A-Levels - Business Studies Solved Paper [MJ 2008] - Paper 3

B. Stds. May/June 2008 Pyramid Televisions 1 (a) PT has its operations set up in three factories that are all currently working at full capacity. Due to the rising consumer demand the factories have been forced to work at maximum capacity. This involves working three shifts a day, including a night shift. Due to this heavy load of work the work force wants a higher pay. For PT it is highly important to resolve this issue. Even though the company is doing very well and is earning high profits; the company is not very stable and does not have substantial reserves. If the workers go on strike, competitors may over take PT’s market share. And PT may not be able to recover from this very easily. Apart from this, even if the workers continue to work for PT, it is very important to have them very highly motivated. As PT has to produce so much in such short span of time, then it is very important that the workers put in effort to keep up the quality, decrease extra costs and increase efficiency. According to the Maslow’s Hierarchy of needs, the bottom two levels in an organization need; money and job security the most. If PT recognizes the trade union, then they may not even have to actually increase the pay of their employees for the time being, as the cover of the trade union will provide the workers with a huge job security. So they might be satisfied with PT only recognizing their union. However, PT will have to be ready to expect heavy discussions and be ready for high demands from the union. Another way for PT to go about is, by somewhat changing the internal structure of the company. They can introduce team works amongst the workers. Teams can be made and the team can be given tasks and then in-turn piece rates or bonuses for extra work. This will improve the motivation levels of the workers and also create a sense of responsibility and belonging for the workers. This has potentially huge benefits for PT. The pay issues can be overcome and efficiency can be increased. However, team building has t be done with a lot of care, as it can very easily lead to a lot of conflicts between the workers, and this can be very harmful for the company as PT can’t afford any more costs due to missed work. Overall, it is very essential for PT to resolve the issues with their workers. And this can easily be achieved by first recognizing their union. And if that is not acceptable to the managers of PT, then some changes as mentioned above can be implemented, that will keep the overall costs of PT in check and at the same time satisfy the workers. And if team-structure is introduced, then other techniques such as job enlargement and job rotation can be used to keep the workers happy and motivated.

1(b) the most important department of PT is probably The Research and Development Department. In the industry of technology, the only way that PT can compete is if they can introduce new innovative products that the customers want. The product life cycle of a ‘high-tech’ product like a ‘high-end’ TV is very short. It

reaches its saturation very quickly, so the research and development department is very crucial in developing new technology that will sell. If the R&D department falls short of its expectations then PT would be left with no new products to make and they will be very restricted and they will not have the appropriate products to make and so they will lose a major segment of their market share will be taken up by their competitors with more ‘in’ products. In a traditional organizational structure, there are the directors above the managers, who are in turn above the other staff. And this chain ends at the workers at the bottom level. So basically this is a straight chain from the highest authority to the lowest. And this chain is present in every department of the business. However, in a matrix structure, people from different levels of command are grouped together to work as a team for a specific target. The present way of PT’s research and development is not working, so the matrix structure provides some positive outlook t the whole thing. If the task of R&D is undertaken in a matrix structure then there is a very high potential for success. As there will be consultation from all the departments, so the target of making a product that will be successful in the market should much more easily, with a higher chance of success. There can be input from different department, which will be crucial, in ensuring that the consumers will want the product. The marketing department can come up with a detailed market research and tell the R&D department what kind of product has chances of success and what market gaps can be filled. The finance department can be asked to coordinate the finances for the project. The production department can be consulted whether they have the capability to produce the product that the R&D department has come up with. Given that there are a lot of advantages of the matrix form of organizational structure, and it is potentially invaluable for PT; there are also some disadvantages that PT have to be aware of and be careful to avoid. Some of the disadvantages of the matrix structure are that, this may result in extra work and may also result in conflicts between the managers of different departments. And this will be very costly for the company. Also the technicians in the R&D department may become the centre of conflicts, and this will decrease the chance of the overall success of the project. But still, overall the matrix structure has more potential benefits then the disadvantages, and even if it does not work, PT will at most be back where they started and no real damage will be done. So PT should introduce this type of organization for the R&D department.

2. As the capacity utilization of a factory increases, generally the costs go down as a result of economies of scale. According to table 1, the fixed costs per unit progressively go down as the capacity utilization increases. However, the variable cost decreases to $50 per TV at 80% capacity; and it rises to $54 and $60 at 90% and 100% capacity respectively. Usually this should not happen. The variable cost per unit should either stay the same, or decrease as a result of cheaper material from bulk buying, and lower labor costs. What is happening here is PT is producing so much that the economies of large scale production are turning into diseconomies. As a result of producing so much, there will be more wastages than the normal level. This is because the workers will have to get so much done that they will not be able to give as much attention to details and the will not be able to work with the same levels of concentration. This will lead to more mistakes, and so more wastages. So the economy that was achieved by buying cheaper material will be downplayed by the money and resources lost as a result of producing more. Another reason that may lead to this unusual increase in the variable price per unit is the overuse of machinery. It is mentioned in the case that the machines used by PT are being used continuously. And so the machines will not be free for regular maintenance. This will lead to higher repair costs. So the variable over heads apportioned to each unit will be more in this case than they would be if regular maintenance is undertaken. Also there is a high possibility that the old and worn out machine wastes more material, and requires more staff to function with. And specially working continuously the regular wear and tear of the machine will take place at a much faster rate, further increasing the costs.

3. PT is a profitable business, and has a huge opportunity to grow. Turnover is high, the products being sold are successful, and also the shareholders are satisfied. But all this is in jeopardy if PT can’t increase their capacity and keep up with the market requirements. Option 1 includes setting up a new factory, which will be large enough to produce double the amount of the current production of PT. this means that PT can close down the three factories that are set up in different regions and all operations can be moved to one place. This will make it easier for the manager to monitor the production, and the larger factory will be more specialized with new equipment, so PT will get a totally new outlook. However, this option means that the company will have to shift its operations. There may be a large number of skilled workers that may leave the company. And there may be some posts in the management that will be no longer necessary so there may even be some need for down-sizing in the higher management. But these two problems can be easily overcome as the area selected for the new factory is in an area of high unemployment, so PT should be able to recreate a good workforce, which may even be cheaper, and with fewer demands. Option 2 is the introduction of new machinery to the old factories. This is cheaper than option 1, and if this option is selected, then PT will not have to move and the basic structure of the business will be the same with pretty much the same employees and the same atmosphere. This option will solve the problem of capacity in much less resources than option 1. The capital investment required for this project is $12m, which is $13m less than option 1. Also the annual fixed cost of all the three factories combined comes to $12m, nearly $9m less than the one larger factory. However, option 1 will give the company economies of scale, by reducing the average variable cost per TV, and so increasing the profit margins. Also the maximum capacity of the larger factory in option 1 is more than the three smaller factories combined, so this gives PT more room for growth. For option 1, the breakeven level is: 21,000,000+ 30(Q) = 60(Q) → Q = 700,000 units The break-even for option 2 is: 12,000,000 + 40(Q) = 60(Q) → Q = 600,000 units So at the current level, if option 2 is selected, there will be a larger margin of safety. The gross profit that will be made in option 1 is $1.5m (50,000 × $30) at current levels. And the Gross profit of option 2 at current level will be $2m (100,000 × $20). So option 2 is also more profitable. However, on full capacity, option 2 will make a gross profit of $12m (600,000 × $20). And at the same level of output, 1.2m units, option 1 will make a gross profit of $15m (500,000 × $30). So in the longer run option 1 will be more profitable.

As seen above, option will provide a much better solution to the capacity problem then option 2. But the capital investment that will need to be made in option 1 is $13m more than option 2. And if the company produces at the present level of production, option 2 will recover the capital cost much more quickly than option 1. From the discussion above it is quite clear that option 1 is better for PT in the longer run, as it will eventually lead to better profits, and PT will have one large factory that will be easier to manage and there should be fewer management problems, in contrast to managing three factories. But if PT want to be safer and do not want to take a lot of loan then option2 is far better. The cost will be low, the basic environment of the business will remain the same, the profits will be substantial and there will be quite a lot of increase in the production capacity. Keeping this in mind, the study of this case suggests that option 2 will be better for PT. there are disputes with their work force and the company does not have a lot resources to bail it out, if the need arises. So it will be safer and at the same time fulfilling to select option 2.

5. PT needs a large loan to put one of the two possible expansion options in operation. For option 1 they need about $25m and for option 2 they need nearly $12m. To get such a big loan from the bank PT will have to convince the bank that they will be able to pay it back and that that bank is safe in giving PT the loan. For this PT will have to prove to the bank that their company is profitable, stable and has enough assets to cover the loan. For this purpose, PT will have to provide their past financial statements; these will contain data about that profitability of the past operations and the utilization of money, and this will give a picture of the stability of the company to the bank. Also these financial statements will show the bank what assets the company has. These statements will give a proof of the profitability of the company, and be an assurance for the bank that the company will be able to pay back the loan. The financial statements that the bank will want to see include; the Profit and Loss Account, the Balance Sheet and the Cash Flow Statement. The Profit and Loss Account will show the profit made by the company, the expenses that the company incurs and the sales figures. Also the Profit and Loss Appropriation account will show how the profits that are made are distributed. The Balance Sheet gives an account of what assets the company has and how many liabilities the company has to pay off. The speculation of this financial statement is very important as this will tell the bank how stable the company is. Whether the company has assets on which it can rely, or if there are a lot of liabilities that the company has to pay off. The Balance Sheet will also tell the bank about the revenue reserves of the business if there are any and the retained profits, and also about the share capital. The Cash Flow Statement will give a picture of the Liquidity of the business. It will show how efficiently the business uses its cash resources. All the information that will be inferred from these statements can be of far more help if some ratios are calculated. Accounting Ratios fall under four broad categories; profitability ratios, liquidity ratios, efficiency ratios and investment ratios. For a bank to process the loan, they will look foremost at the liquidity ratios of the business and then the investment ratios. Also profitability ratios are very important. The first ratio that will be calculated is the ‘Current Ratio’. This is the comparison of the current assets and the current liabilities. This gives a broad picture of the liquidity of the business. Then the ‘Gearing’ of the company will have to be calculated; this shows the dependence of the company on outsider’s funds. Outsider funds includes Debentures/Loans and Preference Shares. This will be of very high importance. If the company is lowly geared, that is low dependence on outside’s funds; the bank will be less hesitant to give PT the loan. Finally, from the Profit and Loss Account, the Profitability Ratios can be calculated. These Ratios include ‘Gross Profit Margin’ and ‘Net Profit Margin’. These ratios will show the profitability of the business. All these ratios can be compared to the ratios calculated form the past Financial Statements. And then a comparison can be made. This comparison will show if the company is improving over the years or not; whether the company is becoming more profitable, more stable and if the company’s liquidity is improving.

From all the data mentioned above the bank will be able to collect enough information about the company and to decide whether or not to give the loan to PT.

6. When a business takes over another business that is in the same industry, it is called business integration. If the business takes over another business that is at the same level of production as itself, it is known as horizontal integration. Such as, a shoe retailer buys a shoe shop down the street. On the other hand, vertical integration is when a business takes over another business which has a level of business above or below the original business. For instance, a flour mill takes over a bakery. In the case the takeover of TV4U in vertical integration, as TV4U are at a different level of business in the TV industry than PT. Business integration allows a business to gain a lot of control over its suppliers or buyers, whatever may be the case. The newly formed larger business is much more efficient and can achieve larger economies of scale, and is more stable as a whole. Also, it is easier for such a business to compete in the market, and secure a good market share. On the contrary, integration can sometimes cause distraction for the managers and the directors and the quality of the produce may deteriorate. Apart from this a competitive edge will be lost, as the business that could first supply to different retailers for example now is restricted to just one business, and vice versa. From the discussion above, the concept of vertical business integration, and its general advantages and disadvantages are quite clear. For PT, vertical integration has a lot of potential benefits. As the chief executive said, PT can work on providing good customer care and so in turn they can charge a high price for their product. This will potentially increase the profits somewhat. But the much more important outcome will be that a very good image of PT will be created. Consumer care will add a feature to all of PT’s products. It will give them a huge competitive edge and also it will work towards increasing the market share of PT. if good customer care services are provided by PT then the chances of success of the new products developed by the R&D department will also increase, as the people will be attracted to buy PT’s products because of their good image. Also, PT can get first hand information on customer feed-back, and so they will get to know what exactly the customers like, and what they want. This information will be invaluable to PT in ensuring future success. However, buying TV4U will cost about $10m. The finance director raised the point that how can PT afford this if they go for one of the two options for expansion. Those options cost $12m and $25m respectively. And the finance for them will be generated through getting a bank loan. So getting another large loan may not be possible. Whether or not buying TV4U will be a help for PT is also unclear. Yes it will be a great step for PT to be able to control its own marketing mix, and market its products the way it wants, and that PT can give high quality customer service. But on the other hand, it may be unprofitable to withdraw all of PT’s products from all the other retailers and sell them only in one chain of stores. Also the revenues generated from TV4U stores may be affected, if the products from the competitors are not offered for sale. So there is a very high possibility that both the businesses will be adversely affected.

Another concern mentioned in the case is the management and running of the shops as well as the factory. There are a lot of issues with the factory as it is. There are disputes with the workers, PT needs more capacity and the machinery needs to be changed as it is outdated. And the solutions to these problems are not very easy or direct. To solve the worker’s issues, directors will have to make some changes in the organizational structure of the business or make some changes in the policy. And the capacity issues and the machinery problem are very expensive to solve. With all this at hand, buying another business, which will pose its own problems, is not at all favorable. There may be problems with keeping the existing TV4U staff, or if PT decide to hire new staff, even in that case it will be very hard. Managing a completely different business will require different kinds of skills, which the people at PT will not have. And making the whole situation more crucial will be the fact that, if there are any problems with managing TV4U, it will result in direct losses for PT as TVU will be the prime retailer if not the only retailer for PT’s products. Also if the problems with PT continue then managing TV4U will be very hard and this will increase the risks and will put too much pressure on the higher management. A better approach for PT is to go for expansion first. Both the options are quite promising. The will both give PT quite good profits over the coming years. From that money, PT can later think of buying a chain of retail stores. Giving good customer service is a very important aspect, and it can really contribute a lot towards the future success of PT. a better plan for providing good customer care is by opening small customer care shops, that deal in repairing and support for the customers. These shops can be located in the cities and they can sever the purpose well enough, rather than spending so much, taking a lot of loan, and taking a lot of risk, it will be far better if PT work out some way to cater to the customers without buying TV4U. this will fulfill the purpose of adding value to some extent at least.