APT provides highly comprehensive support for teachers and students during the run up to the Edexcel A Level Business Paper 3 Context Exam – through PowerPoint Presentations, Research Tasks, Information Sheets on each research bullet, a bank of Student Worksheets (NEW last year), and Practice Exam Papers, which can be pre-ordered here for this June’s exam (and published in stages from this December). Despite the limited research brief and vast possibilities of questions that can be asked on the context in relation to the specification, APT’s bank of Student Worksheets for the June 2019 exam included stimulus material relating to Monarch, and a question almost identical to Q2c in the actual exam – see below.
APT’s W10: Specification topic:
Business failure: Internal and external causes of business failure
Examine the data in the following extract then answer the question that follows
The failure of Monarch Airlines
Chartered airline Monarch had been around for 50 years and was once one of the leading airlines to fly people on their package holidays around Europe, until it entered administration in 2017.
In 2004, it became a low-cost airline, like Ryanair, easyJet and Wizz, although the market was already crowded and Monarch didn’t really offer anything new. These existing players were also big established airlines, and Monarch was relatively small in comparison.
Many of the big costs of running airlines, such as fuel and handling costs, are denominated in dollars, and the pound had fallen by about 10% against the dollar since the Brexit vote. This resulted in Monarch having to pay more to buy its fuel. At the same time, its sales had fallen due to increased competition, which arose from the terror attacks in Egypt, Turkey and Tunisia. These led to demand falling for holidays to these destinations and, as a result, many travel firms and airlines re-focused their efforts on Monarch’s traditional core markets – Spain and Portugal. This further increased the pressure on Monarch and meant it had to reduce prices.
In 2016, Monarch had struck a deal to acquire a new fleet of Boeing-737s to replace its fleet of ageing Airbuses, which would have reduced both fuel and maintenance costs. However, the first plane wasn’t due to be delivered until 2018, by which time it was too late.
A few years earlier, after Greybull took control of Monarch, it decided it would move away from long-haul holiday flights for some of its package holidays. Just before the failure of the airline it said it wanted to go back into that (long-haul) market. One commentator – John Strickland of JLS Consulting – stated this was, perhaps, ‘a little bit late, a little bit uncertain in terms of management planning’. Rivals such as Norwegian, had moved faster; another commentator – Flight Global’s Mr Clark – stated how Norwegian had “experimented with long-haul, low-cost flights on the transatlantic and that’s something that Monarch perhaps might have looked to have done instead of concentrating on those traditional short-haul markets.”
Q) Assess whether the failure of Monarch was due to internal or external causes. (12) [Actual exam Q: Assess whether Monarch Airlines’ business failure was due to internal causes. (12)]
APT’s Example Answer (provided in the ‘Answers’ section to APT’s set of ‘Worksheets’ devised to prepare students for the June 2019 Context exam):
A 10% depreciation of the pound, an external factor beyond Monarch’s control, resulted in higher fuel costs. Given that fuel costs are one of an airline’s biggest costs this would have had a major negative effect on Monarch’s profitability and cash flow position. If a large proportion of customers had already booked and paid for seats on Monarch flights and the price of fuel changed, Monarch might not have been able to increase prices to compensate for this increase in costs. In the worst case scenario, this could have resulted in Monarch having insufficient cash from revenue to meet all its financial obligations.
Whilst competitor airlines such as easyJet and Ryanair, would have faced the same problem, these airlines were much bigger than Monarch, and so their costs and, thus, cash outgoings, were likely to be lower as a result of economies of scale. If so, they would be better able to cope with the increase in fuel costs, and would not necessarily have to put up prices to maintain profit margins and ensure their survival in the longer term.
Although changes in exchange rates and fuel costs are outside the control of a business, it should be appreciated that many airlines mitigate against the risk of rising exchange rates and rising fuel prices through the practice of ‘hedging’. For example, many airlines agree a constant price for fuel for a set period of time eg $500 dollars per tonne, or $50 dollars a barrel for, say, 2 years. Indeed, easyJet hedges up to 85% of its fuel as a way of managing the risk of fluctuating fuel prices (and exchange rates). ‘Hedging’ enables airlines to control costs and set budgets and forecasts (for cash-flow) with greater confidence and further in advance. Many airlines also manage exchange rate risk by ‘forward currency contracts’. These represent a type of ‘hedging’ tool where a business locks in the exchange rate for the purchase or sale of a currency on a future date. For example, an airline may cover up to, say, 90% of its expected currency requirements for a period of up to 30 months in advance, using forward exchange contracts. It is not clear from the extract whether Monarch made effective use of such practices. If not, then this could be an internal factor contributing to its failure.
Another possible internal reason that contributed to Monarch’s failure is that, apart from trying to compete on price, it didn’t really do anything to differentiate itself from competitors. The extract states ‘it became a low-cost airline, like Ryanair, easyJet and Wizz, although the market was already crowded and Monarch didn’t really offer anything new’. Had Monarch differentiated its product offering and in ways that customers valued, for example in terms of standard of customer service, it might have been able to charge slightly higher prices and would, therefore, been better able to withstand a rise in fuel costs, and effectively neutralise the economy of scale advantages that the larger established airlines could exploit.
Poor planning could also be another internal reason for the business’s failure. The extract mentions that Monarch had ordered a fleet of new Boeing-737s to replace aging Airbuses, and this would have reduced both fuel and maintenance costs. However, the first plane wasn’t due to be delivered until 2018, by which time it was too late. On the other hand, the two year wait might have been down to a production backlog at Boeing, which would have been outside Monarch’s control.
The Terror attacks in Egypt, Turkey and Tunisia were certainly external factors outside Monarch’s control that contributed to its failure. As the extract states, this led to demand falling for holidays in these areas, and other travel firms and airlines re-focusing their efforts on Monarch’s core markets, which forced it to reduce prices. Lower prices would have resulted in falling revenues, which, against a rising (fuel) cost base would have squeezed margins further and could, ultimately, have forced Monarch into a loss making and negative cash flow situation.
It could, however, be argued that Monarch could have avoided failure through a different corporate strategy. Perhaps, for example, it should never have entered the highly competitive, low-cost short haul market where there was always pressure on prices and it was competing against other airlines from a higher cost base. Hence, margins were always going to be tight and make it vulnerable to a fall in revenue and / or rise in costs. And later on in its life, perhaps the decision should not have been made to take it out of the long-haul market but to take it further into this market for long haul, low-cost flights – where there was potentially less competition, and in which it had already established itself.
Perhaps, too, there should have been better financial management; businesses operating in the market for holidays, in particular, holidays overseas such as Monarch, are subject to unexpected events that cannot always be foreseen, such as terrorist incidents and natural disasters, and currency fluctuations. Hence, those responsible for the financial management of the company should have striven to maintain a strong balance sheet (ie cash position) to ensure the company’s survival in the event of external shocks.
Possible overall judgement:
To conclude, although, on the face of it, external factors in the form of changes in exchange rates and fuel costs and, in particular, external shocks in the form of terrorist incidences resulted in the downfall of Monarch, circumstances similarly impeding other travel and holiday businesses, it can be argued that its failure could be down to internal causes. Indeed, it can be argued that its failure could have been prevented through clearer vision and foresight from its directors and, perhaps, better financial management. It entered a market where it was always going to struggle on price, and failed to offer something new, and perversely came out of a market which could have potentially proved more lucrative, with less competition and rising demand.
APT’s Complete Context Companion, which includes PowerPoint Presentations, Research Tasks, Information Sheets, Student Worksheets and a Practice (Mock) Exam Paper (with detailed answers) prepared students very well indeed for other questions that came up in the actual exam, including questions on income elasticity of demand (Q1a), factors affecting the success of global businesses when entering a new (emerging) market such as China (Q1b), the influence of exchange rates on the demand for holidays and, thus, the holiday choices of consumers (Q1c), the effect of consumer protection legislation on businesses operating in the holiday market (Q2b), as well as plenty of information relating to pricing useful to answer Q2d in the actual exam.
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