
[5 marks]
Paolo is considering changing the price of his pasta. Describe two possible
pricing strategies and advise Paolo on the most appropriate to adopt.
[6 marks]
$200 per week
$500 per month
$300 per week
$1.25 per kilogram (kg) of pasta produced
$1.60 per kilogram (kg) of pasta produced
$0.15 per kilogram (kg) of pasta produced
(c)
(d) Evaluate whether Paolo should accept the offer from the hotel chain.
2207-5012
[6 marks]
– 26 –
6.
(a)
M07/3/BUSMT/HP2/ENG/TZ0/XX/M
With reference to Paolo’s Pasta, distinguish between fixed costs and
variable costs.
Fixed costs are incurred by a business irrespective of output. They occur even
if nothing is produced and remain the same as the production rises or falls. The
fixed costs incurred by Paolo’s Pasta are leasing, mortgage payments and
Paolo’s salary. Variable costs are dependent on the amount produced.
The higher the output levels, the higher the variable costs. If nothing is
produced no variable costs will be incurred. The variable costs incurred by
Paolo’s Pasta are raw materials, wages and electricity/water/gas.
[3 marks]
An appropriate definition of both fixed costs and variable costs, a clear
distinction between the two and relevant examples from Paolo’s Pasta.
[2 marks]
An appropriate definition of both fixed costs and variable costs. There may be
no examples provided, or one or more examples are incorrect.
[1 marks]
An appropriate definition of fixed costs and/or or variable costs (but perhaps
not both). There may be no examples provided or they may be incorrect
or inappropriate.
[3 marks]
– 27 –
M07/3/BUSMT/HP2/ENG/TZ0/XX/M
(b) Construct a break-even graph showing the break-even level of output,
the margin of safety and the amount of profit at current output level.
(Show any relevant workings)
Contribution
Variable costs
Selling price
Contribution
$1.25 + $1.60 + $0.15 = $3.00 per kg of pasta
$7 per kg of pasta
$7 – $3 = $4 per kg of pasta
Break-even level of output
Fixed costs
($500 x 52) + ($500 x 12 = $6000) = $32 000
Contribution
$4 per kg of pasta
Break-even quality
$32 000 / 4 = 8000 kg of pasta per year
Margin of safety
Current output level – break-even level
10 000 kg – 8000 kg = 2000 kg
Profit at current capacity
Margin of safety × contribution: 2000 kg × $4 = $8000
TR
Rev/
Costs
($)
(1000)
72
Profit at current capacity
TC
64
56
48
40
FC
32
24
16
8
Margin of safety
0
0
1
2
3
4
5
6
7
8
9
10 11 12
Kg of pasta/year
(1000)
[5 marks]
– 28 –
M07/3/BUSMT/HP2/ENG/TZ0/XX/M
[5 marks]
The diagram is correct, properly labeled, drawn to a reasonable scale, and all
the points quantities are correctly identified. Relevant workings are shown.
[3 to 4 marks]
The diagram is essentially correct but there may be a small number of
minor errors. Relevant workings are shown.
Or
The diagram is correct, properly labeled, drawn to a reasonable scale, and all
the points quantities are correctly identified. Relevant working is not shown.
[1 to 2 marks]
There is a diagram, and recognition of costs and revenues, a break-even point
is attempted but might be wrongly identified.
N.B. There is no need for the exact figures for break-even margin of safety and
profit to be given, so long as these are shown accurately on a suitably scaled
graph and clearly identified.
– 29 –
M07/3/BUSMT/HP2/ENG/TZ0/XX/M
(c) Paolo is considering changing the price of his pasta. Describe two
possible pricing strategies and advise Paolo on the most appropriate
to adopt.
Cost-based pricing involves the addition of a profit element to the costs
of production. This form of pricing guarantees a profit since the fixed and the
variable costs are all covered, and the price is always set above the costs to
allow for a net margin. Its drawback is that it ignores the impact of
competition and consumers. If competitors are selling at lower prices then the
firm might see its sales decreasing rapidly.
Competition-based pricing is where the price charged by competitors, not the
cost of producing the good, is the main factor influencing pricing decisions.
The pricing policy is most often used in markets with a lot of producers.
Generally businesses are reluctant to lower prices for fear of setting a
“price war” and they are reluctant to raise prices of fear of lower sales revenue
as consumers switch to the relatively cheaper competitors.
Consumer-orientated pricing is where the business analyses the market
conditions when setting the price. It considers the demand for the product and
the price elasticity of demand of the product along with market potential.
Accept other relevant description and evaluation of any other pricing strategy.
Paolo’s does not currently take into account its competitor’s prices. Paolo
positioned his product as high quality high price. His prices are currently
relatively high (premium pricing / customer- value pricing) and his business
seems to do well with this approach. However, the market is becoming more
competitive and Paolo is worried about future fall in sales. This might be
because competitors are getting more efficient, selling good quality at lower
prices or other variables might be interfering (if income is dropping then
people might be swapping to inferior products). The customers’ perception of
his products might be changing. He, therefore, needs to undertake market
research to fully understand the nature of his target market. He needs to know
what type of price and income elasticity his product has, the customers’
perceptions and his product positioning, he needs to be aware of the sphere of
influence of his competitors and only then act accordingly.
Customer orientated pricing or Competition based pricing might be appropriate
strategies. However, Paolo might have to sacrify some of his profit if prices
are lowered. A reduction in price might also chance the image of the product.
Paolo might want to stick to his premium pricing to differentiate himself from
the competitors. This strategy will be appropriate if the quality of his products
is indeed superior. He does have 2000 kg a year of spare capacity and this has
to be investigated. He might be losing market at $7 and a reduction could put
him closer to the competitors and increase the output.
[6 marks]
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M07/3/BUSMT/HP2/ENG/TZ0/XX/M
[5 to 6 marks]
Two appropriate pricing policies are identified, described in sufficient detail
with a balanced evaluation and appropriate application to the case.
For [6 marks] a reasoned judgment is made as the most appropriate pricing
policy in the circumstances.
[3 to 4 marks]
Two appropriate pricing policies are identified and described with some
consideration of their relevance. A maximum of [3 marks] should be awarded
for a detailed discussion of one pricing policy. At the lower end of the range
the answer may lack detail and balance.
[1 to 2 marks]
A limited and essentially descriptive answer.
– 31 –
(d)
M07/3/BUSMT/HP2/ENG/TZ0/XX/M
Evaluate whether Paolo should accept the offer from the hotel chain.
Currently Paolo’s Pasta has 2000 kg a year of spare capacity. It makes
10 000 kg a year which are sold at the same price of $7 per kg, leaving an
annual profit of $8000. He could therefore add a considerable amount to his
profit if he were to be able to sell the 2000 kg, which he can make but not sell.
If he could sell them at $7 per kg he would make an extra profit of $6000
a year.
Yet the hotel chain is offering to purchase 4000 kg per year. Therefore Paolo
would need to produce annually 8000 kg sold at $7 to break-even, and he is left
with 4000 kg to sell to the hotel chain at $4.50. Contribution from each one of
these kilograms is $1.50. This will give him a profit of $6000 per year.
Clearly if he sells to the hotel, his profit drops by $2000. On these grounds
Paolo might decide not to accept the offer. If a competitor offers the same
premium quality product at the lower prices, the image of Paolo Pasta may be
eroded and sales will fall. If he is to build extra capacity, extra capital has to
be raised and invested. It might be very risky given the prediction of increased
competition. Extra work might increase staff stress level and some motivation
issues can emerge.
On the other hand, sales are dropping. Paolo knows that the pasta market is
highly competitive since entry is relatively easy. There are no great barriers
since the capital needed is not a large amount. So accepting the offer might be
convenient in terms of securing a steady income throughout. He might be able
to decrease costs in the future, supply pasta to other hotel chains and end up
growing into a larger manufacturer.
Yet Paolo might not like this dependent relationship at all and he might want to
keep his independence. He might be able to adjust his pricing policy,
maybe discriminate better, and increase his output to get the same or
more profit.
Accept any other relevant argument for or against the offer. Based on the
financial and non financial data, in the short run the offer is not attractive.
Perhaps the offer will pay off in the longer term when adjustment to the
production facilities has been made as well as the changes in the market
occurred.
Accept any substantiated recommendation.
[6 marks]
– 32 –
M07/3/BUSMT/HP2/ENG/TZ0/XX/M
[5 to 6 marks]
Both advantages and disadvantages of accepting the offer are evaluated in a
balanced manner. A variety of issues- both financial and non financial are
considered, including calculation of future profits and the drop in sales.
[3 to 4 marks]
Both advantages and disadvantages of accepting the offer are analysed but the
answer may lack balance. Some financial and non financial issues are
considered, but calculation of future profits and the drop in sales are not
presented or are not entirely accurate
[1 to 2 marks]
A limited and essentially descriptive answer that may simply identify or list
advantages and/or disadvantages.
––
N06/3/BUSMT/HP2/ENG/TZ0/XX+
5.
Arica Sportswear plc
Arica Sportswear plc produces sports kits. The kits, which include shirts, shorts and socks, are sold by
established sports shops across the European Union. The kits are sold to retailers for a premium price
of $120. In their marketing, Arica Sportswear plc justify the relatively high price by emphasizing
the quality of the materials used and the fact that each kit is customized with the team’s logo and
sponsors’ names. The Arica brand is highly regarded by their target market of 12 to 24 year olds
who are extremely loyal to the brand. The company’s products are used by many international teams,
and endorsed by a number of sports and entertainment celebrities who have their names displayed on
their Arica kit.
Recently the manufacture of the kits was relocated to a factory in a developing country. Each kit now
costs Arica Sportswear plc $43 with an additional printing cost of $12 per kit. This cost is $10 lower
per kit than when Arica Sportswear plc produced in their home country.
Sales representatives receive a commission of $3 per kit sold to retailers. Some have begun to
complain that this commission does not reflect the sales effort required in an increasingly competitive
market segment. The transport costs for each kit is $2. The fixed costs of production are $720 000
per month. The factory capacity is 16 000 kits per month, and since last month, when a special
marketing campaign took place, the factory is working at full capacity. The marketing manager has
proposed to the board of directors that the price of the kits to retailers should be increased by 15 %
to reflect their popularity and to address the problems posed by their limited production capacity.
(a)
With reference to Arica Sportswear plc
(i)
distinguish between fixed and variable costs.
(ii) calculate the contribution earned per kit after relocation.
(Show your working)
[2 marks]
[2 marks]
(b)Construct a break-even chart and identify
the monthly output of kits required by Arica Sportswear plc to break-even.
(i)
(ii) the margin of safety if the factory is producing at full capacity.
(iii) the monthly level of profit assuming 16 000 kits are manufactured
and sold.
[8 marks]
(c)
Evaluate the marketing manager’s proposal to increase the price of Arica sports
kits to retailers by 15 %.
[8 marks]
8806-5012
– 16 –
5.
(a)
N06/3/BUSMT/HP2/ENG/TZ0/XX/M+
With reference to Arica Sportswear plc
(i)
distinguish between fixed and variable costs.
[2 marks]
Fixed costs:
costs that do not change when the level of output changes e.g. rent,
rates, interest. They only remain constant in the short-run.
Variable costs:
costs that change in direct proportion to the output of a firm
e.g. raw materials, sales commission.
[2 marks]
The distinction between fixed and variable costs is clear and accurately explained.
Examples are used from the case.
[1 mark]
There is some understanding of the distinction between fixed and variable costs,
but there may be some lack of clarity.
(ii)
calculate the contribution earned per kit after relocation.
(Show your working)
Variable costs
=
transport costs
manufacturing cost
printing
commission
Contribution to fixed costs
=
price – variable cost
$120 – $60
[2 marks]
$ 2
$43
$12
$ 3
$60
=
$60
Award [1 mark] for the correct answer and [1 mark] for working up to a maximum of
[2 marks].
– 17 –
N06/3/BUSMT/HP2/ENG/TZ0/XX/M+
(b) Construct a break-even chart and identify
(i)
the monthly output of kits required by Arica Sportswear plc to
break-even.
Output
0
4 000
8 000
12 000
16 000
FC
720
720
720
720
720
VC
0
240
480
720
960
TC
720
960
1200
1440
1680
$000s
TR
+/–
0
(720)
480
(480)
960
(240)
1440
0
1920
240
Break-even point
Factory capacity
Sales/Rev ($000)
⎧1920
⎪
240 ⎨
⎪1680
⎩
Total
Revenue
Total
Costs
1440
Area of
profit
(TR > TC)
Area of loss
(TC > TR)
Fixed
costs
730
Margin of safety = 4000 units
0
Break-even =
(ii)
12
12 000 kits
the margin of safety if the factory is producing at full capacity.
Margin of safety
=
=
=
actual production less break-even output
16 000 less 12 000
4 000 units
16
Output
(000s)
– 18 –
N06/3/BUSMT/HP2/ENG/TZ0/XX/M+
(iii) the monthly level of profit assuming 16 000 kits are manufactured
and sold.
Profit = TR – TC
At 16 000 units
TR
–
TC
$192 000 – $168 000
=
[8 marks]
$240 000
or [4 000 units Қ $60 000 contribution = $240 000]
[6 to 8 marks]
The break-even chart is accurately presented with the break-even output, margin of
safety and level of profit correctly identified. If the margin of safety or level of profit
are correctly calculated but not shown on the chart, a maximum of [7 marks] can
be awarded. The lower end of the band is awarded where there are some minor
omissions in presentation or calculation.
[3 to 5 marks]
There is a valid attempt at presenting a break-even chart, but there are some
inaccuracies and/or omissions in presentation or calculations, which may mean that one
or more of the answers are incorrect. When a candidate has just calculated the values
correctly but there is no break-even chart a maximum [3 marks] should be awarded.
[1 to 2 marks]
The break-even chart and/or calculations are highly inaccurate or missing.
principles are understood only in a very general sense.
(c)
Evaluate the marketing manager’s proposal to increase the price of
Arica sports kits to retailers by 15 %.
The
[8 marks]
The present pricing strategy employed by Arica Sportswear plc is a premium pricing
strategy. It could be argued that the firm is price skimming as its “offer” is temporarily
unique. The relatively high price of $120 is justified by the quality of the product and by the
customization that takes place. It is clear that the brand is presently fashionable and adds
value, justifying the higher price and that creaming the market will allow revenue
maximization in the short run. Indeed, the present pricing strategy seems appropriate given
the significant monthly profit level and the relatively high margin of safety.
Clearly the product is very popular and the new factory is producing at full capacity. This
will prove to be a problem as there is no flexibility if demand increases further, possibly
leading to disappointed customers. A price increase should decrease demand in theory
dependent on the products’ price elasticity. The 12 to 24 year old target market may be
fashionable, but disposable incomes are often limited and the impact of a 15 % increase in
price may be significant.
– 19 –
N06/3/BUSMT/HP2/ENG/TZ0/XX/M+
The marketing manager is suggesting that the market will accept such an increase and indeed
this may enhance the status of the product. It would be advisable for the board of directors
to commission some market research first to test these assumptions and ensure that a price
increase will not damage the brand and lead to a decline in popularity; fashion is after all a
fickle phenomenon. It is also important that customers do not notice a corresponding
decline in quality from the new factory, which may undermine its premium position in the
market place.
The price increase and cost decrease should allow Arica Sportswear plc to pay a higher rate of
commission to its sales representatives.
An alternative would be for the price to be reduced to reflect the lower manufacturing costs of
Arica Sportswear plc. This cost plus approach could be justified if the revenues increase
overall. However, the problem of overcapacity would have to be dealt with first, possibly
through outsourcing or by opening new productive capacity.
In a fashion market, price is often part of an image, but competition is likely to become fiercer
if firms like Arica Sportswear plc appear to be achieving large profit margins. There is also
the issue of market saturation, which may force Arica Sportswear plc to employ a more
competitive pricing strategy in the medium to long term.
The board of directors are likely to approve such an increase subject to reassurance that this
will not damage the brand and lower the market share significantly. Research should be
carried out before a discussion is made.
[6 to 8 marks]
The evaluation of the proposed pricing strategy reflects a good understanding of
Arica Sportswear plc’s present market position and its operational difficulties. The
discussion is balanced and makes relevant reference to Arica Sportswear plc. Business
terminology and concepts are used appropriately. A judgement is made for [8 marks].
[3 to 5 marks]
There is some understanding of pricing theory and the appropriateness of the proposed
strategy though the discussion may not always be balanced. There is some attempt to use
relevant marketing theory and/or terminology, but this may be limited.
[1 to 2 marks]
A limited and essentially descriptive answer.