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May 2019 Higher Level Paper 1 Mock Examination RDM Exemplar Answers Interactive Click or Tap to go Question 1 1 A B Question 2 A B Question 3 A B Question 4 A B Question 5 ERQ recommendation C

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com M19 3 BUSMT HP1 ENG TZ0 XX BUSINESS MANAGEMENT HIGHER LEVEL PAPER 1 Practice examination 2019 Radeki de Dovnic Manufacturing 2 hours 15 minutes INSTRUCTIONS TO CANDIDATES Do not open this examination paper until instructed to do so A clean copy of the IB Business Management case study Radeki de Dovnic Manufacturing is required for this examination paper Read the case study carefully A clean copy of the IB Business Management formulae sheet is required for this examination paper Section A answer two questions Section B answer question 4 Section C answer question 5 A calculator is required for this examination paper The maximum mark for this examination paper is 60 marks Page Jump to start 2 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com SECTION A Answer two questions from this section QUESTION ONE a Outline the importance of wholesalers line 52 to Radeki de Dovnic Manufacturing 4 marks Wholesalers are businesses that purchase large quantities of products from a manufacturer and then separate or break the bulk purchase into smaller units for resale to retailers They profit from buying cheaply in bulk purchasing economies of scale and on selling smaller units at a large mark up RDM has used the two intermediary channel of distribution previously when it produced its stoves for sale Wholesalers would have allowed RDM to concentrate on mass producing its standardised goods at low cost using mass flow methods of production They would not achieve the maximum price for these goods because wholesalers take a profit mark up and they would lose some control over its marketing mix However wholesalers would reduce costs to RDM especially stock holding costs and retail delivery Wholesalers would have been a good way for RDM to enter foreign markets RDM would be unfamiliar with Currently wholesalers are unimportant to RDMs marketing mix PLACE as the healthcare products they now specialise in are customised to the individual needs of each customer This means that a direct selling distribution model is better aligned with RDM s strategic objectives Award 3 4 marks if the student s answer meets the following criteria The student demonstrates knowledge and understanding Appropriate terminology is used and explained The response is applied to the stimulus material Page Jump to start 3 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com b With reference to Radeki de Dovnic Manufacturing distinguish between capital expenditures line 54 and revenue expenditures 6 marks Capital expenditures are for fixed assets which are expected to be productive assets for a long period of time An example is the expensive production line machinery such as robotics that RDM has purchased to produce its mass customised goods Revenue expenditures are for costs that are related to specific revenue transactions or operating periods such as the cost of goods sold salaries and wages or repairs and maintenance expenses Thus the differences between these two types of expenditures are as follows Timing RDM s capital expenditures are charged to expense gradually via depreciation and over a long period of time RDM s revenue expenditures are charged to expense in the current period or shortly thereafter Consumption RDM s capital expenditure is assumed to be consumed over the useful life of the related fixed asset AS s revenue expenditure is assumed to be consumed within a relatively short period of time For example components of the healthcare products are used in the production process They are purchased used and sold hopefully in relatively quick succession which is why they are classified as cost of goods sold a revenue expense Size A more questionable difference is that capital expenditures tend to involve larger monetary amounts than revenue expenditures This is because an expenditure is only classified as a capital expenditure if it exceeds a certain threshold value if not it is automatically designated as a revenue expenditure However certain quite large expenditures can still be classified as revenue expenditures as long they are directly associated with sale transactions or are period costs The initial capital expenditures at RDM when they are establishing a new function manufacturing facility will be very high However perhaps after this revenue expenses such as wages salaries or raw materials components will be larger Information about RDM s revenue expenditures would typically be found in the firm s profit and loss statement and its capital expenditures are found in RDM s balance sheet fixed assets Award 5 6 marks if the student s answer meets the following criteria An analysis of the relevant issues is made with good use of business management tools where applicable techniques and theories Appropriate terminology is used throughout the response There is effective use of the stimulus material Page Jump to start 4 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com QUESTION TWO a Outline two key features of a democratic leadership style and two key features of a paternalistic leadership style line 89 4 marks Jan has a democratic leadership style and his father whom he replaced had a paternalistic leadership style A paternalistic leadership style is an approach that involves a dominant authority figure who acts as a patriarch or matriarch and treats employees and partners as though they are members of a large extended family In exchange the leader expects loyalty and trust from employees as well as obedience A paternalistic leader creates such an amicable ambience at the workplace that employees consider their team as a family Yearning to belong to a group is a natural human tendency Just like families have a head organisations have leaders who occupy an authoritative position to determine what s best for the team Paternalistic leadership is an approach where Kristi n was equipped to adhere to the interests of RDM s employees and the organisation Democratic leadership on the other hand is different in that two way communication is used which allows direct feedback from staff to the leader and other members in the team Here Jan would provide workers with information about the business to allow full staff involvement and engagement in the wider organisation and not just necessarily their task at hand RDM s workforce is highly skilled and engaged in cognitively demanding tasks and have higher expectations of their experience from work they expect higher level needs to be partly satisfied at work Democratic leadership is better suited to fulfil these needs Award 3 4 marks if the student s answer meets the following criteria The student demonstrates knowledge and understanding Appropriate terminology is used and explained The response is applied to the stimulus material Page Jump to start 5 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com b With reference to Radeki de Dovnic Manufacturing explain the importance of branding line 123 6 marks A brand is an exclusive name symbol or design used to identify a specific product or business And a brand identity is how a business presents itself to and wants to be perceived by its consumers This corresponds to the intent behind the branding the way a company chooses its name designs its logo uses colours shapes and other visual elements in its products and promotions crafts the language in its advertisements and trains employees to interact with customers all with the goal of cultivating a certain image in consumers minds Brand identity is distinct from brand image Brand image the actual result of efforts to establish a brand identity successful or unsuccessful Branding is a way for RDM to differentiate its products from that of its competitors The brand is the distinguishing name or symbol that is used to differentiate its products from another competitor Branding can have a real influence on the marketing of RDM It can create a powerful image or perception in the minds of consumers either negative or positive and it can give RDM s products a unique identity Successful brands can often charge premium prices as consumers are loyal to their products and the image that it generates Attempting to establish a weak brand or rebranding is often expensive Increasing brand awareness and brand loyalty would be primary goals of any promotional activities of the business It can cost millions of dollars to attempt to create an effective brand image and success cannot be guaranteed If a brand image receives bad publicity such as poor product quality and product failures then the image of all products in the corporate brand will be damaged Thus RDM needs to be sure that its suppliers are supplying a quality product There are the following distinct advantages of RDM having a successful brand Price advantages Firms that s sell undifferentiated products that have a variety of substitutes tend to compete on price and find it difficult to charge higher prices than their rivals Recognition and loyalty Having a recognisable brand increases RDM s competitive advantage as there is a greater chance of the product being sold brand loyalty or perceived trustworthiness Supplier trust Having an established brand would enable RDM to secure supply contracts with important healthcare providers such as a large hospital chain this could be an important factor in the company s growth and evolution Award 5 6 marks if the student s answer meets the following criteria An analysis of the relevant issues is made with good use of business management tools where applicable techniques and theories Appropriate terminology is used throughout the response There is effective use of the stimulus material Page Jump to start 6 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com QUESTION THREE a With reference to Radeki de Dovnic Manufacturing distinguish between product innovation and process innovation line 94 4 marks A product innovation is the introduction of a good or service that is new or has significantly improved characteristics or intended uses Process innovation refers to the implementation of a new or significantly improved production or delivery method Innovation is built into the very fabric of RDM s corporate culture The firm s ability to innovate around its products being able to adapt products to customer needs and specifications is a competitive advantage And the processes the firm has innovated to allow it to do so its mass customisation production model at the leading edge of 21st Century technologies such as cloud computing AI and big data is another source of competitive advantage Award 3 4 marks if the student s answer meets the following criteria The student demonstrates knowledge and understanding Appropriate terminology is used and explained The response is applied to the stimulus material Page Jump to start 7 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com b Explain two reasons why organisations such as Radeki de Dovnic Manufacturing implement corporate social responsibility strategies 6 marks CSR refers to the consideration of ethical and environmental issues relating to business activity A business that adopts CSR will normally act morally towards its various stakeholder groups A key point here is that CSR is about how a business like RDM makes a profit and it s not about how they spend it This means CSR at RDM applies to how they interact and treat their key stakeholders such as the company s employees and suppliers Employees will be made to feel they belong and will be paid fairly and enjoy good working conditions and benefits e g paid parental leave RDM will work hard to have a good relationship with its individual suppliers treating them fairly and not exerting undue pressure on these key stakeholders to keep cutting costs One key reason that RDM would have CSR strategy is that this would help the company in attracting the best motivated and efficient employees may as many workers will prefer to work for and be associated with a socially aware business RDM operates in a competitive environment where innovation and problem solving are key to differentiating itself from the competition Its highly trained talented and motivated staff e g production engineers provide much of this positive differentiation Having the CSR strategies enables RDM to attract retain and motivate the talent they employ Another key reason to RDM having a CSR strategy is that the image of the business and its products can be improved with a green and socially responsible approach This could be a major competitive advantage It would be incorporated in the brand image of the company and again be a positive source of differentiation when selling its products winning over new customers and entering relationships with important suppliers Higher long term profitability for RDM should result from each factor above Award 5 6 marks if the student s answer meets the following criteria An analysis of the relevant issues is made with good use of business management tools where applicable techniques and theories Appropriate terminology is used throughout the response There is effective use of the stimulus material Page Jump to start 8 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com SECTION B Answer the compulsory question from this section QUESTION FOUR Executives at RDM have suggested that it might be profitable to make the manufacture of customised aluminium water bottles a distinct division of the company Jan and his chief financial officer CFO are unsure if this is a good idea and whether it would be in line with the strategic objectives of RDM However buoyed by the success of the manufacturing trial and the positive feedback received from the medical company receiving their aluminium water bottles Jan believes that this is a project worth investigating He tasks his CFO to coordinate with the marketing and operations departments to conduct market research to assess the potential demand for such a product and estimate production capacity the costs price points and revenues associated with the manufacture of aluminium water bottles The marketing team conducted a series of surveys and focus groups Jan is especially interested in how a marketing mix could create a unique selling point for such a product and the quantities that will need to be sold to breakeven When the team reports back to Jan they forecast the following Maximum production capacity 20 000 units per month Fixed costs 80 000 per month Unit variable costs including direct labour and raw materials 2 50 per unit Delivery costs 1 50 per unit Retail price 9 99 per unit They also report that there is considerable interest among potential customers in having a fully customisable water bottle to meet the specifications of each customer However there is considerable competition in this niche market particularly from low cost Chinese manufacturers Page Jump to start 9 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com a Define focus group and state whether the use of focus groups is an example of primary or secondary market research 2 marks Primary research A focus group is a gathering of deliberately selected people who participate in a planned discussion intended to elicit consumer perceptions about a particular topic or area of interest in an environment that is nonthreatening and receptive Here the groups of people were assembled to participate in a discussion about the aluminium water bottles before launch Award 2 marks if the student s answer meets the following criteria b There is a clear definition which must include A group of people assembled to participate in a discussion about a product before it is launched or similar words Calculate the break even point and profit at full capacity Comment on your answer 4 marks Break even point Fixed costs unit contribution 80 000 2 50 1 50 20 000 units per month Profit at full capacity contribution per unit x full capacity break even point 2 50 1 50 x 20 000 units 20 000 units 0 In manufacturing aluminium drink bottles RDM only achieves break even at full capacity and thus the division would not be profitable Award 4 marks if the student s answer meets the following criteria Both the break even point and profit calculations are correct An awareness is shown that even at maximum capacity RDM cannot make a profit on this product Page Jump to start 10 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com c Explain the importance of RDB having a unique selling point for its aluminium water bottles 4 marks Unique selling point proposition USP Differentiating factor that makes a company s product unique designed to motivate customers to buy Unless a business can pinpoint what makes its product unique in a world of homogeneous competitors its sales efforts will not be targeted effectively Customers are often attracted towards goods or services that offer a distinctive image service feature or performance Establishing a USP is about differentiating RDM and its products from its competitors USPs can be based on any aspect of the marketing mix RDM s offer must be distinct from those of its competitors and should fulfil the requirements of the customers of its target markets RDM s positioning is the result of whatever the company does Its marketing mix is the most tangible and the most flexible tool to create the desired positioning RDM must use their marketing mix to create something specific and special for the customer RDM s USP is probably based around the fact that customers can adapt products to their own specifications and order specific quantities that can be quickly fulfilled through RDM s mass customisation production process Further RDM s design and manufacturing process has also resulted in products being cheaper to produce and more stable line 39 Award 3 4 marks if the student s answer meets the following criteria The student demonstrates knowledge and understanding Appropriate terminology is used and explained The response is applied to the stimulus material Page Jump to start 11 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com d Using information from the case study additional information above and your results from part b discuss whether RDM should proceed with setting up a new division to produce customised aluminium water bottles 10 marks If RDM is confident in its market research and forecasted figures it certainly should not set up a new division to manufacture its aluminium drink bottles A diversification strategy is a practice where a firm enters an industry or market that is different from its core business Reasons for diversification include 1 reducing risk of relying on only one or few income sources 2 avoiding cyclical or seasonal fluctuations by producing goods or services with different demand cycles 3 achieving a higher growth rate and 4 countering a competitor by invading the competitor s core industry or market Perhaps the most basic reason for RDM to diversify is survival By definition a company that focuses on a narrow range of products will only have access to a finite number of customers That s fine if the market as it stands is big enough to support several competing businesses but if the pool of customers is small the cost of running RDM may outstrip the potential for revenue In these circumstances diversification into new product lines may be essential to the longterm viability of this company Further in the case of cyclical business diversification can help regulate cashflow throughout the year For instance a business such as RDM that sells health care products may sell the bulk of its products through autumn and winter as the flu season is in full swing as demand falls away with the approach of summer If the company remains focused on health care it will need to sell enough during the high period to make up for the dip in revenue during the fallow months An alternative is to diversify into a product that will balance sales across the seasons aluminium water bottles perhaps But diversification is not just about survival It is a tried and trusted growth strategy New products or business lines will enable RDM to make more sales to existing and new customers and depending on how it diversifies expand into markets that would otherwise have been closed to it There are many ways in which to diversify The most straightforward of these is to provide a natural extension of the goods or services that RDM already offer to customers and this is exactly what the aluminium water bottle manufacturing strategy aims to do However two questions arise from this strategy Firstly is this division likely to be financially successful given the information that we have Secondly what is the opportunity cost of such a strategy e g there may be a better alternative product that RDM could manufacture The first question is essentially answered by the break even analysis Diversifying into aluminium water bottles does not make financial sense for RDM The break even point of production is the level of output at which total costs equal total revenue The contribution per unit is the selling price of a product less variable costs per unit This is an important business concept and must never be confused with profit The contribution of a product aluminium water bottle refers to how much it contributes to the fixed costs and profit of RDM once all of the variable Page Jump to start 12 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com costs have been covered It can be calculated either per unit of output or in terms of the total contribution of all units produced At the break even point of 20 000 units RDM has no excess capacity because this exists when the current levels of demand are less than the full capacity output of a business also known as spare capacity To break even on the figures provided RDM would need to produce at full capacity i e 20 000 units Full capacity is when a business produces at maximum output Any level of demand above 20 000 units would result in a capacity shortage when the demand for RDM s aluminium water bottles exceeds its production capacity The unit contribution on RDM s water bottles can only begin to add to the company s overall profitability once all costs are covered fixed variable costs The point of profitability become break even one unit However as all the costs associated with manufacturing RDM s aluminium water bottles are covered only at full capacity AND full capacity equals the break even point no profit can be made on the aluminium drink bottles There is no upside to manufacturing this product for RDM they can t make a profit on the product there is only a downside they can easily make a loss if they don t achieve full capacity each and every month of operation The capacity utilisation rate cannot exceed beyond 100 as no machine or human can be expected to work to a full capacity of 100 the maximum capacity utilisation rate that could be expected is around 90 as there can be many problems that can arise both with the staff and machinery RDM could have several issues relating to working of machinery that would not allow it to have optimum output for example scheduled maintenance Similarly a worker cannot always perform to her maximum every day sooner or later they will fall ill or take a holiday Thus the capital utilisation rate provides us with a rate that can help the firm s management with establishing the general output that can be generated by the firm There are potential drawbacks to operating at a very high capacity utilisation for a long period of time Staff may feel under pressure due to the workload and this could raise stress levels Operations managers cannot afford to make any production scheduling mistakes as there is no slack time to make up for lost output Regular customers who wish to increase their orders will have to be turned away or kept waiting for long periods This could encourage them to use other suppliers with the danger that they might be lost as long term clients Machinery will be working flat out and there may be insufficient time for maintenance and preventative repairs and this could lead to increased unreliability in the future So RDM like many firms would attempt to maintain a very high level of capacity utilisation but it also needs to keep some spare capacity for unforeseen eventualities This almost necessitates that given the current figures RDM cannot manufacture the water bottles at anything other than a loss The best case scenario of achieving full capacity month in monthout is impossible Further high capacity utilisation is not a substitute for growth Most organisations seek growth and increasing demand for the products they are marketing Taking Page Jump to start 13 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com on extra orders for products will require RDM to raise its productive capacity expand its scale of production Even if RDM decided to invest in expanding the aluminium water bottle manufacturing division to increase its maximum capacity noting that this would also change the figures associated with a break even analysis would this then be the best use of the firm s resources Product portfolio analysis is an analysis of elements of a company s product mix to determine the optimum allocation of its resources The two most common measures used in a portfolio analysis are market growth rates and relative market shares If RDM were to manufacture aluminium water bottles the product would be positioned in the low market share low market growth quadrant of the BCG matrix i e the product would be a dog It is difficult to conceive that the market for aluminium water bottles would enjoy high rates of market growth year on year It is also difficult to believe that RDM could realistically capture significant market share from low cost Asian manufacturing companies Thus based on the relatively low margins and high volumes needed to break even and limited scope for the growth of the market itself and RDM s share of the market this product is highly unlikely to add value to the company If a diversification strategy was to be pursued to meet growth and profitability objectives then RDM should look to alternative products to manufacture and or other businesses it could acquire Award 9 10 marks if the student s answer meets the following criteria Good understanding of the demands of the question including implications where relevant Relevant business management tools where applicable techniques and theories are explained clearly and applied purposefully and appropriate terminology is used throughout the response Effective use of the stimulus material in a way that significantly strengthens the response Evidence of balance is consistent throughout the response The judgments are relevant and well substantiated Page Jump to start 14 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com SECTION C Answer the compulsory question from this section QUESTION FIVE 5 To help with the operations management strategy at RDM Jan has tasked his chief financial officer CFO to provide him with detailed financial forecasts and cost estimates regarding alternative locations for the possible new production facility When reporting back to Jan the CFO summarised the information in the following table The quantitative information relates to the initial cost and profitability of three alternative locations for the production facility Option A Poland Option B Germany Option C Slovenia Each of these locations has good rail road and seaport infrastructure for exporting into European markets and even further abroad if opportunities arise Taking into consideration the external economic environment the CFO was able to produce profitability forecasts based on the different economic conditions that can prevail at any time in the European market for healthcare products during periods of fast and normal economic growth as well as economic recession Based on market research the CFO believes that there is a 20 chance of fast economic growth 50 chance of normal economic growth and a 30 chance of a recession Table 1 Cost and profit estimates for production facilities in three European countries Projected profits based on economic conditions m Initial cost m Fast growth Normal growth Recession Option A Open factory in Poland 120 400 200 100 Option B Open factory in Germany 150 500 300 50 Option C Open factory in Slovenia 80 150 120 100 RDM has the option of financing the alternative production facilities through an initial public offering IPO i e to go public line 117 It also has the option of securing funding with a long term bank loan and the CFO notes that while interest rates are at Page Jump to start 15 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com historic lows bank lending restrictions are relatively tight in the current economic and regulatory environment RDM does not have the option of issuing additional shares privately to raise the large amount of capital that is required to finance this project even for the low cost country The balance sheet of RDM is shown Table 2 below and this provides important financial information to bankers and prospective shareholders interested in a possible IPO Table 2 RDM balance sheet Radeki de Dovnic Manufacturing Balance Sheet as of 30 April 2019 m m Fixed assets Fixed assets 50 Accumulated depreciation 2 Net fixed assets 48 Current assets Cash 1 Debtors 1 2 Stock 3 5 Total current assets 5 7 Current liabilities Overdraft 0 5 Creditors 1 5 Short term loans 2 2 Total current liabilities 4 2 Net current assets Working capital 1 5 Total assets less current liabilities 49 5 Long term liabilities debt 30 Net assets 19 5 Financed by Share capital 11 Retained profit 8 5 Equity 19 5 Page Jump to start 16 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com Using the case study and the additional information on pages 3 5 recommend what you believe to be the best option for RDB to achieve its strategic objectives and the company s best method of finance You will find it useful to prepare a decision tree based on the data for the options and calculate the expected values of each option 20 marks Figure 1 Decision tree for location decision A Poland Decision Germany B Slovenia C Fast growth 20 x 400m 80m Normal growth 50 x 200m 100m Recession 30 x 100m 30 Fast growth 20 x 500m 100m Normal growth 50 x 300m 150m Recession 30 x 50m 15m Fast growth 20 x 150m 30m Normal growth 50 x 120m 60m Recession 30 x 100m 30m 150m 235m 120m Key Corporate or strategic objectives are important broadly defined targets that RDM must reach to achieve its overall aim Then following the hierarchy of objectives see diagram below tactical or operational objectives are those short or medium term goals or targets which must be achieved for an organisation to attain its corporate objectives Tactical or operational objectives are short to medium term goals or targets which must be achieved for an organisation to attain its corporate objectives Divisional operational objectives are set by senior managers to ensure Co ordination between all divisions at RDM if they do not work together the focus of the organisation will appear confused to outsiders and there will be disagreements between departments Decision node Chance node Choice not taken Page Jump to start 17 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com Consistency with strategic corporate objectives Adequate resources are provided to allow for the successful achievement of the objectives Aim Maximise profits Objective Maximise sales in the target market Target Sales of 10 million in each quarter of 2019 Tactic Open new production facility in Germany Objectives strategies and tactics and tactics are all related Strategic objectives relate to the whole organisation What is it that RDM wants to achieve at its core Essentially the company exists to make its owners profit in a socially responsible manner Thus RDM will have the strategic objective of maximising sales in its target market This is because there are two routes to maximising profitability for RDM increasing sales revenues and minimising costs The strategic objective of maximising sales aligns itself more closely to the company s CSR strategy Cutting costs often negatively affects key stakeholder groups such as employees as redundancies downward pressure on wages and less favourable working conditions e g more temporary contracts may result Likewise RDM could use the power it wields over the large supply contracts associated with supplying the firm and exerting pressure on its suppliers to supply RDM with raw materials and component parts cheaply However this would result in supply contracts being awarded to suppliers that produce raw materials and component parts at least cost which may in turn have deleterious effects for the environment workers and families that the suppliers employ communities and the countries that they operate in This is because it is usually cheaper to produce In ways that pollute the environment such as pumping dirty factory emissions into the atmosphere rather than investing in expensive capital equipment to enable clean production processes When wages are low and working conditions poor When taxes paid are minimised e g using suppliers from countries with ineffective and corrupt taxation officials Thus increasing profitability by increasing sales revenue is an objective more aligned with RDM s aim to maximise profits and manufacture in a socially responsible way its CSR Page Jump to start 18 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com approach This conclusion leads us to the next question regarding RDM s growth and evolution Is investing in a new European production facility the best way RDM can maximise profits RDM s competitive advantage is that it can mass produce customised healthcare products and other unspecified products for unspecified markets Its operations enable it to perform this specialised manufacturing efficiently and productively using a capital intensive production system that is highly automated Capital intensity is the amount of fixed or real capital present in relation to other factors of production especially labour In a production process it may be estimated by the capital to labour ratio We know that RDM s capital ratio is greater than its labour ratio Such a production process relies heavily on very expensive connected machines robotics and intelligent software solutions coming from RDM s AI cloud computing and big data capabilities referred hereafter as Industry 4 0 Industry 4 0 is a name given to the current trend of automation and data exchange in manufacturing technologies It includes cyber physical systems the Internet of things cloud computing and cognitive computing Industry 4 0 is commonly referred to as the fourth industrial revolution This necessitates that RDM has large investment outlays as shown in the fixed asset component of the company s balance sheet 50 million which in turn requires RDM to generate large profits to justify such investment return on capital employed ROCE is the most common used means of assessing the profitability of a business it is often referred to as the primary efficiency ratio It looks at how effective or efficient the business is at making the capital invested in the business is at earning profit The large upfront investment and expensive R D programmes in Industry 4 0 makes it difficult for RDM to achieve a satisfactory ROCE However because such a manufacturing system is highly productive per unit costs tend to be very competitive Productivity being a measure of output per unit of input Generally the cost savings accrue to the firm because labour costs are much reduced and in RDM s case Industry 4 0 manufacturing will also likely reduce the costs associated with holding stock raw materials components and especially finished goods materials wastage and reworking to meet quality standards Expanding RDM s capabilities in Industry 4 0 by opening a new production facility will increase its production flexibility and improve its productivity rates RDM will be able to produce a greater product range and allow customers to make more design changes to the products they require Sales should increase and per unit costs will fall However will such improvements in RDM s business model justify the massive upfront investment costs From what we know it is suggested that the investment decision may well be justified on financial grounds i e a consideration of the quantitative factors in investment appraisal especially if the manufacturing facility was to be located in Germany which has the best payoff of the three locations The justification is based on four key factors Firstly consider the financial information in the decision tree The high investment cost 150m is justified by high returns 235m on average across the business cycle Although it should be noted that given RDM has not yet finalised a source of finance the 150 m would be unlikely Page Jump to start 19 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com to include the interest repayments associated with long term loan finance In which case profits would be lower Secondly increasing the productive output of the firm by value and volume will enable RDM to reap further economies of scale EOS are a reduction in average per unit costs as output increases Further providing RDM has the best processes and systems in place the firm should be able to benefit from each of the five different types of EOS namely purchasing economies technical economies financial economies marketing economies and managerial economies This lower average per unit cost adds to RDM s competitive position and should increase the firm s long term profitability Thirdly having the manufacturing located in Germany negates one of the key weaknesses in RDM s current business plan it is only price competitive within a 700 km radius of its current factory in the Czech Republic Having a manufacturing located in RDM s main German market will increase its price competitiveness in this key market Delivery costs are based on weight and location and is a substantial cost to the firm and therefore to its customers It is a variable cost to the firm and as such needs to be factored into break even analyses cost plus pricing etc Further locating in the exporting powerhouse that is Germany means that the country has efficient seaports and this fact may enable RDM to deliver product to customers at lower cost This would increase the company s contribution margin essentially profitability per unit and or its price competitiveness as reducing price usually increases demand for a good Sea freight is generally considered to be the lowest cost delivery method and as such new markets such as the UK and even the US and the large developing markets in China and India may be opened to the firm If so further EOS may be reaped Fourthly RDM will be further diversified More generally having two production facilities means that the firm will have reduced risk in the external environment it operates in Reduced risk lowers the discount rate the firm will use in investment appraisal e g net present value and increases the likelihood such an investment meets expected rates of return e g average rate of return An example of such diversified risk would be if the government of one country imposed new stringent labour laws then more of RDM s production could be shifted to the other location More specifically the new production facility will allow RDM to further diversify its product range and increase the flexibility of its design specifications as the new manufacturing system will have more flexibility built into its systems Perhaps the most basic reason for RDM to diversify is survival By definition a company that focuses on a narrow range of products will only have access to a finite number of customers This is fine if the market as it stands is big enough to support several competing businesses but if the pool of customers is small the cost of running RDM may outstrip the potential for revenue In these circumstances diversification into new product lines may be essential to the longterm viability of this company But diversification is not just about survival It is a tried and trusted growth strategy New products or business lines will enable RDM to make more sales to existing and new customers and depending on how it diversifies expand into markets that would otherwise have been Page Jump to start 20 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com closed to it There are many ways in which to diversify The most straightforward of these is to provide a natural extension of the goods or services that RDM already offer to customers and this is exactly what having a strategy aimed at increasing flexibility in manufacturing aims to achieve for RDM However while the financial considerations make a strong case for opening a new manufacturing facility in Germany RDM will have to seriously weigh the disadvantages of such a move The chief problem being the one of financing As a privately owned family company directors can maintain overall control over the business as they control the trading of shares in their company Owners shareholders of private businesses have more of a say as there are less shareholders so they have more influence over business decisions If the company went public to finance expansion then the family s ownership would necessarily be diluted A public limited company PLC is a company that can advertise and sell its shares to the general public via the stock exchange There are advantages and disadvantages of RDM raising share capital through an IPO The key advantage to RDM of going public is that public limited companies can often raise vast sums of money for financing their investment projects The money raised through selling shares becomes permanent capital meaning that it does not have to be repaid unlike loans Interest does not have to be paid instead shareholders are paid a dividend but only if the company makes a profit The interest payments on a loan of such a size are likely to be sizeable and a feature of RDM s balance sheet for the long term While the investment decision looks promising it does require a huge amount of capital to be raised 150 million The family can still maintain majority control in RDM and still go public if they maintain a combined shareholding at 51 percent or above Whether the 150 million can be raised in an IPO with the family maintaining such control is uncertain Currently RDM is profitable and all dividends in the pool are paid to the family Investing in a new production facility will lead to greater profitability and thus a bigger total dividend pool However the family s share of the dividend pool will be diluted The family will want to carefully assess whether a smaller share of a larger dividend pool makes financial sense for these key stakeholders If the family can maintain majority control of RDM and increase their total dividend payment then the new production facility may well make financial sense However the effect on RDM s corporate culture of such a move must be considered Given what we know about RDM it is suggested here that being privately held is integral to its corporate culture and that the family owned private firm would be associated with the following traits Generational continuity Long term focus Independence Nimbleness Emotional attachment Investment into the workforce Flexibility Page Jump to start 21 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com Lean hierarchies Innovativeness Customer focus Social responsibility Strong regional ties Going public would affect each of these current organisational traits likely to be associated with RDM For example large organisations suffer from communication problems As RDM becomes larger relationships may become more impersonal to both customers and employees Given this loan finance must be a valid option for the new production facility Examining RDM s balance sheet we can see that the company has net assets of almost 20 million which could be used as collateral to secure a long term bank loan If the forecasted financial information is reasonably accurate then the expected profitability of the venture should make loan repayments more than manageable Further the size of the loan may mean that RDM may be able negotiate favourable terms for itself coming from financial economies of scale However there are two important factors that must be considered here Firstly using loan capital to finance the expansion is a long term prospect and the financial forecasting used in the estimates becomes less and less accurate over time It is unlikely that the financial forecasts and estimates provided by the CFO are going to be as accurate in year 15 of the project as they would be in say year 2 Secondly the CFO has indicated that there is a very real risk of economic recession resulting in a substantial yearly loss for the firm and that the risk of recession is very real If the CFO is correct RDM will be operating in a recessionary economic environment 30 percent of the time three years for every ten years of operation Loan repayments cannot easily be delayed and default can have serious considerations to the firm For example in case of default the lending bank could require RDM to sell core assets and or force the company into liquidation A contingency plan must be made for recessionary years if loan finance is going to be used to pursue the new investment opportunity Taking everything that is presented in this analysis the following recommendation can be made Unless better alternative investments are presented the profit objectives at RDM can best be met by pursuing the new production facility in Germany rather than Poland or Slovenia If loan finance can be secured on reasonable terms then this should be the preferred financing option as it keeps family control of the firm and allows RDM s to retain its corporate culture However if loan finance cannot be secured then an IPO is a viable option if family control is retained and expected dividend payments to the family increase Page Jump to start 22 23

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com Exam tip You can duplicate information from answer to answer Different answers are assigned to different examiners for marking If you provide some good knowledge in your answer to say Q3a and some great critical thinking in your answer to Q4d and IF it s applicable feel free to reuse this in answering Q5 An example of this can be found in the use of information around diversification which shows up in the model answers to both Q4d and Q5 Section C Marking Rubric Marking criterion Marking judgement A Knowledge and understanding Award up to 4 marks if good knowledge and of tools techniques and theories understanding of relevant tools techniques or theories is demonstrated B Application Award up to 4 marks if relevant business management tools techniques and theories are well applied to explain the situation and issues of the case study organisation Examples are appropriate and illustrative C Reasoned arguments Award up to 4 marks if relevant balanced arguments are made and these are well justified D Structure Award up to 4 marks if all of the structural elements are present and ideas are clearly organised E Individual and societies An introduction A body A conclusion Fit for purpose paragraphs Award up to 4 marks if balanced consideration is given to relevant individual and group perspectives Page Jump to start 23 23