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May 2020 Higher Level Paper 1 Mock Examination P S Trawlers 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 D

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com M20 3 BUSMT HP1 ENG TZ0 XX BUSINESS MANAGEMENT HIGHER LEVEL PAPER 1 Practice examination 2020 P S Trawlers 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 P S Trawlers 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 P a g e 2 24

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 two advantages of low labour turnover for P S Trawlers line 40 4 marks Labour turnover is the rate at which employees leave a company and are replaced by new employees expressed as a percentage Two advantages to PST having a low a low rate of labour turnover are as follows Cost Savings It is costly for PST to lose one employee and then hire and train a replacement especially a highly skilled employee such as a trawler captain Recruiting hiring processes and training time with the new employee are common costs Additionally PST has an opportunity cost resulting from lower productivity with a new employee High Motivation Over the course of time the employees at PST develop bonds with coworkers Dealing with regular turnover affects those left behind and makes it more likely they will eventually leave as well PST has a high morale culture where employees have good working relationships and this contributes to the effectiveness of the business In the fishing company employees who know each other well more easily collaborate on production and work through glitches 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 P a g e 3 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com b With reference to P S Trawlers distinguish between a partnership and a private limited company lines 9 and 10 6 marks A partnership is a business legal structure where two or more associates are carrying on a business in common with a view to make a profit e g architects engineers It is owned by two or more people and up to 20 this may vary from country to country The firm is managed by the partners Capital comes from partners Partners can pool funds together to make more funds A private limited company is a business legal structure characterised as being a small to medium sized business that is owned by shareholders who are often members of the same family This company cannot sell shares to the general public PTS has changed from a partnership to a private limited company It remains a family owned private company with shares tightly held between the immediate family Students should be ready to evaluate the advantages and disadvantages of changing from a partnership to a private limited company The change in legal ownership makes a lot of sense Company directors can still be held responsible and liable for damages if they have been shown to be willingly negligent in their duties e g gross safety issues and the death of a crew member preventable oil and diesel spillages causing significant environmental damage etc However companies have limited liability which means that the business owners shareholders are not personally liable for business debts Therefore the owners will not have to sacrifice their personal assets if the business is unable to repay all its liabilities This could be a very important consideration considering the possibilities of setting up new businesses e g fish retail shops or purchasing new and larger fishing trawlers Continuity becomes easier We are not given precise information on how old Shae and Patsy the parents are but we confidently assume that they are getting on It is likely that their shares will transfer to the children in time The more shares a person has in a business the more influence they have in business decisions as each share counts for one vote 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 P a g e 4 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com QUESTION TWO a Outline two examples of intangible assets that could feature on the balance sheet of P S Trawlers Appendix 1 4 marks This is an asset that is not physical in nature an asset being any resource owned by the business Anything tangible or intangible that can be owned or controlled to produce value and that is held by a company to produce positive economic value is an asset Goodwill brand recognition and intellectual property such as patents trademarks and copyrights are all examples PST may have intangible assets in the form of brand recognition and trademarks Brand recognition is the extent to which PST s target market fish shops restaurants etc can identify PST s brand by its attributes such as being a reliable supplier of very high quality fish A trademark is a type of intellectual property consisting of a recognisable sign design or expression which identifies PST s products from those of other competitors It may be displayed on boxes of fresh fish delivery vehicles and promotional materials such as emails to customers 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 P a g e 5 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com b Examine the role of bonuses at P S Trawlers as a method of increasing productivity line 64 6 marks Bonuses are likely used to increase the motivation of PST employees and motivation in turn would be expected to increase the productivity of workers especially the trawler captains who are responsible for catching the fish the company sells Productivity describes various measures of the efficiency of production Often a productivity measure is expressed as the ratio of an aggregate output to a single input or an aggregate input used in a production process i e output units of fish caught per unit of input fishing expedition typically over a specific period of time If bonuses increase productivity at PST then more fish will be caught on fewer fishing trips earning PST more income and reducing average unit costs Motivation is the intrinsic and extrinsic factors that stimulate people to take actions that lead to achieving a goal Intrinsic motivation comes from the satisfaction derived from working on and completing a task and bonuses at PST would not increase extrinsic motivation Extrinsic motivation comes from external rewards associated with working on a task for example pay and other benefits Bonuses would increase extrinsic motivation and in turn productivity Bonuses are a gratuity given as gift or compensation earned as reward upon achieving a goal or milestone PST s performance based renumeration aimed to maximise catch sizes of the most valuable fish species If successful the value of the catch per trip will be maximised and the number of trips needed to fulfil the company s quota will be minimised i e the value of fish caught in PST s quota will be maximized at minimum cost profitability is maximised There are advantages and disadvantages of PST using performance based pay bonuses Advantages Trawler captains are motivated to improve performance if they are seeking to increase financial rewards Target setting can help to give purpose and direction to the work of trawler captains The appraisal involved in setting and achieving goals offer the opportunity for feedback on the performance of an individual trawler captain Disadvantages It can fail to motivate if staff are not driven by the need to earn financial rewards Team spirit can be damaged by the rivalry generated trawler crew versus trawler crew Claims of manager favouritism may undermine relationships Less autonomy for workers as they need to conform to the system that generates bonuses 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 P a g e 6 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com QUESTION THREE a Analyse P S Trawlers use of a bank overdraft as a source of finance Appendix 1 4 marks An overdraft is a deficit in a bank account caused by drawing more money than the account holds As such it is a form of short term external finance i e external money raised from sources outside the business Although being classified as being short term it is likely that PST s friendly bank manager is likely to roll it over each year as required and given PST s profitability would even likely extend the overdraft as required i e be willing to let PST draw down more than the current 200 000 The amount borrowed should not exceed the agreed limit facility The amount of the facility made available is a matter for negotiation with the bank Interest is charged on the amount overdrawn The bank may also charge PST an overdraft facility fee Overdrafts are generally meant to cover short term financing requirements they are not generally meant to provide a permanent source of finance At two years this looks like becoming permanent and PST should look at using its positive net cash flow to pay the facility down perhaps by reducing the amount it pays out in dividends to its four shareholders If PST finds that its overdraft facility appears to be becoming a long term feature of the business the bank may suggest converting the overdraft into a medium term loan Depending on the size of the overdraft facility the bank may require PST to provide some security for example by securing the overdraft against tangible fixed assets e g trawlers The amount of an overdraft at any one time will depend on the cash flows of the business the timing of receipts and payments seasonal trends in fishing and sales etc From the Appendix we can see that the firm has burnt through its cash reserves in 2019 staving off a liquidity crisis by securing a bank overdraft The company forecasts that this cash outflow is stemmed in 2020 with the amount of the bank overdraft stabilising 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 P a g e 7 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com b Examine the impact of one technological and one social factor that could arise in the external environment that P S Trawlers operates within 6 marks Technological Adopt new fishing technologies Fishing is evolving There are many recent technological developments Such technologies can be collaborative i e involving more than one stakeholder groups along the value chain or noncollaborative which are set up by governments to monitor the fisheries sector These include the increased computing power of handheld devices the proliferation of user friendly Global Positioning System GPS and Global Navigation Satellites Systems GNSS applications increased capacity for big data storage sharing and analysis variety and improved durability of drones and low maintenance radar stations accessibility and accuracy of satellite imagery continuous improvements in on board digital cameras and recorders expanded use of Automatic Identification Systems AIS and Vessel Monitoring Systems VMS and the internet at sea Only the largest fishing companies can adopt such new technologies and reap the benefits and spread this cost across their expanded fishing fleets defraying the average cost economies of scale Thus providing the biggest fishing operators with an even better ability to outbid rivals for fishing quotas This would be a driving force in favour of Pekka s wish to upgrade PST s fleet to bigger more efficient trawlers to catch more fish more efficiently and at a lower unit cost that increases profit margins Social Increasing demand for fish PST is operating in a market where demand for its product is growing and it can grow revenues as the market expands The increased demand for fish likely comes from an increasing social awareness of the negative effects of large scale livestock farming pollution deforestation CO2 and methane emissions as well as the poor health outcomes associated with eating red meat such as beef and lamb As people become more health conscious the demand for healthier proteins such as fish increases Increased demand for a product also results in an increase in price all other things being equal Further if the increase in demand is being driven at least in part by rising consumer incomes then PST is well positioned to reap the rewards of its premium pricing Moving to bigger more efficient trawlers and obtaining additional quota would capitalise on this increasing demand for fish However regulations and quotas may limit the company s ability to take advantage of this external opportunity 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 P a g e 8 24

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 The management of P S Trawlers PST have received a report back from a business consulting company which examines both strategic options the firm is considering pursuing to grow the company diversifying operations or increasing the scale of operations by purchasing new modern ocean going trawlers that are much larger than those currently operating The report suggests that opening new fish retail shops would be a better option for diversification than offering services and facilities to other fishing businesses or finding alternative uses for the trawlers these are markets that PST has no real experience or competencies in The report also concluded that increasing the scale of operations was also a viable option if financing could be obtained on reasonable terms Additional fishing quotas could be obtained from both the government and purchased from smaller fishing companies The business consulting company also warned that according to PST s own working capital projections for 2020 the firm was likely to experience liquidity problems If PST can find suitable financing there are no real limits on the number of retail shops that could be opened or the number of large ocean going trawlers that could be operated The business consulting company is confident forecasted costs are accurate given the quality of the research and available data but less certain about the forecasted revenues as the price of fish is volatile and catch sizes and quotas are variable year to year Further sales revenues in each shop will be very dependent on the marketing mix PST chooses to employ and the effectiveness of its unique selling proposition a Identify which sectors of the economy PST s fishing operations and retail activities operate in 2 marks PST s fishing operations occur in the primary sector of the economy PST s retail activities occur in the tertiary sector of the economy Award 2 marks if the student s answer meets the following criteria Two economic sectors are correctly identified P a g e 9 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com b Ratio analysis using selected financial data for PST as shown in Appendix 1 i Calculate PST s return on capital employed ROCE in 2019 2 marks ROCE Net profit Capital employed x 100 Net profit Sales x net profit margin 14 5m x 13 1 885 000 Capital employed non current current assets current liabilities 2 600 000 ROCE 1 885 000 2 600 000 x 100 72 5 Award 2 marks if the student s answer meets the following criteria The calculations are correct ii Calculate the current ratio and the acid test ratio PST projects in 2020 2 marks Current ratio current assets current liabilities 300 000 400 000 0 75 Acid test ratio liquid assets i e current assets stocks current liabilities 150 000 400 000 0 375 Award 2 marks if the student s answer meets the following criteria Each calculation is correct c Analyse how opening new retail fish stores would allow PST to exert more control over its marketing mix 4 marks Thee marketing mix is a combination of factors that can be controlled by a company to influence consumers to purchase its products and when the product is a good such as fish rather than a service this typically includes product price place and promotion Tapio has floated the idea of the company opening its own fish shops and vertically integrate the business Vertical integration is the combination in one firm of two or more stages of production normally operated by separate firms i e fish producer and fish retailer This is an idea that makes intuitive sense as it provides PST with more control over its marketing mix and allows the firm to better differentiate its product i e creating a unique selling proposition a feature of a product that makes it different from and better than all its competitors products Essentially if this strategy was successfully implemented PST would be able to catch and sell more fish at higher prices price by differentiating its product through seizing greater control P a g e 10 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com over its marketing mix Its fish would be perceived as less of a commodity product product and a brand identity could be built around locally sustainably and ethically sourced fish promotion Further nothing in this strategy precludes catching and selling its fish as it always has restaurants other fish shops supermarket chains and for export Further PST would eliminate an intermediary in the chain of distribution place and increase the price it receives for its product It would be difficult to develop a brand identity around a commodity product such as fish However creating a brand identity to differentiate its product would tie nicely with the strategic option of PST opening its own fish retail shops The brand would be based on something like the freshest fish of the highest quality being locally and ethically sourced More of its fish could be sold for a premium price Such brand development would likely be impossible if PST moved to increase the size of its catch using bigger trawlers 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 P a g e 11 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com d Recommend a preferred source of finance for each of the two strategic options opening new fish retail shops and purchasing new ocean going trawlers 10 marks Key financial information in the Appendix highlights that PST s balance sheet has fixed assets of 2 3 million excluding intangible assets It would be considered to be a small to medium sized business It is estimated that the cost of purchasing two pelagic ocean going trawlers would easily be over 100 million This weakness in the firm s balance sheet would exclude all but the highest rate lenders of corporate debt e g finance companies rather than banks PST has the option of obtaining a bank loan secured against the firm s assets i e trawlers or to exchange a large percentage of the business in return for a significant investment from an investor or group of investors Such external financing for small businesses falls into two categories Debt financing involves borrowing a fixed sum from a lender which is then paid back with interest Equity financing is the sale of a percentage of the business to an investor in exchange for capital There are six factors influencing the choice of finance The use to which finance is to be put which affects the time period for which finance is required It is very risky to borrow long term finance to pay for short term needs Businesses should match the sources of finance to the requirement Thus the funds raised by long term debt finance should be used to finance the expansion of PST rather than pay down its current liabilities Short term finance would be advisable to finance a short term need to increase stocks or pay creditors Permanent capital may be needed for the long term business expansion This is because long term loans need to be repaid resulting in reduced cash flow cash that could be used for expansion and interest payments reduce net profits and lower retained profits as a source of internal finance Cost Obtaining finance is never free even internal finance may have an opportunity cost Loans may become very expensive during a period of rising interest rates Conversely in today s low interest environment more can be borrowed and or debt can repaid be more quickly The opportunity cost of equity finance must be considered In addition to giving up a large share in their company a large percentage of future profits will be foregone as this will be the new investor s share Flexibility When a firm has a variable need for finance e g it has seasonable sales and cash receipts flexible forms of finance are better than long term and inflexible source Equity finance allows PST more flexibility because equity finance does not preclude the firm from using debt finance in the future In fact by using equity to finance PST s expansion the balance sheet will be stronger and the firm could access other forms of credit such as a bank overdraft to stave off the impending liquidity crisis Legal structure and desire to retain control This is an important consideration here Share issues can only be used by limited companies Doing this runs the risk of current owners losing some control If the owners want to retain control of the business at all costs then a sale of shares may be unwise P a g e 12 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com Size of existing borrowing This is a key issue the higher the existing debts of a business compared to its size the greater the risk of lending more Banks and other lenders will become anxious about lending more finance This concept is referred to as gearing The gearing ratio looks at the long term liquidity position of a firm Creditors and investors will be interested in this ratio as a high degree of gearing could mean that a firm is risky in that it may have difficulty meeting its debt repayment obligations especially if interest rates rise From the balance sheet we can see that PST has an effective gearing ratio of zero 50 would indicate a highly geared business but PST has no long term liabilities The higher the ratio the greater the risk taken by management when investing in assets or financing operating costs with longterm loans This places PST in an ideal position to borrow funds for the retail outlets it s looking to open because the required finance is much less than the amount required to finance the purchase of new trawlers an estimated 100 000 versus 100 million Amount required Share issues and sales and debentures because of their administration and other costs would generally only be used for large capital sums Smaller bank loans or reducing debtors payment period could be used to raise small sums Obviously such a significant expansion as the purchase of pelagic trawlers means that a large sum of money is required by PST The price paid by PST for this finance will be onerous debt repayment obligations to an unforgiving bank that has sought and received collateral guaranteed by the firm or giving up a large percent of their firm and future profits We can summarise the advantages and disadvantages of debt and equity finance Pros of equity financing For businesses that are yet to attain profitability equity financing can be the best if not the only option PST is profitable Investors take on almost all the risk they receive their returns only if PST succeeds The purchase of trawlers would leave the family shareholders exposed to the loss of 2 5 million in assets and an income stream if the pelagic trawler venture failed and the firm went bankrupt The exposure of the owners is much less with the retail option because the amount of finance is so much lower No percentage of PST s revenues will be diverted to pay loans Cons of equity financing The family owners give up a percentage of their business and future profits The new investor will probably have control over key decisions and influence the culture of the firm even if they are uninvolved in the day to day running of PST Landing investment can be a full time effort and reporting to investors regularly can take precious man hours Investors or equity partners usually do not expect a return on their investment for 3 5 years but they often exit after 5 7 years Pros of debt financing P a g e 13 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com Can be used by almost any kind and size of business This means it could be suitable for financing 100 000 to open a retail shop or more than 100 million to purchase two new pelagic trawlers The family would retain ownership of their business which means they will not have to share profits long term They know when they need to make repayments There are a range of options different kinds of loans credit cards lines of credit etc However PST would seek and most likely receive a long term bank loan to open retail stores and these other forms of credit may also be made available increasing the firm s flexibility to use the best form of credit for any given situation and eventuality Interest on the debt can be deducted from the firm s tax return Interest rates on loans are usually lower than the return on equity investments especially as the rate of interest in the EU is low However this low interest rate environment lowers the discount rate used in NPV calculations in turn making NPV investment analysis more favourable Cons of debt financing Requires repayment of both principal and interest whether PST s business is good or bad We know from the case study that fish catches can be variable and there are probably seasonal aspects to this industry Cash flow at PST is lumpy Debt is an expense and expenses prevent the owners from reinvesting revenue in the business There is always a risk Defaulting will cost the owners the assets that has been pledged as collateral Lenders may restrict what PST can use the money for or whether the company can look for more financing elsewhere With some analysis and information we can determine whether debt or equity funding will most benefit PST for each option In terms of expanding the trawler fleet it is difficult to envision a bank lending the company over 100 million when the firm has less than 3 million in assets and is inexperienced in operating a fishing company that is an order of magnitude larger than the current scale of operation It is too much risk for a bank to take on and the hands of the bank may be tied anyway by EU bank regulations The firm could still pursue debt financing of this venture by issuing its own debentures However this is an expensive and complicated process It is handled by large investment banks with high fees and commissions Notwithstanding the expense of this option the company is likely too small to engage in this type of financing Thus a shares issue becomes the preferable means to finance this expansion The scale of the investment needed to pursue Pekka s preferred option would necessitate a relinquishing of family ownership and control in return for the equity investment needed to finance purchasing the pelagic trawlers I note here that PST could use a combination of equity and debt to finance the purchase of the trawlers A cash injection by an investor would strengthen PST s balance sheet to a point where banks are satisfied there is enough capital in the company to secure a long term bank loan Less equity would be required and less company ownership would be relinquished by P a g e 14 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com the family However the final decision and the final debt to equity split would require a careful consideration because while the benefits of both debt and equity finance are gained by PST so too are the disadvantages of each the decision becomes more complicated Financing the rollout of retail stores is less complicated Given the smaller scale of investment needed I recommend PST use debt financing specifically a bank loan A single retail shop could be up and running for around 20 000 with more shops opening at a multiple of this The firm easily has the necessary assets on its book to secure such a loan and the interest rate environment today is extremely favourable to debt financing Further if market research showed that this was a viable strategic option PST could test the market by opening a single fish shop to test the waters so to speak an investment that could probably be made for less than 20 000 If successful more branded shops could be rolled out and a franchise model could even be used to minimise the upfront costs to the company reducing the firm s debt load Thus we consider debt financing to be the most viable option to open retail stores 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 P a g e 15 24

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 Net cashflow forecasts have been prepared for both strategic options and these are shown in Table 1 and Table 2 below The forecasted cash flows for each retail outlet PST chooses to open are as follows Table 1 Forecasted net cash flows per retail fish shop opened Year For each retail fish shop Discount factor 5 0 60 000 1 10 000 0 9524 2 30 000 0 9070 3 50 000 0 8638 4 70 000 0 8227 5 70 000 0 7835 The forecasted cash flows for each ocean going trawler PST chooses to operate are as follows Table 2 Forecasted net cash flows per trawler operated Year Trawler 1 Trawler 2 Trawler 3 Trawler 4 Trawler 5 Discount factor 12 millions millions millions millions millions 0 150 140 130 120 120 1 20 22 24 25 25 0 893 2 20 22 24 25 25 0 797 3 20 22 24 25 25 0 712 4 20 22 24 25 25 0 636 5 20 22 24 25 25 0 567 P a g e 16 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com The directors of PST agree that the company needs to focus on only one strategic option It does not have the management resources to pursue both options Using the case study and the additional information on pages 3 5 recommend what you believe to be the best option for PST to achieve its strategic objectives and an appropriate scale of operations You will find it useful to use Business Management investment appraisal tools to analyse the data provided 20 marks Investment appraisal Year For each retail fish shop 0 60 000 1 10 000 2 Discounted cash flows Cumulative cash flow Discount factor 5 60 000 9 524 50 476 0 9524 30 000 27 210 23 266 0 9070 3 50 000 43 190 19 924 0 8638 4 70 000 57 589 77 513 0 8227 5 70 000 54 845 132 358 0 7835 NPV 132 358 after five years thus investment is profitable at an interest rate of 5 Payback Within the third year Average monthly cash flow in Year 3 50 000 12 4167 30 000 4167 7 2 month Payback period 2 years and 8 months ARR 170 000 5 34 000 60 000 57 Comment The low cost of this investment opportunity combined with relatively good returns means that there is a short payback period a high rate of average return and a profitable investment in today s euros after factoring in discounted future cashflows There are however a few points to consider It s forecasted in the above figures that same store net cash flows peak at 70 000 and this is substantially less than PST s current profitability estimated at around 1 885 000 per annum Net profit Sales x net profit margin 14 5m x 13 1 885 000 Thus it s questionable whether this investment really adds anything of real substance to PST profitability PST would likely have to roll out a number of retail shops in different locations around Finland for this strategic option to be worth the time and effort of PST s management P a g e 17 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com team and shareholders Opening more shops would not improve the payback or ARR unless economies of scale apply and they probably would to some extent of this investment option but the NPV increases in multiples of the number of shops opened For example if PST opened five shops then the NPV of the total investment would be 132 358 x 5 661 790 and the strategy would now increase the profitability of the company by over a third Year Trawler 1 millions Discounted cash flows Trawler 2 Trawler 3 Trawler 4 millions millions millions 140 130 120 0 150 1 20 17 86 22 24 25 2 20 15 94 22 24 3 20 14 24 22 4 20 12 72 5 20 11 34 Discounted cash flows Trawler 5 millions Discount factor 12 120 22 325 25 0 893 25 19 925 25 0 797 24 25 17 8 25 0 712 22 24 25 15 9 25 0 636 22 24 25 14 175 25 0 567 NPV 77 9 NPV 29 875 Payback Trawlers 4 and 5 in the fifth year trawlers 1 2 and 3 cannot be paid back across the five years of figures Further it is assumed that economies of scale are operating here Thus five trawlers could be purchased at 120 million each and that net cash flows are maximised when at least four trawlers are operationalised This means that if PST purchased four or five trawlers this investment would be paid back within five years ARR Trawler 1 20 150 13 33 Trawler 4 25 120 20 83 The ARR is favourable especially for investing in four or more trawlers The payback period becomes more favourable the more trawlers the company invests in The concern is that the NPV is negative across the five years of cashflows provided whether a single trawler or multiple trawlers are purchased It is noted here that the investment returns on the trawlers are likely skewed downwards given the relatively short to medium term cashflows given Given adequate maintenance and technology upgrades when required each new pelagic trawler P a g e 18 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com will have a functional lifespan of much more than five years The added net cashflow from years six to ten would likely turn the NPV of four to five trawlers to a positive figure i e a profit would be made A residual value being assigned to each trawler which is not provided in the financial data would result in further improved investment metrics We can see through investment appraisal that both strategic options are favourable for the company The size of the investment dictates the size of the return The massive investment required to purchase four or more strategic trawlers nearing half a billion euros would bring PST a massive 100 million in annual net cash flows This is an order of magnitude greater than the company s current profitability The smaller investment in retail shops 60 000 each returns less in increased net cash flows perhaps an extra 350 000 if five shops were opened This is a good improvement on the company s profitability at close to its current scale of operations If the investment metrics look good for both strategic options which is the option best suited to PST s desire to grow the company There is the diversification strategy and the strategy to achieve scale Diversification strategies new products new markets and or vertical integration The firm can market to other consumer segments diversify into new products and diversify into new markets Fish is typically targeted at households The fact that PST s fish are of high quality and are locally and sustainably caught may mean that it could be successfully targeted at new consumer segments that PST could successfully target for example targeting consumers who are keen to reduce their red meat consumption New products can be developed such as servicing the fishing fleets of other companies mentioned late in the case study or perhaps using the boats for a tourism product This is a good opportunity to the firm however market research must be undertaken to find the right product or products that fit with the firm s corporate strategy It s assumed that the distribution reach of PST is tightly restricted due to high distribution costs refrigerated transportation being comparatively expensive If this distribution disadvantage can be overcome increased scale perhaps then new geographic markets can be opened to the business and its products Tapio has floated the idea of the company opening up its own fish shops and vertically integrate the business Vertical integration is the combination in one firm of two or more stages of production normally operated by separate firms i e fish producer and fish retailer This is an idea that makes intuitive sense as it provides PST with more control over its marketing mix and allows the firm to better differentiate its product Further PST would eliminate an intermediary in the chain of distribution and increase the price it receives for its product It is difficult to develop an effective integrated marketing mix around a commodity product because it is difficult for PST to differentiate its product from the product of other companies a fish is a fish On a smaller more local scale PST could create a USP around its fish being fresher locally and ethically sourced This would be more difficult to scale to further flung domestic and international markets This is an issue that the management of PST need to carefully consider as control over the company s marketing mix the ability to differentiate its product will lessen the more fish they catch and the more product they need to sell The company needs to carefully consider this issue if they adopt Pekka s plan to purchase bigger P a g e 19 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com trawlers that catch more fish The firm may have to accept lower unit prices on higher volumes of fish Whereas if Tapio s plan to open the company s own fish shops would enable more control over PST s marketing mix 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 Further the firm could then invest more in brand development It would be difficult to develop a brand identity around a commodity product such as fish However creating a brand identity to differentiate its product would tie nicely with the strategic option of PST opening its own fish retail shops The brand would be based on something like the freshest fish of the highest quality being locally and ethically sourced More of its fish could be sold for a premium price Such brand development would likely be impossible if PST moved to increase the size of its catch using bigger trawlers The other strategic option to consider is to achieve scale by purchasing bigger more efficient trawlers Upgrading PST s fishing fleet to large pelagic trawlers has many advantages Catch more fish taking fewer trips Make big savings on fuel costs identified as a major source of expenditure for the company Make big savings on salaries i e fewer boats mean fewer captain and senior crewman as well as fewer deckhands as the most efficient boats are largely automated salaries have been identified as a major source of expenditure for the company Incorporate the latest fishing technologies and driving efficiencies e g time to locate the biggest shoals of the most valuable species Be granted more quota and purchase additional quota from less efficient firms i e PST can catch more product Have safer boats fewer accidents at sea and lower insurance premiums Provide the company with more market power when negotiating price in markets and with fish wholesalers Not only is PST competing against other EU fishing companies to sell its product it is also competing against the same firms to obtain fishing quotas Any fishing company can purchase a fishing quota Fishing quotas are allocated in a tendering process For example the Finnish government may allocate an annual quota for 100 tonnes of herring to the highest bidder Only the most efficient fishing firms can afford to purchase these quotas and large fishing companies running big efficient boats can outbid smaller less efficient companies and still make a profit PST is a smaller fishing company operating smaller trawlers If the company calculates that it will cost the firm 200 000 to catch process and distribute 100 tonnes of herring and that that herring will on average sell for 300 000 then PST can only afford to bid 100 000 for that particular quota to break even Whereas a bigger more efficient fishing P a g e 20 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com company could catch the same quota for only 150 000 then it could afford to bid any extra 50 000 for the same quota And this is all assuming a level playing field We have information in the case study that foreign trawlers are behaving illegally or at least unethically These companies may obtain more value from their quota and therefore afford to bid more for a quota All these factors above are arguments for the economies of scale that drive efficiencies in the fishing industry decrease unit costs and increase the profitability of large fishing firms at least in theory New trawlers may enable PST to fish for higher value fish species Investing in new technology such as big data satellite tracking better under water imaging techniques and specialised nets may enable PST to fill more of their quota with more valuable fish species e g john dory and less of it with less valuable fish species e g cod This would maximise the return to the company for any given fish quota In terms of new technology the pelagic trawlers would allow PST to adopt new and expensive fishing technologies the unit cost of doing so is much less than at smaller scale Fishing is evolving There are many recent technological developments Such technologies can be collaborative i e involving more than one stakeholder groups along the value chain or noncollaborative which are set up by governments to monitor the fisheries sector These include the increased computing power of handheld devices the proliferation of user friendly Global Positioning System GPS and Global Navigation Satellites Systems GNSS applications increased capacity for big data storage sharing and analysis variety and improved durability of drones and low maintenance radar stations accessibility and accuracy of satellite imagery continuous improvements in on board digital cameras and recorders expanded use of Automatic Identification Systems AIS and Vessel Monitoring Systems VMS and the internet at sea Only the largest fishing companies can adopt such new technologies and reap the benefits and spread this cost across their expanded fishing fleets defraying the average cost economies of scale Thus providing the biggest fishing operators with an even better ability to outbid rivals for fishing quotas This would be a driving force in favour of Pekka s wish to upgrade PST s fleet to bigger more efficient trawlers to catch more fish more efficiently and at a lower unit cost that increases profit margins Further there is government support for the fishing industry Annual EU fishing subsidies total approximately I billion Most of such subsidies go to the largest fishing companies as subsidies are aimed at increasing production and unsurprisingly the biggest fishing companies are the more productive Thus PST may be able to further boost its income through EU subsidies if it expands its fishing operation by investing in bigger trawlers This would be a driving force for Pekka s proposal to grow the company however there would be a clear conflict in greatly expanding PST s fish catch and maintaining its ethical objectives The majority owners Pekka and Tapio agree that PST should pursue a growth strategy they are just undecided on what strategy suits the firm its stakeholders and its owners best Both strategic options provide clear opportunities for the firm Tapio s preferred option is to diversify the company She has slated a range of different options to this end none of them having any clear synergies between them P a g e 21 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com Fish and fishing are PST s core operations PST uses contractors to service their trawlers and equipment and they rent their warehousing premises Because of this it is unclear that the company has any institutional expertise to competitively offer services to other fishing companies It would take a significant capital investment in equipment and warehousing not to mention considerable staff recruitment in a tight labour market to begin to offer such services Thus I discount this strategic option In a similar vein finding alternative uses for the trawlers indicates that Pekka may be thinking about using company trawlers for a possible tourism venture Again the company has no core strengths or competencies here A trawler used to ferry tourists around Finland s fjords is a trawler not catching fish A purpose built ferry would be much more suited to this sort of task with comfortable seating enclosed viewing areas and a caf bar would be much more appropriate to this commercial activity This would require substantial investment in an economic activity that PST does not have any core competencies in Thus I discount this option as well PST opening its own fish shops is a better diversification strategy than the other two options that have been floated Introducing a vertical integration strategy could have many advantages for PST such as Increased competitiveness Greater process control Increased market share Increased supply chain coordination Decreased cost Essentially if this strategy was successfully implemented PST would be able to catch and sell more fish at higher prices by differentiating its product through seizing greater control over its marketing mix Its fish would be perceived as less of a commodity product and a brand identity could be built around locally sustainably and ethically sourced fish Further nothing in this strategy precludes catching and selling its fish as it always has restaurants other fish shops supermarket chains and for export If market research showed that this was a viable strategic option PST could test the market by opening a single fish shop to test the waters so to speak an investment that could be made for less than 20 000 If successful more branded shops could be rolled out and a franchise model could even be used to minimise the upfront costs to the company Thus we consider this strategy to be a very viable option The other strategic option Pekka s is to increase the scale of operations Larger newer fishing trawlers would be purchased to make PST s operations competitive with the larger international fishing companies also plying their trade in EU waters and beyond Productivity would increase and unit costs would decrease i e more fish could be caught for less money As a larger supplier PST would have greater negotiating strength with retailers and wholesalers The company could gain a higher price for its fish and its better ability to supply product may open new contracts to the firm especially in lucrative export markets Additional EU and Finnish fishing subsidies may also be obtained All of which would significantly increase the company s profitability P a g e 22 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com This is a good strategy that builds on PST s core competencies However the real issue with this strategic option is the level of investment required The company would need to invest in open sea pelagic trawlers The purchase of just two new pelagic trawlers would be a capital investment of over 200 million This is a level of scale that towers above PST s current assets a mere 2 5 million In terms of financing we do not believe that PST has the balance sheet to secure a bank loan of this size If the company were to issue shares to raise the necessary capital a minimum of 100 million would need to be raised from investors the rest could then be secured with debt financing Ownership and control of PST would effectively be transferred to the new investors This may be worth it it is often more lucrative to individuals to own a smaller slice of a much larger pie However we also see the issue of finance in this strategic option to be compounded further by the size of the new company which clashes with PST s corporate culture a family owned ethical and sustainable characterised by a friendly working environment In conclusion the scale of the investment needed to pursue Pekka s preferred option would necessitate a relinquishing of family ownership and control and a change to PST s corporate culture This would negate much of the advantages accruing to the firm from achieving economies of scale and greater profitability Therefore I discount this option and recommend to the management of PST to investigate a growth strategy built on the concept of vertical integration exploring the viability of opening its own retail fish outlets 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 Section C Marking Rubric Marking criterion Marking judgement A Knowledge and understanding Award up to 4 marks if good knowledge and understanding of relevant tools techniques or theories is of tools techniques and theories 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 P a g e 23 24

IB Business Management Higher Level Paper 1 Examination IB Business Management www BusinessManagementIB com 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 P a g e 24 24