IB Business Management SL 1.5 Growth and Evolution Questions

Analyse why businesses grow or remain small, how scale changes costs and how mergers, acquisitions, alliances and franchising shape growth decisions.

Exam points

Analyse economies and diseconomies of scale using average costs, coordination, communication and motivation.
Distinguish internal from external growth and explain effects on control, finance, risk and operations.
Recommend whether a business should grow or stay small using market, control, flexibility and risk evidence.

Covered syllabus points

1.5.1—Economies and diseconomies of scale 1.5.2—Internal and external growth 1.5.3—Reasons to grow 1.5.4—Reasons to stay small 1.5.5—External growth methods

[Maximum number: 14]

EkoLogiczne Ltd. (EL)
EkoLogiczne Ltd. (EL) is a packaging company owned 60 % by Marek Kowalski and 40 % by his father. EL is a private limited company. Marek founded the company when he realized that the rise in e-commerce would mean the demand for packaging would always increase.
Originally, Marek imagined that EL's unique selling point/proposition (USP) would be to offer recyclable packaging. However, the eco-friendly market was dominated by one large company, Big Boxes (BB), which enjoyed economies of scale. Marek reimagined his USP: EL would have small factories that enabled customized orders to be fulfilled quickly.
Over time, EL opened four factories across Poland and the Czech Republic. Its customers, which included online retailers and small manufacturing companies, placed orders online; if the factory nearest the customer was too busy with other orders, the order would be shifted to another factory. Many customers chose EL rather than BB for this reason. With growth, however, EL began to experience diseconomies of scale and increasingly failed to fulfil orders on time.
Marek is now considering bidding on a large five-year contract for all the packaging solutions for WszystkoMart (WM), a huge traditional retailer trying to expand its e-commerce presence. The contract would require building a huge factory and focusing almost exclusively on keeping costs low. In terms of scale, EL would be almost as big as BB, the large company dominating the eco-friendly packaging market.
To finance the new factory, Marek would either have to sell many shares and reduce his and his father's combined ownership to 40 % or take a 30 -year loan from a bank.

(a)

Explain two diseconomies of scale that EL may have experienced.

[ 4 ]

(b)

Discuss whether EL should enter into the contract with W M if they have the winning bid.

[ 10 ]

[Maximum number: 10]

Option 1: Take over a specialist coffee business TZ is considering taking over Green Glass (GG) for $600 million. GG owns 1000 cafés in the USA that sell speciality products at high prices. It also has an e-commerce subscription service that sells its coffee beans to consumers. In 2020, GG’s net profits were $120 million. GG has a well-organized distribution channel and strong brand awareness in the USA. TZ would operate the cafés using the GG branding.

Trestle Z PLC (TZ ), a specialist coffee roaster, operates in the secondary sector. Its instant coffees are sold worldwide in a very competitive market. Consumers in this market have strong brand loyalty. Although demand for instant coffee has not grown in many richer countries, it is growing in emerging markets and Eastern Europe. TZ has no control over the price of its raw material (coffee beans), as prices are determined by world markets.

Trestle Z PLC (TZ)
Trestle Z PLC (TZ), a specialist coffee roaster, operates in the secondary sector. Its instant coffees are sold worldwide in a very competitive market. Consumers in this market have strong brand loyalty.
Although demand for instant coffee has not grown in many richer countries, it is growing in emerging markets and Eastern Europe. TZ has no control over the price of its raw material (coffee beans),

Figure for Question 2 — IB Business Management SL

as prices are determined by world markets.

The directors of TZ want to increase the company's gross profit margin and net profit margin and grow the business. Table 5 gives selected financial information for the company for 2019 and 2020.

Table 5: Selected financial information for TZ

TZ's directors are considering two options.
Option 1: Take over a specialist coffee business
TZ is considering taking over Green Glass (GG) for $\$ 600$ million. GG owns 1000 cafés in the USA that sell speciality products at high prices. It also has an e-commerce subscription service that sells its coffee beans to consumers. In 2020, GG's net profits were $\$ 120$ million. GG has a well-organized distribution channel and strong brand awareness in the USA. TZ would operate the cafés using the GG branding.
Option 2: Launch its own chain of cafés
These cafés would compete against established chains of cafés serving the mass market. Initially, the launch would be in three EU countries but would then, if successful, be launched across the world. TZ would produce a range of freshly ground coffees for sale in the cafés.

Recommend whether TZ's directors should choose Option 1 or Option 2.

Option 1 Advantages
- Speed - once the deal is struck TZ will have expanded quickly
- Proven profitability GG made a profit of $\$ 120 \mathrm{~m}$ in 2021 - is therefore less risky than Option 2
- This business has a well organised distribution channel and strong brand awareness in the USA and therefore is already well established.

Option 1 Disadvantages
- TZ only has $\$ 400 \mathrm{~m}$ in cash and the takeover price is $\$ 600 \mathrm{~m}$ and therefore TZ will need external finance the purchase
- TZ will have to raise external finance, which means that its debt (and interest expense) will increase or some dilution of ownership will occur. .
- This option is only based in US - will the concept transfer to other countries and how much cost will be incurred to establish its brand overseas?

Option 2 Advantages
- This can be seen as diversification, reducing risks as the market of jars of coffee has stagnated in many richer countries
- It already has experience of purchasing coffee beans on a large scale and can use the same suppliers for its new chain of cafes
- It has great potential as demand is growing in eastern Europe. Demand is also growing in emerging markets so the prospects for sales may be good.

Option 2 Disadvantages
- TZ has no experience of running cafes selling coffee
- It will have to go head on with established brands (students are likely to name them eg Starbucks, Dunkin Donuts etc) and may find it hard to compete with the brand loyalties already established.
- Will not have the economies of scale that existing chains have
- Will take much longer - is only trialling this in 3 countries in EU
- If successful in these countries will it work worldwide? - cannot be certain as consumers in these countries may have different tastes or attitudes to rest of the world.

In order to reach the top bands of the markscheme candidates must have a balanced view, made a judgement AND also used the data in Table 3 effectively

Accept any other relevant evaluation.
The table below should be followed (along with the markbands on page 3).
These mark awards in the table below should be viewed as maximums. That is, just because a candidate has one argument for option 1 and one argument against does not mean that they will automatically get a 4. One strong argument for one side and merely a weak or nominal argument for the other side might result in a 3.

Maximum Mark award

Should HP OPT FOR 1 OR 2

Judgments/conclusion

3

One argument for or one argument against one option

n/a

4

One argument for and one argument against for one option Or, two or more arguments for one side of argument and none for the other

n/a

5

A balance argument for one option (at least one argument for and one against) and an unbalanced argument for the other option (at least one argument for or against)

n/a

6

Balance arguments (at least one argument for and one against) for both options.

No judgments/conclusions

7-8

Balance arguments (at least one argument for and one against) for both options plus a conclusion that is more than nominal actually flows out of the analysis. Largely effective use of business language and the stimulus

Judgments/conclusions based upon analysis and explanation in the body of the response

9-10

Balance arguments (at least one argument for and one against) for both options plus a conclusion that is more than nominal actually flows out of the analysis. Rich use of business language, business theory and the stimulus

Two arguments for, two arguments against plus a conclusion that is more than nominal actually flows out of the analysis.

Marks should be allocated according to the markbands on page 3.

[Maximum number: 10]

The Burnt Tomato (BTO)
In 2003, Ben opened a street-food stall selling vegan food. The food stall was successful. Ben spent little on marketing, mainly advertising on the food stall itself and relocating it to places or events where many consumers would pass by.
In 2008, Ben used the profits from the food stall to open a restaurant, The Burnt Tomato (BTO), which initially employed 16 people. In the following years, labour turnover was low. Employees received an annual bonus, which increased with each year of employment.
In 2015, Ben created a website and began to use social-media marketing. Customers were encouraged to rate their BTO experience online. Their reviews consistently rated BTO's experienced staff highly and showed that they thought the food was exceptional value. Ben replied to all reviews. Many BTO customers also joined a BTO social media group and communicated with each other and BTO regularly. For many customers, the total BTO experience of vegan food and social networking was like being in a club.
Unfortunately, high labour costs, reasonable profits and the use of high-quality ingredients meant that BTO's gross and net profit margins were below industry averages.
Aware of the growing demand for vegan food, Ben borrowed money from a family member in 2018 and opened two more BTOs in different cities, hiring 32 new employees. However, in January 2019, a long-time customer of the original BTO ate at one of the new restaurants and wrote a negative review. The review went viral and sales at all three BTOs declined.

Discuss Ben's decision to enlarge the scale of BTO from one restaurant to three restaurants.

All question bank results loaded

Covered syllabus points

Question 1

Question (a)

Question (b)

Question 2

Question 3