OCR F297 (Candy Cabs) - Options

Some thoughts on the “strategic” options being considered by Candy Cabs:

General points to remember:

- Financial information only provided for the first three options
- Financial estimates produced by Catherine & Yvonne who are financial illiterates
- No input from Andrew into the analysis of options 1-3 [line 48]
- Existing turnover of the business - £800k
- Objective to have annual revenue growth of 8%+
- The three options are not necessarily mutually exclusive (i.e. they could pursue all three, subject to available finance)
- Options based around some rough estimates of existing business: e.g. £8 average fare for normal taxi trade and a 10% net profit margin
- Of more interest would be the “contribution” that additional revenues makes (likely to be much higher than 10% - which already takes into account fixed costs) and the different average fares for each market segment (i.e. public sector)

Option 1: Taxi Vouchers

- In theory the scheme (perhaps a better word is “scam”) involves Candy Cabs getting 90% of the second-hand, disposal value of private vehicles sold by elderly car drivers
- Ansoff: market penetration (existing product / existing customers - albeit taking revenue in advance)

E.g
Mrs Smith sells her car to Traylen Motors for £4,000
Traylen Motors sells the car to another third party via the motor trade - e.g. for £5,000
Traylen Motors “pays Candy Cabs 90% of the purchase price” (e.g. £4,500)
= A very poorly worded part of the case study!

What the examiner probably intended to write!
- Mrs Smith gifts her car to Traylen Motors and, in exchange, receives 90% of the resale value (£4,500) in the form of prepaid taxi vouchers from Candy Cabs, with Traylen Motors making a 10% profit margin for handling the sale.

Financial forecasts:
- Setup costs estimated to be negligible - £1,000
- Annual revenue of £28,000 p.a. equates to 4% revenue growth on existing business
- Forecast assumes no growth from Year 1

BUT…

- The proposed business model for this option is NOT THE SAME as running a traditional taxi business
- The forecasts ignore the substantial cash inflows that arise at the start of the scheme
- Revenues are received up-front (after a 60-day delay) for the entire value of pre-paid taxi fares. A customer might expect to use those taxi vouchers over several (perhaps many) years
- In terms of accounting for the scheme, amounts received from Traylen Motors are treated as “deferred income” and released to the profit and loss account as and when the vouchers are used
- However, for investment appraisal purposes, it is the cash flow which is most important
- Payback is much quicker than assumed in the forecasts - in fact there is probably no up-front investment requirement
- Main benefit financially - upfront cash inflows from the vehicle disposals + the release to profit of un-used taxi vouchers (e.g. when elderly customer dies, is no longer able to use the vouchers, or moves out of the area)
- The non-transfeable element of the scheme is legally dubious & difficult to enforce

Challenging the assumptions:
- Why should revenue per journey be £8 (the existing general average)?
- Elderly customers more likely to take shorter, less costly journeys?
- Unused taxi vouchers will earn a 100% margin!

Option 2: Taxi Services in Upham

- Low-risk organic growth option, servicing a market in which Candy Cabs already operates
- Ansoff: market penetration - existing product sold to existing market
- Setup costs primarilly involve recruiting & paying extra drivers + two vehicles (outright purchase rather than leasing?)
- Significant revenue growth opportunity - circa £250k p.a., which would easily enable Candy Cabs to achieve its revenue growth objective
- Year 1&2 assumptions look pessimistic in the context of subsequent years - will it really take two years before the 10% profit margin is achieved?
- Payback in just over 2 years, which is reasonable and probably cautious in terms of assumptions made
- Strategically the option which makes most sense for Candy Cabs: organic growth into nearby geographic markets
- The option cash flows and investment returns could be significantly better if alternative financing methods were used - e.g. leasing the two new vehicles, or using the Upham opportunity as a pilot to test the franchise model

Option 3: Executive travel

- A slightly higher-risk (but still low risk) option
- The strategic challenge is a marketing one (the marketing mix for executive travel is different) & an operational one (driver training)
- Ansoff: market development: existing product (taxi services) sold into a new market segment (executive travel)
- Forecasts based on a “few rough calculations” [line 79] - hardly a suitable basis for making an investment decision
- Estimated £200 per fare looks extremely high as an average; it is substantially higher than existing average
- VW 3yrd old VW Touareg is NOT AN EXECUTIVE CAR! - standard would be a high-end BMW / Mercedes to justify the average fare assumption
- Again - why purchase a vehicle outright when it makes much better cash flow sense to lease or contract hire?
- Estimated annual revenues of £40,000 (£10,000 margin) from Year 1 - no assumption of growth beyond Year 1
- Payback 1.5 years - but could be much quicker if leasing option is taken
- No evidence of relevant market research to justify the estimated demand of 200 bookings per year. Sensible to assume that demand will grow only steadily as word-of-mouth recommendation + customer awareness builds
- Positive NPV

Andrew’s Option: Candy Cabs as a Franchisor

- A fundamental shift in strategy: different business model; different financial and investment structure
- Andrew’s idea - “richer for doing less” - a naive understanding of how hard it is to run a franchisor business - less investment (certainly) but no less hard work
- No financial forecasts for this option
- Position of existing driver workforce is a challenge: cannot simply change their employment status to self-employment - there has to be agreement
- Switch to franchise basis needs to be attractive for both Candy Cabs & the drivers
- Franchises normally work on an exclusive territorial basis: difficult to organise and police this for existing drivers
- Billing systems unlikely to be adequate to monitor and record income due to Candy Cabs
- Many operational challenges - the most important being maintaining product quality