AQA BUSS1 Pierre’s Personalised T-Shirts - Observations & Suggested Answers

Many thanks to colleagues who faxed over yesterday’s paper. Here are a few thoughts on potential approaches & answers for the January 2012 BUSS1 paper.

Don’t forget that this paper was a last-minute replacement paper (note the BUSS1R code on the front cover) after AQA withdrew the original paper. Was it a rush job? Not sure. If asked to rush a BUSS1 paper out, you’d probably want to keep it pretty simple and focus on the basics (market research, profit, breakeven and cash flow etc).!

I’m pleased that we nailed breakeven at the BUSS1 workshop and encouraged students to expect a lot more use of the results of calculations in other questions too. That change in the BUSS1 paper approach is now well established and some centres may need to refocus their SOW to spend more time practising profit and breakeven calculations from a variety of angles. The AQA examiners are now encouraging students to access good application (which leads to good analysis) through the use of calculations - an encouraging development, but one students will need more support on, I suspect.

The overall balance of the paper? Perhaps over-weighted towards breakeven and profit calculations, with a further emphasis on cash flow/sources of finance. But isn’t that what setting up a simple trading business like personalised t-shirts is all about? Many candidates might have been confused by question 2(c) which seemed to suggest more complicated calculations than were actually required.

Anyway, here are a few suggestions on possible responses to each question in the paper:

1(a) What is meant by the term “market segment” (2 marks):

A part of the market where a group of customers shares one or more distinct characteristics (needs or wants)

1(b) What is meant by the term “electronic market”? (2 marks)

A market - where buyers and sellers meet in order to transact. An electronic market enables the buyer and seller to transact using technology - e.g. online or other digital channels

1(c) Explain one reason why personalising T-shirts might be an effective way to add value (4 marks)

Adding value: where the price paid for by a customer for a product exceeds the cost of the resources (inputs) used in the transformation process.

Personalisation & adding value:
- Specific customer requirements (e.g. design) are being incorporated into the product
- The potential for a T-shirt to be unique/distinctive
- Evidence from the case study: a selling price of £9-12 can be achieved for a base input (the unprinted t-shirt) which costs just £2-3: implies a potential for adding value of at least £6-7 per t-shirt
- The ability to choose requirements efficiently online (size, colour, design) is valued by customers

1(di) Based on the data and information in the case study, calculate Pierre’s expected total contribution in his first year (2012) (3 marks)

A slightly sneaky calculation here, in that the information for the correct calculation wasn’t just contained in Figure 1. There was some additional information about variable costs per unit on line 30 (labour, printing & power costs of £0.50 which needed to be added to the purchase price of t-shirts. Students who missed out the £0.50 from their contribution calculations would be probably docked a mark, but would then get full credit for later calculations based on the Own Figure Rule.

Option 1 (2012)

Selling price per shirt: £9.20
less: Purchase Cost per shirt: £3.29
less: Other variable costs per shirt: £0.50

= Contribution per shirt: £5.41
Forecast quantity sales: 9,000 t-shirts

= Contribution: £48,690 [9,000 x £5.41]

1(dii) Based on the data and information in the case study, calculate Pierre’s expected profit in his first year (2012) (3 marks)

Contribution (calculated in 1di): £48,690

less:

Fixed costs - rent: £20,000
Other fixed costs: £28,000
Total fixed costs £48,000

=

Profit: £690

1(e) Explain possible reasons why Pierre carried out primary market research (6 marks0

Primary research: Market research that is carried out for a specific research purpose

Why Pierre carried it out: (develop a couple of these points: reason - explanation - benefits)

- No experience of trading in the t-shirt market, so primary research would provide useful insights into customer preferences
- Needed qualitative views on key decisions such as pricing and product quality - secondary research unlikely to provide this
- To supplement results of secondary research
- To obtain feedback on his efforts so far (website, sample products etc)

2(a) Analyse the benefits to Pierre’s business of having the bank overdraft (10 marks)

{develop at least two of these points in depth and then consider at least one "depends on" point to build quality of analysis}

Bank overdraft: a financial facility provided by the bank which enables a business to loan a flexible amount up to an agreed amount. Short-term borrowing arrangement with the bank.

Benefits to Pierre:

Evidence from Figure 2 is particularly useful:

Year 1
Opening balance: £15,000
Closing balance: £-13,290
Net cash flow: £-28,290

Maximum balance £15,000
Minimum balance: £-14,192

- Whilst business starts Year 1 with a positive cash balance (£15,000) there is a large net cash outflow in Year 1 of £28,290. At the end of October 2012 there is a forecast negative balance of £14,192, suggesting that either a bank overdraft is required, or the business needs to source additional alternative finance

- primary market research indicates that the t-shirt market is very seasonal; demand highest in summer and at Christmas; so cash flows likely to be seasonal too; bank overdrafts are a form of short-term finance designed to help businesses with predictable but seasonal demand.

- there is a timing difference between when Pierre needs to pay for his costs (t-shirts, rent etc) and when customers are likely to pay (three months after delivery for clubs). This creates a need for working capital - a bank overdraft is ideal financing for this

- Pierre is not forecast to make a substantial profit in the first year of trading; so he can’t rely on retained profits as a source of finance in the first year

- No evidence that Pierre needs to invest significant amounts in capital items - so a bank loan (alternative to a bank overdraft) not really appropriate

Depends on points:

- Customers may not be clubs - if he sells direct to individuals, then he will get payment at the point of transaction, which will improve his cash flow
- May be able to arrange trade credit terms with t-shirt suppliers, which will reduce the cash flow timing difference
- A bank overdraft is a temporary facility - no guarantee that the bank will continue to make it available if they have concerns about the viability of Pierre’s business

2(b) Pierre believes that his break-even output may have been too high. With reference to the case study, what would have been the best approaches for him to use in order to reduce his break-even output? Justify your view (15 marks)

Breakeven output:
- the output at which total contribution (revenues less variable costs) = total fixed costs
- the output at which the business is making neither a profit nor a loss

What is Pierre’s breakeven output?

Year 1 (chosen option)

Fixed costs: £48,000
Contribution per unit: £5.41
Breakeven output (£48,000 / £5.41) = 8,872
Margin of safety: 128 t-shirts (forecast sales of 9,000 less breakeven output of 8,872)
Suggests a very high breakeven output even for a business which is achieving high added value

The major issue behind the breakeven output - the fixed costs of the business
Fixed costs (£48,000) are higher than variable costs in Year 1 (£34,110)

Potential savings in fixed costs - work from home rather than rent an expensive location. A saving of £28,000 would reduce the breakeven output by over 5,000 t-shirts (evaluation - very significant reduction)
Possible downside from this option: stock control problems; disruption at home. But these costs of these downside highly unlikely to be anything like the saving he would enjoy.

Can variable costs be reduced?
Purchasing of t-shirts: a cheaper t-shirt is available at £2.29 each (compared with £3.29 each for chosen option);
A £1 saving in variable costs, assuming selling price stays the same would increase contribution per unit by the same amount and, therefore reduce his breakeven output (by about 1,400 units)
However: primary market research suggested that quality of t-shirt was more important than selling price; a lower-priced t-shirt likely to be lower quality, which may result in lower demand, resulting in lower revenues and possibly lower profits.
An option: can Pierre negotiate a better purchase price from his supplier for t-shirts of the required quality? Perhaps by buying in greater bulk?

Another option to reduce variable costs - lower labour rate: Pierre paying more than competitors (though we’re not told by how much)
Overall saving unlikely to be significant though, because extra variable cost per unit only £0.50.

Can selling prices be improved:
Rejected option suggested a higher selling price was possible (£12) but this would result in lower quantity demanded (approx 25% lower).
Is there an option to price in between £9.20 and £12 - is there a higher price point where customers will still buy at the original quantities (e.g. £9.99)

The best approach for Pierre to reduce his breakeven output - focus on reducing his fixed costs

2(c) Pierre set himself one primary objective: to achieve an annual profit of £15,000 in his second year (2013). If Pierre keeps to the original options chosen (Figure 1), do you believe that he will achieve this objective? Justify your view. You should use calculations to support your answer.

Objective - a specific target or outcome that a business wants to achieve.

Pierre’s stated objective - profit of £15,000 in Year 2 (assuming original options chosen).

Will he achieve it? Working through the numbers and making the stated assumption of 30% growth in sales volume:

Option 1(Year 2)
Contribution per shirt: £5.41
Quantity sales:11,700 (9,000 x 1.3)
Contribution: £63,297 (11,700 x £5.41)
Fixed costs - rent: £20,000 (assumed to be the same)
Other fixed costs: £28,000 (assumed to be the same)
Total fixed costs: £48,000

Profit = £15,297 (£63,297 less £48,000)

The calculations suggest that Pierre will achieve his objective - just! However, what factors will this achievement depend on? Good answers would develop at least two points for and against:

Reasons why Pierre might do better than forecast:

- The market is “said” to be growing by 30% per year (for new businesses); strong growth, albeit from a low base (which makes percentage growth in the second year easier)
- A major competitor with a large market share expected to stop trading - if it happens, then remaining competitors in the market should all benefit by sharing the demand that is released
- As the business establishes itself, Pierre should benefit from repeat business (existing customers coming back) and also recommendation / word-of-mouth recommendation.
- Strong feedback on his website: if he can get this right and continue to improve this, then he ought to be able to take a higher market share
- Pierre is focusing on quality rather than price, which ought to enable him to remain competitive if the quality achieved is good

Reasons why the objective might not be achieved:

- Primary research: small sample (how representative, how chosen); results and interpretation may be wrong
- Research did not include target customers (clubs etc) - do they have a different view on price v quality?
- Assumption that there is no increase in fixed costs: how realistic is this?