1.1 – Business Activity
The word ‘business’ is very familiar to us. We are surrounded by businesses and we could not imagine our life without the products we buy from them. So, what is a business, or what is business studies? Here’s the very posh definition for it:
“The study of economics and management”
Not clear? Don’t worry, by the end of this chapter, you should be getting a clear picture of what a business is.
The Economic Problem: Needs, Wants and Scarcity
Need– It is a good or service essential for living. Example: water.
Want– It is a good or service that people would like to have but is not required for living. Example: car.
Scarcity is the main economic problem. It is a situation that exists when there are unlimited wants and limited resources to produce the goods and services to satisfy those wants.
Opportunity cost
Opportunity cost is the next best alternative forgone by choosing another item. Due to scarcity, people are often forced to make choices. When choices are made it leads to an opportunity cost
SCARCITY→ CHOICE →OPPORTUNITY COST
Example – The government has a limited amount of money (scarcity) and must decide on whether to use it to build a road or construct a hospital (choice). The government chooses to construct the hospital instead of the road. The opportunity cost here are the benefits from the road that they have sacrificed (opportunity cost).
Factors of Production
Factors of Production- Resources required to produce goods or services.
- Land- Land is the natural resources that can be obtained from nature. This includes minerals, forests, oil and gas. The reward for land is rent.
- Labour– It is the physical and mental efforts put in by the workers in the production process. The reward for labour is wage/salary
- Capital- Capital is the finance, machinery and equipment needed to produce goods and services. The reward for capital is interest received on the capital
- Enterprise- The risk-taking ability of the person who brings the other factors of production together to produce a good or service. The reward for enterprise is profit from the business.
Specialization
Specialization occurs when a person or organization concentrates on a task at which they are best at. Instead of everyone doing every job, the tasks are divided among people who are skilled and efficient at them.
Advantages
- Workers are trained to do a task and specialize in this- thus increasing efficiency
- Saves time and energy- production is faster by specializing.
- Quicker to train labourers– Workers only concentrate on a task, they do not have to be trained in all aspects of the production process.
Skill development- workers can develop their skills as they do the same tasks repeatedly, mastering it.
Disadvantages
- It can get monotonous/boring for workers, doing the same tasks repeatedly.
- Higher labour turnover as the workers may demand for higher salaries and company is unable to keep up with their demands.
- Over-dependency – if worker(s) responsible for a task is absent, the entire production process may halt since nobody else may be able to do the task.
Why Business?
So, we’ve gone through factors of production, the problem of scarcity and specialization, but what is business?
Business is any organization that uses all the factors of production (resources) to create goods and services to satisfy human wants and needs.
Added Value
Added value is the difference between the cost of materials bought in and the selling price of the product. Which is, the amount of value the business had added to the raw materials by turning it into finished products. Every business wants to add value to their products so they may charge a higher price for their products and gain more profits.
How to increase added value?
- Reducing the cost of production. Added value of a product is its price less the cost of production. Reducing cost of production will increase the added value.
- Raising prices. By increasing prices, they can raise added value, in the same way as described above.
But there will be problems to both of this. To lower cost of production, cheap labour, raw materials etc. may have to be employed, which will create poor quality products and only lowers the value of the product. People may not buy it. And when prices are raised, the high price may result in customer loss, as they will turn to cheaper products.
In a practical example, how would you add value to a jewellery store?
- Design an attractive package to put the jewellery items in.
- An attractive shop-window-display.
- Well-dressed and knowledgeable shop assistants.
All of this will help the jewellery store to raise prices above the additional costs involved.
1.2 – Classification of Businesses
Primary, Secondary and Tertiary Sector
Businesses can be classified into three sectors:
Primary sector: this involves the use/extraction of natural resources. Examples include agricultural activities, mining, fishing, wood-cutting, oil drilling etc.
Secondary sector: this involves the manufacture of goods using the resources from the primary sector. Examples include auto-mobile manufacturing, steel industries, cloth production etc.
Tertiary sector: this consist of all the services provided in an economy. This includes hotels, travel agencies, hair salons, banks etc.
Up until the mid-18th century, the primary sector was the largest sector in the world, as agriculture was the main profession. After the industrial revolution, more countries began to become more industrialized and urban, leading to a rapid increase in the manufacturing sector (industrialization).
Nowadays, as countries are becoming more developed, the importance of tertiary sector is increasing, while the primary sector is diminishing. The secondary sector is also slightly reducing in size (de-industrialization) compared to the growth of the tertiary sector. This is due to the growing incomes of consumers which raises their demand for more services like travel, hotels etc.
Private and Public Sector
Private sector: where private individuals own and run business ventures. Example: Nike is a private sector business.
Public sector: where the government owns and runs business ventures. Example: the Indian Railways is a public sector organization owned by the govt. of India.
In a mixed economy, both the public and private sector exists.
1.3 – Enterprise, Business Growth and Size
Enterprise and entrepreneurship
An entrepreneur is a person who organizes, operates and takes risks for a new business venture. The entrepreneur brings together the various factors of production to produce goods or services. Check below to see whether you have what it takes to be a successful entrepreneur!
- Risk taker
- Creative
- Optimistic
- Self-confident
- Innovative
- Independent
- Effective communicator
- Hard working
Business plan
A business plan is a document containing the business objectives and important details about the operations, finance and owners of the new business.
Making a business plan before starting the business can be very helpful. By documenting the various details about the business, the owners will find it much easier to run it. There is a lesser chance of losing sight of the mission and vision of the business as the objectives have been written down. Moreover, having the objectives of the business set down clearly will help motivate the employees. A new entrepreneur will find it easier to get a loan or overdraft from the bank if they have a business plan.
Comparing business sizes
Businesses come in many shapes and sizes. They can be owned by a single individual or have up to 50 shareholders. They can employ thousands of workers or have a mere handful. But how can we classify a business as big or small?
Business size can be measured in the following ways:
- Number of employees
- Value of output
- Value of sales
- Value of capital employed
- Profits
However, these methods have their limitations and are not always accurate. Example: When using the ‘number of employees’ method to compare business size. This method states that more workers employed means a bigger business. This is not accurate as a capital-intensive firm (one that employs a large amount of capital equipment) can produce large output by employing very little labour (workers).
Business growth
How can a business grow?
There are two ways in which a business can grow- internally and externally.
Internal growth
This occurs when a business expands its existing operations. For example, when a fast food chain opens a new branch in another country. This is a slow means of growth but easier to manage than external growth.
External growth
This is when a business takes over or merges with another business. It is sometimes called integration as one firm is ‘integrated’ into the other.
A merger is when the owner of two businesses agree to join their firms together to make one business.
A takeover occurs when one business buys out the owners of another business, which then becomes a part of the ‘predator’ business.
External growth can largely be classified into three types:
- Horizontal merger/integration: This is when one firm merges with or takes over another one in the same industry at the same stage of production. For example, when a firm that manufactures furniture merges with another firm that also manufacturers furniture.
Benefits:- Reduces number of competitors in the market, since two firms become one.
- Opportunities of economies of scale.
- Merging will allow the businesses to have a bigger share of the total market.
- Vertical merger/integration: This is when one firm merges with or takes over another firm in the same industry but at a different stage of production. Therefore, vertical integration can be of two types:
- Backward vertical integration: When one firm merges with or takes over another firm in the same industry but at a stage of production that is behind the ‘predator’ firm. For example, when a firm that manufactures furniture merges with a firm that supplies wood for manufacturing furniture.
Benefits:- Merger gives assured supply of essential components.
- The profit margin of the supplying firm is now absorbed by the expanded firm.
- The supplying firm can be prevented from supplying to competitors.
- Forward vertical integration: When one firm merges with or takes over another firm in the same industry but at a stage of production that is ahead of the ‘predator’ firm. For example, when a firm that manufactures furniture merges with a furniture retail store.
Benefits:- Merger gives assured outlet for their product.
- The profit margin of the retailer is now absorbed by the expanded firm.
- The retailer can be prevented from selling the goods of competitors.
- Conglomerate merger/integration: This is when one firm merges with or takes over a firm in a completely different industry. This is also known as ‘diversification’. For example, when a firm that manufactures furniture merges with a firm that produces clothing.
Benefits:- Conglomerate integration allows businesses to have activities in more than one country. This allows the firms to spread its risks.
- There could be a transfer of ideas between the two businesses even though they are in different industries. This transfer of ideas could help improve the quality and demand for the two products.
Why businesses stay small
Not all businesses grow. Some stay small, employ a handful of workers and have little output. Here are the reasons why.
- Type of industry: Some firms remain small due to the industry they operate in. Examples of these are hairdressers, car repairs, catering, etc., which give personal services and therefore cannot grow.
- Market size: If the firm operates in areas where the total number of customers is small, such as in rural areas, there is no need for the firm to grow and thus stays small.
- Owners’ objectives: Not all owners want to increase the size of their firms and profits. Some of them prefer keeping their businesses small and having a personal contact with all their employees and customers.
Why businesses fail
For lack of a better way to start this paragraph…. Not all businesses are successful. For new firms especially, the rate of failure is rather high. The main reasons why they fail are:
- Poor management: This is a common cause of business failure for new firms. The main reason is lack of experience which could lead to bad decision making. New entrepreneurs could make mistakes when choosing the location of the firm, the raw materials to be used for production, etc., all resulting in failure.
Over-expansion: This could lead to diseconomies of scale and greatly increase costs. this could happen if a firm expands too quickly or over their optimum level.
Failure to plan for change: The demands of customers keep changing with change in tastes and fashion. Due to this, firms must always be ready to change their products to meet the demand of their customers. Failure to do so could result in losing customers and loss.
Poor financial management: If the owner of the firm does not manage his finances properly, it could result in cash shortages. This will mean that the employees cannot be paid, and enough goods cannot be produced. Poor cash flow can therefore also cause businesses to fail.
1.4 – Types of Business Organizations
Sole Trader/Sole Proprietorship
A business organization owned and controlled by one person. Sole traders can employ other workers, but only he/she invests and owns the business.
Advantages:
- Easy to set up: there are very few legal formalities involved in starting and running a sole proprietorship. A less amount of capital is enough by sole traders to start the business. There is no need to publish annual financial accounts.
- Full control: the sole trader has full control over the business. Decision-making is quick and easy, since there are no other owners to discuss matters with.
- Sole trader receives all profit: Since there is only one owner, he/she will receive all the profits the company generates.
- Personal: since it is a small form of business, the owner can easily create and maintain contact with customers, which will increase customer loyalty to the business and let the owner know about consumer wants and preferences.
Disadvantages:
- Unlimited liability: if the business has bills/debts left unpaid, legal actions will be taken against the investors, where their even personal property can be seized, if their investments don’t meet the unpaid amount. This is because the business and the investors are the legally not separate (unincorporated).
- Full responsibility: Since there is only one owner, the sole owner must undertake all running activities. He/she doesn’t have anyone to share his responsibilities with. This workload and risks are fully concentrated on him/her.
- Lack of capital: As only one owner/investor is there, the amount of capital invested in the business will be very low. This can restrict growth and expansion of the business. Their only sources of finance will be personal savings or borrowing or bank loans (though banks will be reluctant to lend to sole traders since it is risky).
- Lack of continuity: If the owner dies or retires, the business dies with him/her.
Partnerships
A partnership is a legal agreement between two or more (usually, up to twenty) people to own, finance and run a business jointly and to share all profits.
Advantages:
- Easy to set up: Like sole traders, very few legal formalities are required to start a partnership business. A partnership agreement/ partnership deed is a legal document that all partners must sign, which forms the partnership. There is no need to publish annual financial accounts.
- Partners can provide new skills and ideas: The partners may have some skills and ideas that can be used by the business to improve business profits.
- More capital investments: Partners can invest more capital than what a sole trade only by himself could.
Disadvantages:
- Conflicts: arguments may occur between partners while making decisions. This will delay decision-making.
- Unlimited liability: like sole traders, partners too have unlimited liability- their personal items are at risk if business goes bankrupt
- Lack of capital: smaller capital investments as compared to large companies.
- No continuity: if an owner retires or dies, the business also dies with them.
Joint-stock companies
These companies can sell shares, unlike partnerships and sole traders, to raise capital. Other people can buy these shares (stocks) and become a shareholder (owner) of the company. Therefore, they are jointly owned by the people who have bought its stocks. These shareholders then receive dividends (part of the profit; a return on investment).
The shareholders in companies have limited liabilities. That is, only their individual investments are at risk if the business fails or leaves debts. If the company owes money, it can be sued and taken to court, but it’s shareholders cannot.
The companies have a separate legal identity from their owners, which is why the owners have a limited liability. These companies are incorporated.
Companies also enjoys continuity, unlike partnerships and sole traders. That is, the business will continue even if one of its owners retire or die.
Shareholders will elect a board of directors to manage and run the company in its day-to-day activities. In small companies, the shareholders with the highest percentage of shares invested are directors, but directors don’t have to be shareholders. The more shares a shareholder has, the more their voting power.
These are two types of companies:
Private Limited Companies: One or more owners who can sell its’ shares to only the people known by the existing shareholders (family and friends). Example: Reliance Industries Limited.
Public Limited Companies: Two or more owners who can sell its’ shares to any individual/organization in the general public through stock exchanges. Example: Verizon Communications
Advantages:
- Limited Liability: this is because, the company and the shareholders have separate legal identities.
- Raise huge amounts of capital: selling shares to other people (especially in Public Ltd. Co. s), raises a huge amount of capital, which is why companies are large.
- Public Ltd. Companies can advertise their shares, in the form of a prospectus, which tells interested individuals about the business, its activities, profits, board of directors, shares on sale, share prices etc. This will attract investors.
Disadvantages:
- Required to disclose financial information: Sometimes, private limited companies are required by law to publish their financial statements annually, while for public limited companies, it is legally compulsory to publish all accounts and reports. All the writing, printing and publishing of such details can prove to be very expensive, and other competing companies could use it to learn the company secrets.
- Private Limited Companies cannot sell shares to the public. Their shares can only be sold to people they know with the agreement of other shareholders. Transfer of shares is restricted here. This will raise lesser capital than Public Ltd. Companies.
- Public Ltd. Companies require a lot of legal documents and investigations before it can be listed on the stock exchange.
- Public and Private Limited Companies must also hold an Annual General Meeting (AGM), where all shareholders are informed about the performance of the company and company decisions, vote on strategic decisions and elect board of directors. This is very expensive to set up, especially if there are thousands of shareholders.
- Public Ltd. Companies may have managerial problems: since they are very large, they become very difficult to manage. Communication problems may occur which will slow down decision-making.
- In Public Ltd. Companies, there may be a divorce of ownership and control: The shareholders can lose control of the company when other large shareholders outvote them or when board of directors control company decisions.
A summary of everything learned until now, in this section, in case you’re getting confused:
1.5 – Business Objectives and Stakeholder Objectives
Business objectives:
Business objectives are the aims and targets that a business works towards to help it run successfully. Although the setting of these objectives does not always guarantee the business success, it has its benefits.
- Setting objectives increases motivation as employees and managers now have clear targets to work towards.
- Decision making will be easier and less time consuming as there are set targets to base decisions on. i.e., decisions will be taken in order to achieve business objectives.
Setting objectives reduces conflicts and helps unite the business towards reaching the same goal.
Managers can compare the business’ performance to its objectives and make any changes in its activities if required.
Objectives vary with different businesses due to size, sector and many other factors. however, many businesses in the private sector aim to achieve the following objectives.
- Survival: New or small firms usually have survival as a primary objective. Firms in a highly competitive market will also be more concerned with survival rather than any other objective. To achieve this, firms could decide to lower prices, which would mean forsaking other objectives such as profit maximization.
- Profit: This is the income of a business from its activities after deducting total costs. Private sector firms usually have profit making as a primary objective. This is because profits are required for further investment into the business as well as for the payment of return to the shareholders/owners of the business.
- Growth: Once a business has passed its survival stage it will aim for growth and expansion. This is usually measured by value of sales or output. Aiming for business growth can be very beneficial. A larger business can ensure greater job security and salaries for employees. The business can also benefit from higher market share and economies of scale.
- Market share: This can be defined as the proportion of total market sales achieved by one business. Increased market share can bring about many benefits to the business such as increased customer loyalty, setting up of brand image, etc.
- Service to the society: Some operations in the private sectors such as social enterprises do not aim for profits and prefer to set more economical objectives. They aim to better the society by providing social, environmental and financial aid.
A business’ objectives do not remain the same forever. As market situations change and as the business itself develops, its objectives will change to reflect its current market and economic position. For example, a firm facing serious economic recession could change its objective from profit maximization to short term survival.
Stakeholder groups:
A stakeholder is any person or group that is interested in or directly affected by the performance or activities of a business. These stakeholder groups can be external – groups that are outside the business or they can be internal – those groups that work for or own the business. Following are some of the stakeholder’s groups and their objectives:
Shareholder/ Owners:
These are the risk takers of the business. They invest capital into the business to set up and expand it. These shareholders are liable to a share of the profits made by the business.
Objectives:
- Shareholders are entitled to a rate of return on the capital they have invested into the business and will therefore have profit maximization as an objective.
- Business growth will also be an important objective as this will ensure that the value of the shares will increase.
Workers:
These are the people that are employed by the business and are directly involved in its activities.
Objectives:
- Contract of employment that states all the right and responsibilities to and of the employees.
Regular payment for the work done by the employees.
Workers will want to benefit from job satisfaction as well as motivation.
The employees will want job security– the ability to be able to work without the fear of being dismissed or made redundant.
Managers:
They are also employees, but managers control the work of others. Managers oversee making key business decisions.
Objectives:
- Like regular employees, managers too will aim towards a secure job.
- Higher salaries due to their jobs requiring more skill and effort.
- Managers will also wish for business growth as a bigger business means that managers can control a bigger and well-known business.
Customers:
Customers are a very important part of every business. They purchase and consume the goods and services that the business produces/ provides. Successful businesses use market research to find out customer preferences before producing their goods.
Objectives:
- Price that reflects the quality of the good.
- The products must be reliable and safe.i. e, there must not be any false advertisement of the products.
- The products must be well designed and of a perceived quality.
Government:
The role of the government is to protect the workers and customers from the business’ activities and safeguard their interests.
Objectives:
- The government will want the business to grow and survive as they will bring a lot of benefits to the economy. A successful business will help increase the total output of the country, will improve employment as well as increase government revenue through payment of taxes.
- They will expect the firms to stay within the rules and regulations set by the government.
Banks:
These banks provide financial help for the business’ operations’
Objectives:
- The banks will expect the business to be able to repay the amount that has been lent along with the interest on it. The bank will thus have business liquidity as its objective.
Community:
This consists of all the stakeholder groups, especially the third parties that are affected by the business’ activities.
Objectives:
- The business must offer jobs and employ local employees.
- The production process of the business must in no way harm the environment.
- Products must be socially responsible and must not pose any harmful effects from consumption.
Public- sector businesses:
Government owned and controlled businesses do not have the same objectives as those in the private sector.
Objectives:
- Financial: Although these businesses do not aim to maximize profits, they will have to meet the profit target set by the government. This is so that it can be reinvested into the business for meeting the needs of the society.
- Service: The main aim of this organization is to provide a service to the community that must meet the quality target set by the government.
- Social: Most of these social enterprises are set up in order to aid the community. This can be by providing employment to local citizens, providing good quality goods and services at an affordable rate, etc.
Conflicts of stakeholders’ objectives:
As all stakeholders have their own aims they would like to achieve, it is natural that conflicts of stakeholders’ interests could occur. Therefore, if a business tries to satisfy the objectives of one stakeholder, it might mean that other stakeholders’ objectives could go unfulfilled.
For example, workers will aim towards earning higher salaries. Shareholders might not want this to happen as paying higher salaries could mean that less profit will be left over for payment of return to the shareholders.
2.1 – Motivating Workers
People work to earn money and fulfil their necessities and wants. But there are several other reasons for work as well.
Motivation is the reason why employees want to work hard and work effectively for the business. Money is the main motivator, as explained above. Other factors that may motivate a person to choose to do a job may include social needs (need to communicate and work with others), esteem needs (to feel important, worthwhile), job satisfaction (to enjoy good work), security (knowing that your job and pay are secure- that you will not lose your job).
Why motivates workers? Why do firms go to the pain of making sure their workers are motivated? When workers are well-motivated, they become highly productive and effective in their work and thus increases the firm’s efficiency and output, leading to higher profits. For example, in the service sector, if the employee is unhappy at his work, he may act lazy and rude to customers, leading to low customer satisfaction, more complaints and ultimately a bad reputation and low profits.
Motivation Theories
- F. W. Taylor: Taylor based his ideas on the assumption that workers were motivated by personal gains, mainly money and that increasing pay would increase productivity (amount of output produced). Therefore, he proposed the piece-rate system, whereby workers get paid for the number of outputs they produce. So, in order, to gain more money, workers would produce more.
However, this theory is not entirely true. There are various other motivators in the modern workplace, some even more important than money. The piece rate system is not very practical in situations where output cannot be measured (service industries) and will lead to (high) output that doesn’t guarantee high quality. - Maslow: Abraham Maslow’s hierarchy of needs shows that employees are motivated by each level of the hierarchy going from bottom to top. Mangers can identify which level their workers are on and then take the necessary action to advance them onto the next level.
- One limitation of this theory is that it doesn’t apply to every worker. For some employees, for example, social needs aren’t important, but they would be motivated by recognition and appreciation for their work from seniors.
- Herzberg: Frederick Herzberg’s two-factor theory, wherein he states that people have two sets of needs- one basic animal needs called ‘hygiene factors’, the other needs that allow the human being to grow psychologically, called the ‘motivators’.
- According to Herzberg, the hygiene factors need to be satisfied, if not they will act as de-motivators to theworkers. However, hygiene factors don’t act as motivators as their effect quickly wear off. Motivators will truly motivate workers to work more effectively.
Motivating Factors
Financial Motivators
- Wages: often paid weekly. They can be calculated in two ways:
- Time-Rate: pay based on the number of hours worked. Although output may increase, it doesn’t mean that workers will work sincerely use the time to produce more- they may simply waste time on very few outputs since their pay is based only on how long they work. The productive and unproductive worker will get paid the same amount, irrespective of their output.
- Piece-Rate: pay based on the no. of output produced. Same as time-rate, this doesn’t ensure that quality output is produced. Thus, efficient workers may feel demotivated as they’re getting the same pay as inefficient workers, despite their efficiency.
- Salary: paid monthly or annually.
- Commission: paid to salesperson, based on a percentage of sales they’ve made. The higher the sales, the more the pay. Although this will encourage salespersons to sell more products and increase profits, it can be very stressful for them because no sales made means no pay at all.
- Bonus: additional amount paid to workers for good work
- Performance-related pay paid based on performance. An appraisal (assessing the effectiveness of an employee by senior management through interviews, observations, comments from colleagues etc.) is used to measure this performance and a pay is given based on this.
- Profit-sharing: a scheme whereby a proportion of the company’s profits is distributed to workers. Workers will be motivated to work better so that a higher profit is made.
- Share ownership: shares in the firm are given to employees so that they can become part owners of the company. This will increase employees’ loyalty to the company, as they feel a sense of belongingness.
Non-Financial Motivators
Fringe benefits are non-financial rewards given to employees
- Company vehicle/car
- Free healthcare
- Children’s education fees paid for
- Free accommodation
- Free holidays/trips
- Discounts on the firm’s products
Job Satisfaction: the enjoyment derived from the feeling that you’ve done a good job. Employees have different ideas about what motivates them- it could be pay, promotional opportunities, team involvement, relationship with superiors, level of responsibility, chances for training, the working hours, status of the job etc. Responsibility, recognition and satisfaction are in particular very important.
So, how can companies ensure that they’re workers are satisfied with the job, other than the motivators mentioned above?
- Job Rotation: involves workers swapping around jobs and doing each specific task for only a limited time and then changing round again. This increases the variety in the work itself and will also make it easier for managers to move around workers to do other jobs if somebody is ill or absent. The tasks themselves are not made more interesting, but the switching of tasks may avoid boredom among workers. This is very common in factories with a huge production line where workers will move from retrieving products from the machine to labelling the products to packing the products to putting the products into huge cartons.
- Job Enlargement: where extra tasks of similar level of work are added to a worker’s job description. These extra tasks will not add greater responsibility or work for the employee but make work more interesting. Eg: a worker hired to stock shelves will now, as a result of job enlargement, arrange stock on shelves, label stock, fetch stock etc.
- Job Enrichment: involves adding tasks that require more skill and responsibility to a job. This gives employees a sense of trust from senior management and motivate them to carry out the extra tasks effectively. Some additional training may also be given to the employee to do so. Eg: a receptionist employed to welcome customers will now, as a result of job enrichment, deal with telephone enquiries, word-process letters etc.
- Team-working: a group of workers is given responsibility for a process, product or development. They can decide as a team how to organize and carry out the tasks. The workers take part in decision making and take responsibility for the process. It gives them more control over their work and thus a sense of commitment, increasing job satisfaction. Working as a group will also add to morale, fulfill social needs and lead to job satisfaction.
2.2 – Organization and Management
Organizational Structure
refers to the levels of management and division of responsibilities within a business. They can be represented on organizational charts (left).
Advantages:
- All employees are aware of which communication channel is used to reach them with messages
- Everyone knows their position in the business. They know who they are accountable to and who they are accountable for
- It shows the links and relationship between the different departments
- Gives everyone a sense of belonging as they appear on the organizational chart
The span of control is the number of subordinates working directly under a manager in the organizational structure. In the above figure, the managing director’s span of control is four. The marketing director’s span of control is the number of marketing managers working under him (it is not specified how many, in the figure).
The chain of command is the structure of an organization that allows instructions to be passed on from senior managers to lower levels of management. In the above figure, there is a short chain of command since there are only four levels of management shown.
Now, if you look closely, there is a link between the span of control and chain of command. The wider the span of control the shorter the chain of command since more people will appear horizontally aligned on the chart than vertically. A short span of control often leads to long chain of command. (If you don’t understand, try visualizing it on an organizational chart).
Advantages of a short chain of command (these are also the disadvantages of a long chain of command):
- Communication is quicker and more accurate
- Top managers are less remote from lower employees, so employees will be more motivated and top managers can always stay in touch with the employees
- Spans of control will be wider, this means managers have more people to control This is beneficial because it will encourage them to delegate responsibility (give work to subordinates) and so the subordinates will be more motivated and feel trusted. However, there is the risk that managers may lose control over the tasks.
Line Managers have authority over people directly below them in the organizational structure. Traditional marketing/operations/sales managers are good examples.
Staff Managers are specialists who provide support, information and assistance to line managers. The IT department manager in most organizations act as staff managers.
Management
So, what role do manager really have in an organization? Here are their five primary roles:
- Planning: setting aims and targets for the organizations/department to achieve. It will give the department and its employees a clear sense of purpose and direction. Managers should also plan for resources required to achieve these targets – the number of people required, the finance needed etc.
- Organizing: managers should then organize the resources. This will include allocating responsibilities to employees, possibly delegating.
- Coordinating: managers should ensure that each department is coordinating with one another to achieve the organization’s aims. This will involve effective communication between departments and managers and decision making. For example, the sales department will need to tell the operations dept. how much they should produce in order to reach the target sales level. The operations dept. will in turn tell the finance dept. how much money they need for production of those goods. They need to come together regularly and make decisions that will help achieve each department’s aims as well as the organizations.
- Commanding: managers need to guide, lead and supervise their employees in the tasks they do and make sure they are keeping to their deadlines and achieving targets.
- Controlling: managers must try to assess and evaluate the performance of each of their employees. If some employees fail to achieve their target, the manager must see why it has occurred and what he can do to correct it- maybe some training will be required or better equipment.
Delegation is giving a subordinate the authority to perform some tasks.
Advantages to managers:
- managers cannot do all work by themselves
- managers can measure the efficiency and effectiveness of their subordinates’ work
However, managers may be reluctant to delegate as they may lose their control over the work.
Advantages to subordinates:
- the work becomes more interesting and rewarding- increased job satisfaction
- employees feel more important and feel trusted– increasing loyalty to firm
- can act as a method of training and opportunities for promotions, if they do a good job.
Leadership Styles
Leaderships styles refer to the different approaches used when dealing with people when in a position of authority. There are mainly three styles you need to learn: the autocratic, democratic and laissez-faire styles.
Autocratic style is where the managers expects to oversee the business and have their orders followed. They do all the decision-making, not involving employees at all. Communication is thus, mainly one way- from top to bottom. This is standard in police and armed forces organizations.
Democratic style is where managers involve employees in the decision-making and communication is two-way from top to bottom as well as bottom to top. Information about future is openly communicated and discussed with employees and a final decision is made by the manager.
Laissez-faire (French phrase for ‘leave to do’) style makes the broad objectives of the business known to employees and leaves them to do their own decision-making and organize tasks. Communication is rather difficult since a clear direction is not given. The manger has a very limited role to play.
Trade Unions
A trade union is a group of workers who have joined together to ensure their interest are protected. They negotiate with the employer (firm) for better conditions and treatment and can threaten to take industrial action if their requests are denied. Industrial action can include overtime ban (refusing to work overtime), go slow (working at the slowest speed as is required by the employment contract), strike (refusing to work at all and protesting instead) etc. Trade unions can also seek to put forward their views to the media and influence government decisions relating to employment.
Benefits to workers of joining a trade union:
- strength in number- a sense of belonging and unity
- improved conditions of employment, for example, better pay, holidays, hours of work etc.
- improved working conditions, for example, health and safety
- improved benefits for workers who are not working, because they’re sick, retired or made redundant (dismissed not because of any fault of their own)
- financial support if a member thinks he/she has been unfairly dismissed or treated
- benefits that have been negotiated for union member such as discounts on firm’s products, provision of health services.
Disadvantages to workers of joining a trade union:
- costs money to be member- a membership fee will be required
- may be asked to take industrial action even if they don’t agree with the union- they may not get paid during a strike, for example.
2.3 – Recruitment, Selection and Training of Workers
The Role of the H.R. (Human Resource) Department
- Recruitment and selection: attracting and selecting the best candidates for job posts
- Wages and salaries: set wages and salaries that attract and retain employees as well as motivate them
- Industrial relations: there must be effective communication between management and workforce to solve complaints and disputes as well as discussing ideas and suggestions
- Training programmes: give employees training to increase their productivity and efficiency
Health and safety: all laws on health and safety conditions in the workplace should be adhered to
Redundancy and dismissal: the managers should dismiss any unsatisfactory/misbehaving employees and make them redundant if they are no longer needed by the business.
Recruitment
Job Analysis, Description and Specification
Recruitment is the process from identifying that the business needs to employ someone up to the point where applications have arrived at the business.
A vacancy arises when an employee resigns from a job or is dismissed by the management. When a vacancy arises, a job analysis must be prepared. A job analysis identifies and records the tasks and responsibilities relating to the job. It will tell the managers what the job post is for.
Then a job description is prepared that outlines the responsibilities and duties to be carried out by someone employed to do the job. It will have information about the conditions of employment (salary, working hours, pension scheme), training offered, opportunities for promotion etc. This is given to all prospective candidates so they know what exactly they will be required and expected to do. Once this has been done, the H.R. department will draw up a job specification, a document that outlines the requirements, qualifications, expertise, skills, physical/personal characteristics etc. required by an employee to be able to take up the job.
Advertising the vacancy
Internal recruitment is when a vacancy is filled by an existing employee of the business.
Advantages:
- Saves time and money- no need for advertising and interviewing
- Person already known to business
- Person knows business’ ways of working
- Motivating for other employees to see their colleagues being promoted- urging them to work hard
Disadvantages:
- No new skills and experience coming into the business
- Jealousy among workers
External recruitment is when a vacancy is filled by someone who is not an existing employee and will be new to the business. External recruitment needs to be advertised, unlike internal recruitment. This can be done in local/national newspapers, specialist magazines and journals, job centers run by the government (where job vacancies are posted and given to interested people; usually for unskilled or semi-skilled jobs) or even recruitment agencies (who will recruit and send along candidates to the company when they request it).
When advertising a job, the business needs to decide what should be included in the advertisement, where it should be advertised, how much it will cost and whether it will be cost-effective.
When a person is interested in a job, they should apply for it by sending in a curriculum vitae (CV) or resume, this will detail the person’s qualifications, experience, qualities and skills. The business will use these to see which candidates match the job specification. It will also include statements of why the candidate wants the job and why he/she feels they would be suitable for the job.
Selection
Applicants who are shortlisted will be interviewed by the H.R. manager. They will also call up the referee provided by the applicant (a referee could be the previous employer or colleagues who can give a confidential opinion about the applicant’s reliability, honesty and suitability for the job). Interviews will allow the manager to assess:
- the applicant’s ability to do the job
- personal qualities of the applicant
- character and personality of applicant
In addition to interviews, firms can conduct certain tests to select the best candidate. This could include skills tests (ability to do the job), aptitude tests (candidate’s potential to gain additional skills), personality tests (what kind of a personality the candidate has- will it be suitable for the job?), group situation tests (how they manage and work in teams) etc.
When a successful candidate has been selected the others must be sent a letter of rejection.
The contract of employment: a legal agreement between the employer and the employee listing the rights and responsibilities of workers. It will include:
- the name of employer and employee
- job title
- date when employment will begin
- hours to work
- rate of pay and other benefits
- when payment is made
- holiday entitlement
- the amount of notice to be given to terminate the employment that the employer or employee must give to end the employment etc.
Employment contracts can be part-time or full-time. Part-time employment is often considered to be between 1 and 30-35 hours a week whereas full-time employment will usually work 35 hours or more a week.
Advantages to employer of part-time employment (disadvantages of full-time employment to employer):
- more flexible hours of work
easier to ask employees just to work at busy times
easier to extend business opening/operating hours by working evenings or at weekends
works lesser hours so employee is willing to accept lower pay
less expensive than employing and paying full-time workers.
Disadvantages to employer of part-time employment (advantages of full-time employment to employers)
- less likely to be trained because the workers see the job as temporary
- takes longer to recruit two part-time workers than one full-time worker
- can be less committed to the business/ more likely to leave and go get another job
- less likely to be promoted because they will not have gained the skills and experience as full-time employees
- more difficult to communicate with part-time workers when they are not in work- all work at different times.
Training
Training is important to a business as it will improve the worker’s skills and knowledge and help the business be more efficient and productive, especially when new processes and products are introduced. It will improve the workers’ chances at getting promoted and raise their morale.
The three types of training are:
Induction training: an introduction given to a new employee, explaining the firm’s activities, customs and procedures and introducing them to their fellow workers.
Advantages:
- Helps new employees to settle into their job quickly
- May be a legal requirement to give health and safety training before the start of work
- Less likely to make mistakes
Disadvantages:
- Time-consuming
- Wages still must be paid during training, even though they aren’t working
- Delays the state of the employee starting the job
On-the-job training: occurs by watching a more experienced worker doing the job
Advantages:
- It ensures there is some production from worker whilst they are training
- It usually costs less than off-the-job training
- It is training to the specific needs of the business
Disadvantages:
- The trainer will lose some production time as they are taking some time to teach the new employee
- The trainer may have bad habits that can be passed onto the trainee
- It may not necessarily be recognized training qualifications outside the business
Off-the-job training involves being trained away from the workplace, usually by specialist trainers
Advantages:
- A broad range of skills can be taught using these techniques
- Employees may be taught a variety of skills and they may become multi-skilled that can allow them to do various jobs in the company when the need arises.
Disadvantages:
- Costs are high
- It means wages are paid but no work is being done by the worker
- The additional qualifications mean it is easier for the employee to leave and find another job
Workforce Planning: the establishing of the workforce needed by the business for the foreseeable future in terms of the number and skills of employees required.
They may have to downsize (reduce the no. of employees) the workforce because of:
- Introduction of automation
- Falling demand for their products
- Factory/shop/office closure
- Relocating factory abroad
- A business has merged or been taken over and some jobs are no longer needed
They can downsize the workforce in two ways:
- Dismissal: where a worker is told to leave their job because their work or behavior is unsatisfactory.
- Redundancy: when an employee is no longer needed and so loses their work, though not due to any fault of theirs. They may be given some money as compensation for the redundancy.
Worker could also resign (they are leaving because they have found another job) and retire (they are getting old and want to stop working).
Legal Controls Over Employment Issues
There are lot so government laws that affect equal employment opportunities. These laws require businesses to treat their employees equally in the workplace and when being recruited and selected- there should be no discrimination based on age, gender, religion, race etc.
Employees are protected in many areas including
- against unfair discrimination
health and safety at work (protection from dangerous machinery, safety clothing and equipment, hygiene conditions, medical aid etc.)
against unfair dismissal
wage protection (through the contract of employment since it will have listed the pay and conditions). Many countries have a legal minimum wage– the minimum wage an employer must pay its employee. This avoids employers from exploiting its employees, and encourages more people to find work, but since costs are rising for the business, they may make many workers redundant- unemployment will rise.
An industrial tribunal is a legal meeting which considers workers’ complaints of unfair dismissal or discrimination at work. This will hear both sides of the case and may give the worker compensation if the dismissal was unfair.
2.4 – Internal and External Communication
Effective Communication
Communication is the transferring of a message from the sender to the receiver, who understands the message.
Internal communication is between two members of the same organizations. Example: communication between departments, notices and circulars to workers, signboards and labels inside factories and offices etc.
External communication is between the organization and other organizations or individuals. Example: orders of goods to suppliers, advertising of products, sending customers messages about delivery, offers etc.
Effective communication involves:
- A transmitter/sender of the message
- A medium of communication eg: letter, telephone conversation, text message
- A receiver of the message
- A feedback/response from the receiver to confirm that the message has been received and acknowledged.
One-way communication involves a message which does not require a feedback. Example: signs saying ‘no smoking’ or an instruction saying ‘deliver these goods to a customer’
Two-way communication is when the receiver gives a response to the message received. Example: a letter from one manager to another about an important matter that needs to be discussed. A two-way communication ensures that the person receiving the message understands it and has acted up on it. It also makes the receiver feel more a part of the process- could be a way of motivating employees.
Downward communication: messages from managers to subordinates i.e. from top to bottom of an organization structure.
Upward communication: messages/feedback from subordinates to managers i.e. from bottom to top of an organization structure
Horizontal communication occurs between people on the same level of an organization structure.
Communication Methods
Verbal methods (eg: telephone conversation, face-to-face conversation, video conferencing, meetings)
Advantages:
- Quick and efficient
- There is an opportunity for immediate feedback
- Speaker can reinforce the message- change his tone, body language etc. to influence the listeners.
Disadvantages:
- Can take long if there is feedback and therefore, discussions
- In a meeting, it cannot be guaranteed that everybody is listening or has understood the message
- No written record of the message can be kept for later reference.
Written methods (eg: letters, memos, text-messages, reports, e-mail, social media, faxes, notices, signboards)
Advantages:
- There is evidence of the message for later reference.
- Can include details
- Can be copied and sent to many people, especially with e-mail
- E-mail and fax are quick and cheap
Disadvantages:
- Direct feedback may not always be possible
- Cannot ensure that message has been received and/or acknowledged
- Language could be difficult to understand.
- Long messages may cause disinterest in receivers
- No opportunity for body language to be used to reinforce messages
Visual Methods (eg: diagrams, charts, videos, presentations, photographs, cartoons, posters)
Advantages:
- Can present information in an appealing and attractive way
- Can be used along with written material (eg: reports with diagrams and charts)
Disadvantages:
- No feedback
- May not be understood/ interpreted properly.
Factors that affect the choice of an appropriate communication method:
- Speed: if the receiver must get the information quickly, then a telephone call or text message must be sent. If speed isn’t important, a letter or e-mail will be more appropriate.
Cost: if the company wishes to keep costs down, it may choose to use letters or face-to-face meetings as a medium of communication. Otherwise, telephone, posters etc. will be used.
Message details: if the message is very detailed, then written and visual methods will be used.
Leadership style: a democratic style would use two-way communication methods such as verbal mediums. An autocratic one would use notices and announcements.
The receiver: if there is only receiver, then a personal face-to-face or telephone call will be more apt. If all the staff is to be sent a message, a notice or e-mail will be sent.
Importance of a written record: if the message is one that needs to have a written record like a legal document or receipts of new customer orders, then written methods will be used.
Importance of feedback: if feedback is important, like for a quick query, then a direct verbal or written method will have to be used.
Formal communication is when messages are sent through established channels using professional language. Eg: reports, emails, memos, official meetings.
Informal communication is when information is sent and received casually with the use of everyday language. Eg: staff briefings. Managers can sometimes use the ‘grapevine’ (informal communication among employees- usually where rumors and gossips spread!) to test out the reactions to new ideas (for example, a new shift system at a factory) before officially deciding whether to make it official.
Communication Barriers
Communication barriers are factors that stop effective communication of messages.
3.1 – Marketing, Competition and the Customer
What is a market?
A market consists of all buyers and sellers of a good.
What is Marketing?
Marketing is the management process responsible for identifying, anticipating and satisfying consumers’ requirements profitably.
The role of marketing in a business is as follows:
- Identifying customer needs: through market research
- Satisfying customer needs: by producing and selling goods and services
- Maintaining customer loyalty: building customer relationships – by a variety of methods that encourage customers to keep buying one firm’s products instead of their rivals’. For eg: loyalty card schemes, discounts for continuous purchases, after-sales services, message system that informs past customers of new offers.
Gain information about customers: by understanding why customers buy their products, they can develop and sell better products in the future.
Anticipate changes in customer needs: the business will need to keep looking for any changes in customer spending patterns and see if they can produce goods that customers want that are not currently available in the market.
Some objectives the marketing department in a firm may have:
- Raise awareness of their product
- Increase sales revenue and profits
- Increase or maintain market share (this is the proportion of sales a company has in the overall market sales. For example, if in a market $1 million worth of toys were sold in a year and company A’s total sales was $30,000 in that year, company A’s market share for the year is ($30,000/ $1000000) *100 = 30%)
- Enter new markets at home or abroad
- Develop new products or improve existing products.
Marketing Changes
Why customer spending patterns may change:
- change in their tastes and fashions
- change in technology: as new technology becomes available, the old versions of products become outdated and people want more sophisticated features on products.
- change in income: the higher the income, the more expensive goods consumers will buy; and vice versa.
- ageing population: in many countries, the proportion of older people is increasing and products that are required by them are increasing- such as anti-ageing creams, medical assistance etc.
The power and importance of changing customer needs:
Firms need to always know what their consumers want (and they will need to undertake lots of research and development to do so) in order to stay ahead of competitors ans stay profitable. If they don’t produce and sell what customers want, they will buy competitors’ products and the firm will fail to survive.
Why some markets have become more competitive:
- Globalization: products are being sold in markets all over the world, so there are more competitors in the market.
- Improvement in transportation infrastructures: better transport systems means that it is easier and cheaper to distribute and sell products everywhere.
- Internet/E-Commerce: customers can now buy products over the internet form anywhere in the world, making the market more competitive.
How business can respond to changing spending patterns and increased competition:
A business has to ensure that it is keeping up its market share and remain competitive in the market. It can ensure this by:
- maintaining good customer relationships: by ensuring that customers keep buying from their business only, they can increase market share. By doing so, they can also get information about their spending patterns and respond to their wants and needs to increase market share.
- keep improving its existing products, so that sales are maintained.
- introduce new products to keep customer’s interest, so that they don’t buy competitors’ products.
- keep costs low to maintain profitability: low costs mean the firms can afford to charge low prices. And low prices generally mean more demand and sales, and thus market share.
Niche & Mass Marketing
Niche Marketing: identifying and exploiting a small segment of a larger market by developing products to suit it. For example, Versace designs and Clique perfumes have niche markets- the rich, high-status consumer group.
Advantages:
- Small firms can thrive in niche markets where large forms have not yet established.
- If there are no or very few competitors, firms can sell products at a high price and gain high profit margins because customers will be willing be willing to pay more for exclusive products.
- Firms can focus on the needs of just one customer group, thereby giving them an advantage over large firms who only sell to the mass market and gain more sales.
Mass Marketing: selling the same product to the whole market with no attempt to target groups with in it. For example, the iPhone sold is the same everywhere, there are no variations in design over location or income.
Advantages:
- Larger amount of sales, as compared to niche market.
- Can benefit from economies of scale: a large volume of products is produced and so the average costs will be low, as compared to niche market.
- Risks are spread, unlike in niche market. If the product isn’t successful in one market, it’s fine as there are several other markets.
- More chances for the business to grow since there is a large market. In niche markets, this is difficult as the product is only targeted towards a particular group.
Market Segmentation
A market segment is an identifiable sub-group of a larger market in which consumers have similar characteristics and preferences
Market segmentation is the process of dividing a market of potential customers into groups, or segments, based on different characteristics. For example, PepsiCo identified the health-conscious market segment and targeted/marketed the Diet Coke towards them.
Markets can be segmented based on socio-economic groups (income), age, location, gender, lifestyle, use of the product (home/work, leisure/business.) etc.
Each segment will require different methods of promotion and distribution. For example, products aimed towards kids would be distributed through popular retail stores and products for businessmen would be advertised in exclusive business magazines.
Advantages:
- Makes marketing cost-effective, as it only targets a specific segment and meets their needs.
- The above leads to higher sales and profitability
- Increasing opportunities to increase sales
3.2 – Market Research
Product-oriented business: such firms produce the product first and then tries to find a market for it. Their concentration is on the product – its quality and price. The most common example are all basic necessities for living- foods and agricultural tools.
Market-oriented businesses: such firms will conduct market research to see what consumers want and then produce goods and services to satisfy them. They will set a marketing budget and undertake the different methods of researching consumer tastes and spending patterns, as well as market conditions. Example, mobile phone markets.
Market Research
Market research is the process of collecting, analyzing and interpreting information about a date.
Why is market research important/needed?
Firms need to conduct market research in order to ensure that they are producing goods and services that will sell successfully in the market and generate profits. If they don’t, they could lose a lot of money and fail to survive. Market research will answer a lot of the business’ questions prior to product development such as ‘will customers be willing to buy this product?’, ‘what is the biggest factor that influences customers’ buying preferences-price or quality?’, ‘what is the competition in the market like?’ and so on.
Market research data can be quantitative (numerical-what percentage of teenagers in the city have internet access) or qualitative (opinion/judgement- why do more women buy the company’s product than men?)
Market research methods can be categorized into two: primary and secondary market research.
Primary Market Research (Field Research)
The collection of original data. It involves directly collecting information from existing or potential customers. First-hand data is collected by people who want to use the data (i.e. the firm). Examples include questionnaires, focus groups, interviews, observation, online surveys and so on.
The process of primary research:
(Sample is a subset of a population that is used to represent the entire group as a whole. When doing research, it is often impractical to survey every member of a particular population because the number of people is simply too large). Selecting a sample is called sampling. A random sampling occurs when people are selected at random for research, while quota sampling is when people are selected on the basis of certain characteristics (age, gender, location etc.) for research.
Methods of primary research
- Questionnaires: Can be done face-to-face, through telephone, post or the internet. Online surveys can also be conducted whereby researchers will email the sample members to go onto a particular website and fill out a questionnaire posted there. These questions need to be unbiased, clear and easy to answer to ensure that reliable and accurate answers are logged in.
Advantages:
- Detailed information can be collected
- Customer’s opinions about the product can be obtained
- Online surveys will be cheaper and easier to collate and analyze
- Can be linked to prize draws and prize draw websites to encourage customers to fill out surveys.
- If questions are not clear or is misleading, then unreliable answers will be given.
- Time-consuming and expensive to carry out research, collate and analyze them.
- Interviews: interviewer will have ready-made questions for the interviewee.
Advantages:
- Interviewer is able to explain questions that the interviewee doesn’t understand and can also ask follow-up questions
- Can gather detailed responses, body-language also allowing interviewer to come to accurate conclusions about the customer’s opinions.
- The interviewer could lead and influence the interviewee to answer a certain way. For example, by phrasing a question such as ‘Would you buy this product’ to ‘But, you would definitely buy this product, right?’ to which the customer in order to appear polite would say yes when in actuality they wouldn’t buy the product.
- Time-consuming and expensive to interview everyone in the sample.
- Focus Groups: A group pf people representative of the target market (a focus group) agree to provide information about a particular product or general spending patterns over time. They can also test the company’s products and give opinions on them.
Advantage:
- They can provide detailed information about the consumer’s opinions
- Time-consuming
- Expensive
- Opinions could be influenced by others in the group.
- Observation: This can take the form of recording (eg: meters fitted to TV screens to see what channels are being watched), watching (eg: counting how many people enter a shop), auditing (eg: counting of stock in shops to see which products sold well).
Advantage:- Inexpensive
- Only gives basic figures. Does not tell the firm why consumer buys them.
Secondary Market Research (Desk Research)
The collection of information that has already been made available by others. Second-hand data about consumers and markets is collected from already published sources.
Internal sources of information:
- Sales department’s sales records, pricing data, customer records, sales reports
- Opinions of distributors and public relations officers
- Finance department
- Customer Services department
External sources if information:
- Government statistics: will have information about populations and age structures in the economy.
- Newspapers: articles about economic conditions and forecast spending patterns.
- Trade associations: if there is a trade association for a particular industry, it will have several reports on that industry’s markets.
- Market research agencies: these agencies carry out market research on behalf of the company and provide detailed reports.
- Internet: will have a wide range of articles about companies, government statistics, newspapers and blogs.
Accuracy of Market Research Data
The reliability and accuracy of market research depends upon a large number of factors:
- How carefully the sample was drawn up, the size, the types of people selected etc.
- How questions were phrased in questionnaires and surveys
- Who carried out the research: secondary research is likely to be less reliable since it was drawn up by others for different purpose at an earlier time?
- Bias: newspaper articles are often biased and may leave out crucial information deliberately.
- Age of information: researched data shouldn’t be too outdated. Customer tastes, fashions, economic conditions, technology all move fast, and the old data will be of no use now.
Presentation of data from Market Research
Different data handling methods can be used to present data from market research. This will include:
- Tally Tables: used to record data in its original form. The tally table below shows the number and type of vehicles passing by a shop at different times of the day:
- Charts: shows the total figures for each piece of data (bar/column charts) or the proportion of each piece of data in terms of the total number (pie charts). For example, the above tally table data can be recorded in a bar chart.
- Graphs: used to show the relationship between two sets of data. For example, how average temperature varied across the year.
3.3 – Marketing Mix
Marketing mix refers to the different elements involved in the marketing of a good or service- the 4 P’s- Product, Price, Promotion and Place.
Product
Product is the good or service being produced and sold in the market. This includes all the features of the product as well as its final packaging.
Types of products include consumer goods, consumer services, producer goods, producer services.
New Product Development: development of a new product by a business.
Advantages:
- Can create a Unique Selling Point (USP) by developing a new innovative product for the first time in the market. This USP can be used to charge a high price for the product as well as be used in advertising.
- Charge higher prices for new products (price skimming as explained later)
- Increase potential sales, revenue and profit
- Helps spreads risks because business: having more products mean that even if one fails, the other will keep generating a profit for the company
Disadvantages:
- Market research to identify customer needs- expensive and time consuming
- Investment can be very expensive
Why is brand image important?
Brand image is an identity given to a product that differentiates itself from competitors’ products. Brand loyalty when customers keep buying the same brand again and again instead of switching over to competitors’ product.
- Consumers recognize their product more easily when looking at similar products- helps differentiate one company’s product from another.
- Their product can be charged higher than less well-known brands – if there is an established high brand image, then it is easier to charge high prices because customers will buy it, nonetheless.
- Easier to launch new products into the market if the brand image is already established. Apple is one such company- their brand image is so reputed that new products that they launch now become an immediate success.
Why is packaging important?
- Protect the product
- Provide information about the product (it’s ingredients, price, expiry dates etc.)
- To help consumers recognize the product (the brand name and logo will help identify what product it is)
- To keep product fresh
Product Life Cycle (PLC)
The product life cycle refers to the stages a product goes through from its introduction to its retirement in terms of sales.
At these different stages, the product will need different marketing decisions/strategies in terms of the 4Ps.
Extension strategies: marketing techniques used to extend the maturity stage of a product (keep the product in the market):
- Finding new markets for the product
- Finding new uses for the product
- Redesigning the product or the packaging to improve its appeal to consumers
- Increased advertising and other promotional activities
The effect on the PLC of a product of a successful extension strategy:
Price
Price is the amount of money producers are willing to sell or consumer are willing to buy for the product.
Different methods of pricing:
- Market skimming: Setting a high price for a new product that is unique or very different from other products on the market.
Advantages:- Profit earned is very high
- Helps recover/compensate research and development costs
Disadvantages:
- It may backfire if competitors produce similar products at a lower price
- Penetration pricing: Setting a very low price to attract customers to buy a new product
Advantages:- Attracts customers more quickly
- Can increase market share quickly
Disadvantages:
- Low revenue due to lower prices
- Cannot recover development costs quickly
- Competitive pricing: Setting a price similar to that of competitor’s products which are already available in the market
Advantage:- Business can compete on other matters such as service and quality
Disadvantage:
- Still need to find ways of competing to attract sales.
- Cost plus pricing: Setting price by adding a fixed amount to the cost of making or buying the product
Advantages:- Quick and easy to work out the price
- Makes sure that the price covers all of the costs
Disadvantage:
- Price might be set higher than competitors or more than customers are willing to pay, which reduces sales and profits
- Loss leader pricing/Promotional pricing: Setting the price of a few products at below cost to attract customers into the shop in the hope that they will buy other products as well
Advantages:- Helps to sell off unwanted stock before it becomes out of date
- A good way of increasing short term sales and market share
Disadvantage:
- Revenue on each item is lower so profits may also be lower
Factors that affect what pricing method should be used:
- Is it a new or existing product?
If it’s new, then price skimming or penetration pricing will be most suitable. If it’s an existing product, competitive pricing or promotional pricing will be appropriate. - Is the product unique?
If yes, then price skimming will be beneficial, otherwise competitive or promotional pricing. - Is there a lot of competition in the market?
If yes, competitive pricing will need to be used. - Does the business have a well-known brand image?
If yes, price skimming will be highly successful. - What are the costs of producing and supplying the product?
If there are high costs, costs plus pricing will be needed to cover the costs. If costs are low, market penetration and promotional pricing will be appropriate. - What are the marketing objectives of the business?
If the business objective is to quickly gain a market share and customer base, then penetration pricing could be used. If the objective is to simply maintain sales, competitive pricing will be appropriate.
Price Elasticity
The PED of a product refers to the responsiveness of the quantity demanded for it to changes in its price.
PED (of a product) = % change in quantity demanded / % change in price
When the PED is >1, that is there is a higher % change in demand in response to a change in price, the PED is said to be elastic.
When the PED is <1, that is there is a lower % change in demand in response to a change in price, the PED is said to be inelastic.
Producers can calculate the PED of their product and take a suitable action to make the product more profitable.
If the product is found to have an elastic demand, the producer can lower prices to increase profitability. The law of demand states that a price fall increases the demand. And since, it is an elastic product (change in demand is higher than change in price), the demand of the product will increase highly. The producers get more profit.
If the product is found to have an inelastic demand, the producer can raise prices to increase profitability. Since quantity demanded wouldn’t fall much, as it is inelastic, the high prices will make way for higher revenue and thus higher profits.
Promotion
Promotion: marketing activities used to communicate with customers and potential customers to inform and persuade them to buy a business’s products.
Aims of promotion:
- Inform customers about a new product
- Persuade customers to buy the product
- Create a brand image
- Increase sales and market share
Types of promotion
- Advertising: Paid-for communication with consumers which uses printed and visual media like television, radio, newspapers, magazines, billboards, flyers, cinema etc. This can be informative (create product awareness) or persuasive (persuade consumers to buy the product). The process of advertising:
- Sales Promotion: using techniques such as ‘buy one get one free’, occasional price reductions, free after-sales services, gifts, competitions, point-of–sale displays (a special display stand for a product in a shop), free samples etc. to encourage sales.
- Below-the-line promotion: promotion that is not paid for communication but uses incentives to encourage consumers to buy. Incentives include money-off coupons or vouchers, loyalty reward schemes, competitions and games with cash or other prizes.
- Personal selling: sales staff communicate directly with consumer to achieve a sale and form a long-term relationship between the firm and consumer.
- Direct mail: also known as mailshots, printed materials like flyers, newsletters and brochures which are sent directly to the addresses of customers.
- Sponsorship: payment by a business to have its name or products associated with an event. For example, Emirates is Spanish football club Real Madrid’s jersey sponsor- Emirates pays the club to be its sponsor and gains a high customer awareness and brand image in return.
What affects promotional decisions?
- Stage of product on the PLC: different stages of the PLC will require different promotional strategies; see above.
- The nature of the product: If it’s a consumer good, it would use persuasive advertising and use billboards and TV commercials. Producer goods would have bulk-buy-discounts to encourage more sales. The kind of product it is can affect the type of advertising, the media of advertising and the method of sales promotion.
- The nature of the target market: a local market would only need small amounts of advertising while national markets will need TV and billboard advertising. If the product is sold to a mass market, extensive advertising would be needed. But niche market products such as water skis would only need advertising in special sports and lifestyle magazines.
Place
Place refers to how the product is distributed from the producer to the final consumer. There are different distribution channels that a product can be sold through.
| Distribution Channel | Explanation | Advantages | Disadvantages |
| Manufacturer to Consumer | The product is sold to the consumer straight from the manufacturer. A good example is a factory outlet where products directly arrive at their own shop from the factory and are sold to customers. |
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| Manufacturer to Retailer to Consumer | The manufacturer will sell its products to a retailer (who will have stocks of products from other manufacturers as well) who will then sell them to customers who visit the shop. For example, brands like Sony, Canon and Panasonic sell their products to various retailers. |
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| Manufacturer to Wholesaler to Retailer to Consumer | The manufacturer will sell large volumes of its products to a wholesaler (wholesalers will have stocks from different manufacturers). Retailer will buy small quantities of the product from the wholesaler and sell it to the consumers. One good example is the distribution of medicinal drugs. |
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| Manufacturer to Agent to Wholesaler to Retailer to Consumer | The manufacturer will sell their products to an agent who has specialized information about the market and will know the best wholesalers to sell them to. This is common when firms are exporting their products to a foreign country. They will need a knowledgeable agent to take care of the products’ distribution in another country |
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What affects place decisions?
- The type of product it is: If it’s sold to producers, distribution would either be direct (specialist machinery) or wholesaler (nuts, bolts, screws etc.).
- The technicality of the product: As lots of technical information needs to be passed to the customer, direct selling is usually preferred.
- How often the product is purchased: If the product is bought daily, it should be sold through retail stores that customers can easily access.
- The price of the product: if the products is an expensive, luxury good, it would only be sold through a few specialist, high-end outlets eg: luxury watches and jewelry.
- The durability of the product: if it’s an easily perishable product like fruits, it will need to be sold through a wide number of retailers to be sold quickly.
- Location of customers: the products should be easily accessible by its customers. If customers are located over the world, e-commerce (explained below) will be required.
- Where competitors sell their product: In order to directly compete with competitors, the products need to be sold where competitors are selling too.
Technology and the Marketing Mix
It is also worth noting that the internet/ E-commerce is now widely used to distribute products. E-Commerce is the use of the internet and other technologies used by businesses to market and sell goods and services to customers. Examples of e-commerce include online shopping, internet banking, online ticket-booking, online hotel reservations etc.
Websites like Amazon and e-Bay act as online retailers.
Online selling is favored by producers because it is cheaper in the long-run and they can sell products to a larger customer base/ market. However, there will be increased competition from lots of producers.
Consumers prefer online shopping because there are wider choices of detailed products that are also cheaper, and they can buy things at their own convenience 24×7. However, there is no personal communication with the producer and online security issues may occur.
The internet is also used for promotion and advertising of products in the form of paid YouTube ads and sponsors, pop-ups, email newsletters etc.
3.4 – Marketing Strategy
A marketing strategy is a plan to combine the right combination of the four elements of the marketing mix for a product to achieve its marketing objectives. Marketing objectives could include maintaining market shares, increasing sales in a niche market, increasing sale of an existing product by using extension strategies etc.
Factors that affect the marketing strategy:
Legal Controls on Marketing
There are various laws that can affect marketing decisions on quality, price and the contents of advertisements.
- laws that protect consumers from being sold faulty and dangerous goods
- laws that prevent the firms from using misleading information in advertising. Example: Volkswagen falsely advertised environmentally friendly diesel cars.
- laws that protect consumers from being exploited in industries where there is little or no competition, known as monopolising.
Entering New Markets
Growing in other countries can increase sales, revenue and profits. This is because the business is now available to a wider group of people, which increases potential customers. If the home markets have saturated (product is in maturity stage), firms take their products to international markets. Trade barriers and restrictions have also reduced significantly over the years, along with new transport infrastructures, so it is now cheaper and easier to export products to other countries.
Problems of entering foreign markets:
- Difference in language and culture: It may be difficult to communicate with people in other countries because of language barriers and as for the culture, different images, colors and symbols have different meanings and importance in different places. For example, McDonald’s had to make its menu more vegetarian in Indian markets.
Lack of market knowledge: The business won’t know much about the market it is entering and the customers won’t be familiar with the new business brand, and so establishing in the market will be difficult and expensive.
Economic differences: The cost and prices may be lower or higher in different countries so businesses may not be able to sell the product at the price which will give them a profit.
High transport costs
Social differences: Different people will have different needs and wants from people in other countries, and so the product may not be successful in all countries.
Difference in legal controls to protect consumers: The business may have to spend more money on producing the products in a way that complies with that country’s laws.
How to overcome such problems:
- Joint venture: an agreement between two or more businesses to work together on a project. The foreign business will work with a domestic business in the same industry. Eg: Japan’s Suzuki Motor Corporations created a joint venture with India’s Maruti Udyog Limited to form Maruti Suzuki, a highly successful car manufacturing project in India.
Advantages- Reduces risks and cuts costs
- Each business brings different expertise to the joint venture
- The market potential for all the businesses in the joint venture is increased
- Market and product knowledge can be shared to the benefit of the businesses
Disadvantages
- Any mistakes made will reflect on all parties in the joint venture, which may damage their reputations
- The decision-making process may be ineffective due to different business culture or different styles of leadership
- Franchise: the owner of a business (the franchisor) grants a license to another person or business (the franchisee) to use their business idea – often in a specific geographical area. Fast food companies such as McDonald’s and Subway operate around the globe through lots of franchises in different countries.
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4.1 – Production of Goods and Services
Production is the effective management of resources in producing goods and services.
The operations department in a firm overlooks the production process. They must:
- Use the resources in a cost-effective and efficient manner
- Manage inventory effectively
- Produce the required output to meet customer demands
- Meet the quality standards expected by customers
Productivity
Productivity is a measure of the efficiency of inputs used in the production process over a period. It is the output measured against the inputs used to produce it. The formula is:
Businesses often measure the labour productivity to see how efficient their employees are in producing output. The formula for it is:
Businesses look to increase productivity, as the output will increase per employee and so the average costs of production will fall.
Ways to increase productivity:
- improving labour skills by training them so they work more productively and waste lesser resources
- introducing automation (using machinery and IT equipment to control production) so that production is faster and error-free
- improve employee motivation so that they will be willing to produce more and efficiently so.
- improved quality control and assurance systems to ensure that there is no wastage of resources
Inventory Management
Firms can hold inventory (stock) of raw materials, goods that are not completed yet (a.k.a work-in-progress) and finished unsold goods. Finished good stocks are kept so that any unexpected rise in demand is fulfilled.
- When inventory gets to a certain point (reorder level), they will be reordered by the firm to bring the level of inventory back up to the maximum level again. The business must reorder inventory before they go too low since the reorder supply will take time to arrive at the firm
- The time it takes for the reorder supply to arrive is known as lead time.
- If too high inventory is held, the costs of holding and maintaining it will be very high.
- The buffer inventory level is the level of inventory the business should always hold at the very minimum to satisfy customer demand. During the lead time the inventory will have hit the buffer level and as reorder arrives, it will shoot back up to the maximum level.
Lean Production
Lean production refers to the various techniques a firm can adopt to reduce wastage and increase efficiency/productivity.
The seven types of wastage that can occur in a firm:
- Overproduction– producing goods before they have been ordered by customers. This results in too much output and so high inventory costs
- Waiting– when goods are not being moved or processed in any way, then waste is occurring
- Transportation– moving goods around unnecessarily is simply wasting time. They also risk damage during movement
- Unnecessary inventory– too much inventory takes up valuable space and incurs cost
- Motion– unnecessary moving about my employees and operation of machinery is a waste of time and cost respectively.
- Over– processing-using complex machinery and equipment to perform simple tasks may be unnecessary and is a waste of time, effort and money
- Defects– any fault in equipment can halt production and waste valuable time. Goods can also turn out to be faulty and need to be fixed- taking up more money and time
By avoiding such wastage, a firm can benefit in many ways
- less storage of raw materials, components and finished goods- less money and time tied up in inventory
- quicker production of goods and services
- no need to repair faulty goods- leads to good customer satisfaction
- ultimately, costs will lower, which helps reduce prices, making the business more competitive and earn higher profits as well
Now, how to implement lean production? The different methods are:
- Kaizen: it’s a Japanese term meaning ‘continuous improvement’. It aims to increase efficiency and reduce wastage by getting workers to get together in small groups and discuss problems and suggest solutions. Since they’re the ones directly involved in production, they will know best to identify issues. When kaizen is implemented, the factory floor, for example, is rearranged by re-positioning machinery and equipment so that production can flow smoothly through the factory in the least possible time.
Benefits:
- increased productivity
- reduced amount of space needed for production
- improved factory layout may allow some jobs to be combined, so freeing up employees to do other jobs in the factory
- Just-in-Time inventory control: this technique eliminates the need to hold any kind of inventory by ensuring that supplies arrive just in time they are needed for production. The making of any parts is done just in time to be used in the next stage of production and finished goods are made just in time they are needed for delivery to the customer/shop. The firm will need very reliable suppliers and an efficient system for reordering supplies.
Benefits:- Reduces cost of holding inventory
- Warehouse space is not needed any more, so more space is available for other uses
- Finished goods are immediately sold off, so cash flows in quickly
- Cell Production: the production line is divided into separate, self-contained units each making a part of the finished good. This works because it improves worker morale when they are put into teams and concentrate on one part alone.
Methods of Production
- Job Production: products are made specifically to order, customized for each customer. Eg: wedding cakes, made-to-measure suits, films etc.
Advantages:
- Most suitable for one-off products and personal services
- The product meets the exact requirement of the customer
- Workers will have more varied jobs as each order is different, improving morale
- very flexible method of production
- Skilled labour will often be required which is expensive
- Costs are higher for job production firms because they are usually labor-intensive
- Production often takes a long time
- Since they are made to order, any errors may be expensive to fix
- Materials may have to be specially purchased for different orders, which is expensive
- Batch Production: similar products are made in batches or blocks. A small quantity of one product is made, then a small quantity of another. Eg: cookies, building houses of the same design etc.
Advantages:
- Flexible way of working- production can be easily switched between products
- Gives some variety to workers
- More variety means more consumer choice
- Even if one product’s machinery breaks down, other products can still be made
- Can be expensive since finished and semi-finished goods will need moving about
- Machines must be reset between production batches which delays production
- Lots of raw materials will be needed for different product batches, which can be expensive.
- Flow Production: large quantities of products are produced in a continuous process on the production line. Eg: a soft drinks factory.
Advantages:- There is a high output of standardized (identical) products
- Costs are low in the long run and so prices can be kept low
- Can benefit from economies of scale in purchasing
- Automated production lines can run 24×7
- Goods are produced quickly and cheaply
- Capital-intensive production, so reduced labour costs and increases efficiency
- A very boring system for the workers, leads to low job satisfaction and motivation
- Lots of raw materials and finished goods need to be held in inventory- this is expensive
- Capital cost of setting up the flow line is very high
- If one machinery breaks down, entire production will be affected
Factors that affect which production method to use:
- The nature of the product: Whether it is a personal, customized-to-order product, in which case job production will be used. If it is a standard product, then flow production will be used
- The size of the market: For a large market, flow production will be required. Small local and niche markets may make use of batch and flow production. Goods that are highly demanded but not in very large quantities, batch production is most suitable.
- The nature of demand: If there is a fair and steady demand for the product, it would be more suitable to run a production line for the product. For less frequent demand, batch and job will be appropriate.
- The size of the business: Small firms with little capital access will not produce using large automated production lines but will use batch and job production.
Technology and Production
- Automation: equipment used in the factory is controlled by computers to carry out mechanical processes, such as spray painting a car body.
- Mechanization: production is done by machines but is operated by people
- CAD (computer aided designing): a computer software that draws items being designed more quickly and allows them to be rotated, zoomed in and viewed from all angles.
- CAM (computer aided manufacturing): computers monitor the production process and controls machines and robots-similar to automation
- CIM (computer integrated manufacturing): the integration of CAD and CAM. The computers that design the product using CAD is connected to the CAM software to directly produce the physical design.
- EPOS (electronic point-of-sale): used at checkouts/tills where operator scans the bar-code of each item bought by the customer individually. The item details and price appear on screen and are printed in the receipt. They can also automatically update and reorder stock as items are bought.
- EFTPOS (electronic funds transfer at point-of-sale): the electronic cash register at the till will be connected to the retailer’s main computer and different banks. When the customer swipes the debit card at the till, information is read by the scanner and an amount is withdrawn from the customer’s bank account (after the PIN is entered).
Advantages of technology in production
- Greater productivity
- Greater job satisfaction among workers as boring, routine jobs are done by machines
- Better quality products
- Quicker communication and less paperwork
- More accurate demand levels are forecast since computer monitor inventory levels
- New products can be introduced as new production methods are introduced
Disadvantages of technology in production
- Unemployment rises as machines and computers replace human labour
- Expensive to set up
- New technology quickly becomes outdated and frequent updation of systems will be needed- this is expensive and time-consuming.
- Employees may take time to adjust to new technology or even resist it as their work practices change.
4.2 – Costs, Scale of Production and Break-even Analysis
Costs
Fixed Costs are costs that do not vary with output produced or sold in the short run. They are incurred even when the output is 0 and will remain the same in the short run. In the long-run they may change. Also known as overhead costs.
Eg: rent, even if production has not started, the firm still must pay the rent.
Variable Costs are costs that directly vary with the output produced or sold. Eg: material costs and wage rates that are only paid according to the output produced.
TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS
TOTAL COST = AVERAGE COST * OUTPUT
AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT
A business can use these cost data to make different decisions. Some examples are: setting prices (if the average cost of one unit is $3, then the price would be set at $4 to make a profit of $1 on each unit), deciding whether to stop production (if the total cost exceeds the total revenue, a loss is being made, and so the production might be stopped), deciding on the best location (locations with the cheaper costs will be chosen) etc.
Scale of production
As output increases, a firms average cost decrease.
Economies of scale are the factors that lead to a reduction in average costs as a business increases in size. The five economies of scale are:
- Purchasing economies: For large output, a large number of components have to be bought. This will give them some bulk-buying discounts that reduce costs
- Marketing economies: Larger businesses will be able to afford its own vehicles to distribute goods and advertise on paper and TV. They can cut down on marketing labour costs. The advertising rates costs also do not rise as much as the size of the advertisement ordered by the business. Average costs will thus reduce.
- Financial economies: Bank managers will be more willing to lend money to large businesses as they are more likely to be able to pay off the loan than small businesses. Thus, they will be charged a low rate of interest on their borrowings, reducing average costs.
- Managerial economies: Large businesses may be able to afford to hire specialist managers who are very efficient and can reduce the business’ costs.
- Technical economies: Large businesses can afford to buy large machinery such as a flow production line that can produce a large output and reduce average costs.
Diseconomies of scale are the factors that lead to an increase the average costs of a business as it grows beyond a certain size. They are:
- Poor communication: as a business grows large, more departments and managers and employees will be added, and communication can get difficult. Messages may be inaccurate and slow to receive, leading to lower efficiency and higher average costs in the business.
- Low morale: when there are lots of workers in the business and they have non-contact with their senior managers, the workers may feel unimportant and not valued by management. This would lead to inefficiency and higher average costs.
- Slow decision-making: As a business grows larger, its chain of command will get longer. Communication will get very slow and so any decision-making will also take time, since all employees and departments may need to be consulted with.
Businesses are now dividing themselves into small units that can control themselves and communicate more effectively, to avoid any diseconomies from arising.
Break-even
Break-even level of output is the output that needs to be produced and sold in order to start making a profit. So, the break-even output is the output at which total revenue equals total costs (neither a profit nor loss is made, all costs are covered).
A break-even chart can be drawn, that shows the costs and revenues of a business across different levels of output and the output needed to break even.
Example:
In the chart below, costs and revenues are being calculated over the output of 2000 units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000 at output 2000- so you just draw a straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts and be parallel to the variable costs (since T.C.=F.C.+V.C. You can manually calculate the total cost at output 2000: ($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the breakeven point can be calculated at the point where total revenue and total cost equals– at an output of 1000. (In order to find the sales revenue at output 1000, just do $8*1000= $8000. The business needs to make $8000 in sales revenue to start making a profit).
Advantages of break-even charts:
- Managers can look at the graph to find out the profit or loss at each level of output
- Managers can change the costs and revenues and redraw the graph to see how that would affect profit and loss, for example, if the selling price is increased or variable cost is reduced.
- The break-even chart can also help calculate the safety margin- the amount by which sales exceed break-even point. In the above graph, if the business decided to sell 2000 units, their margin of safety would be 1000 units. In sales terms, the margin of safety would be 1000*8 = $8000. They are $8000 safe from making a loss. Margin of Safety (units) = Units being produced and sold – Break-even output
Limitations of break-even charts:
- They are constructed assuming that all units being produced are sold. In practice, there are always inventory of finished goods. Not everything produced is sold off.
- Fixed costs may not always be fixed if the scale of production changes. If more output is to be produced, an additional factory or machinery may be needed that increases fixed costs.
- Break-even charts assume that costs can always be drawn using straight lines. Costs may increase or decrease due to various reasons. If more output is produced, workers may be given an overtime wage that increases the variable cost per unit and cause the variable cost line to steep upwards.
Break-even can also be calculated without drawing a chart. A formula can be used:
Break-even level of production =Total fixed costs/ contribution per unit
Contribution = Selling price – variable cost per unit (this is the value added/contributed to the product when sold)
In the above example, the contribution is $8 -$3 =$5, so the break-even level is: $5000/$5 = 1000 units!
4.3 – Achieving Quality Production
Quality means to produce a good or service which meets customer expectations. The products should be free of faults or defects. Quality is important because it:
- establishes a brand image
- builds brand loyalty
- maintains good reputation
- increase sales
- attract new customers
If there is no quality, the firm will
- lose customers to other brands
- must replace faulty products and repeat poor service, increasing costs
- bad reputation leading to low sales and profits
There are three methods a business can implement to achieve quality: quality control, quality assurance and total quality management.
Quality Control
Quality control is the checking for quality at the end of the production process, whether a good or a service.
Advantages:
- Eliminates the fault or defect before the customer receives it, so better customer satisfaction
- Not much training required for conducting this quality check
Disadvantages:
- Still expensive to hire employees to check for quality
- Quality control may find faults and errors but doesn’t find out why the fault has occurred, so the it’s difficult to solve the problem
- if product must be replaced and reworked, then it is very expensive for the firm
Quality Assurance
Quality assurance is the checking for quality throughout the production process of a good or service.
Advantages:
- Eliminates the fault or defect before the customer receives it, so better customer satisfaction
- Since each stage of production is checked for quality, faults and errors can be easily identified and solved
- Products don’t have to be scrapped or reworked as often, so less expensive than quality control
Disadvantages:
- Expensive to carry out
- How well will employees follow quality standards?
Total Quality Management (TQM)
Total Quality Management or TQM is the continuous improvement of products and production processes by focusing on quality at each stage of production. There is great emphasis on ensuring that customers are satisfied. In TQM, customers just aren’t the consumers of the final product. It is every worker at each stage of production. Workers at one stage must ensure the quality standards are met for the product in production at their stage before they are passed onto the next stage and so on. Thus, quality is maintained throughout production and products are error-free.
TQM also involves quality circles and like Kaizen, workers come together and discuss issues and solutions, to reduce waste ensure zero defects.
Advantages:
- quality is built into every part of the production process and becomes central to the workers principles
- eliminates all faults before the product gets to the final customer
- no customer complaints and so improved brand image
- products don’t have to be scrapped or reworked, so lesser costs
- waste is removed and efficiency is improved
Disadvantages:
- Expensive to train employees all employees
- Relies on all employees following TQM– how well are they motivated to follow the procedures?
How can customers be assured of the quality of a product or service?
They can look for a quality mark on the product like ISO (International Organization for Standardization). The business with these quality marks would have followed certain quality procedures to keep the quality mark. For services, a good reputation and positive customer reviews are good indicators of the service’s quality
4.4 – Location Decisions
Owners need to decide a location for their firm to operate in, at the time of setting up, when it needs to expand operations, and when the current location proves unsatisfactory for some reason. Location is important because it can affect the firm’s costs, profits, efficiency and the market base it reaches out to.
Factors that affect location decisions
Factors that affect the location decisions of a manufacturing firm:
- Production Method: when job production is used, the business will operate on a small scale, so the nearness to components/raw materials won’t be that important. For flow production, on the other hand, production will be on a large scale- there will be a huge number of components and transport costs will be high- so components need to be close by.
- Market: if the product is a consumer good and perishable, the factories need to be close to the markets to sell out quickly before it perishes.
Raw Materials/Components: the factories may need to be located close to where raw materials can be acquired, especially if the raw material is to be processed while still fresh, like fruits for fruit juice.
External economies: the business may locate near other firms that support the business by provide services- eg: business that install and maintain factory equipment.
Availability of labour: Businesses will need to locate near areas where they can get workers of the skills they need in the factory. If lots of unskilled workers are needed in the factory’s firms locate in areas of high unemployment. Wage rates also vary by location and firms will want to set up in locations where wage rates are low.
Government Influence: the government sometimes gives incentives and grants to firms that set up in low- development, rural and high-unemployment areas. There may also be govt. rules and restrictions in setting up, eg: in some areas of great natural beauty. The business needs to consider these.
Transport & Communication infrastructure: the factories need to be located near areas where there are good road/rail/port/air transport systems. If goods are to be exported, it needs to be set up near ports.
Power and water supply: factories need water and power to operate and a reliable and steady supply of both should be ensured by setting up in areas where they are available.
Climate: not the most important factor but can influence certain sectors. Eg: the dry climate in Silicon Valley aids the manufacturing of silicon chips.
Owner’s personal preferences
Factors that affect the location decisions of a service-sector firm:
- Customers: service-sector businesses that have direct contact with customers need to locate in customer- accessible and convenient places. Eg; restaurants, hairdressers, post offices etc.
- Technology: today, with increasing use of IT to shop and make payments, customers do not need direct access to services and proximity to the market/customer is not a very important factor in location decisions. They locate away from customers in places where there are low rent and wage rates. Eg: banks
- Availability of labour: if large number of workers are required in the firm, then it will need to locate close to residential areas. If they want certain types of worker skills, they will need to locate in places where such skilled workers can be found. However, with work-from-home and technology, this is not that big of a factor nowadays.
- Climate: tourism services need to be in places of good climate.
- Nearness to other business: some services serve the needs of large companies, such as firm equipment servicing and so they need to be very close to such businesses. Businesses may also set up where close competitors are to watch them and snatch away their customers.
- Rent/taxes
- Owner’s personal preferences
Factors that affect the location decisions of a retailing firm:
- Shoppers: retailers need to be in areas where shoppers frequent, like malls, to attract as many customers as possible.
Nearby shops: being located to other shops that are visited regularly will also attract attention of customers into your shop. Being near competitors also helps keep an eye on competition and snatch away customers.
Customer parking availability: when parking is available nearby, more people will find it convenient to shop in that area.
Availability of suitable vacant premises: Obviously, there needs to be a vacant premise available to set up the business. Vacant premises can also help the business expand their premises in the future.
Rent/taxes: rents and taxes on the locations need to be affordable.
Access to delivery vehicles: if the retailer has home delivery services, then delivery vehicles will be required.
Security: high rates of crime and theft can happen in shops. Shopping complexes with security guards will thus be preferred by firms.
Why businesses locate in different countries?
- New markets overseas.
- Cheaper or new raw materials available in other countries.
- Cheaper and/or skilled workers are available overseas.
- Rent/ taxes are lower.
- Availability of government grants and other incentives
- Avoid trade barriers and tariffs: when exporting goods to other countries, there will be some tariffs, rules and regulations to get by. in order to avoid this, firms start operating in the country itself, since there is no exporting/importing involved now.
The role of legal controls on location decisions
Governments influence location decisions:
- to encourage businesses to set up and expand in areas of high unemployment and under-development. Grants and subsidies can be given to businesses that set up in such areas.
- to discourage firms from setting in areas of that are overcrowded or renowned for natural beauty. Planning restrictions can be put into place to do so.
5.1 – Business Finance: Needs and Sources
Finance is the money required in the business. Finance is needed to set up the business, expand it and increase working capital (the day-to-day running expenses).
Start-up capital is the initial capital used in the business to buy fixed and current assets before it can start trading.
Working Capital finance needed by a business to pay its day-to-day running expenses
Capital expenditure is the money spent on fixed assets (assets that will last for more than a year). Eg: vehicles, machinery, buildings etc.
Revenue Expenditure, like working capital, is the money spent on day-to-day expenses which does not involve the purchase of long-term assets. Eg: wages, rent
Sources of Finance
Internal finance is obtained from within the business itself.
- Retained Profit: profit kept in the business after owners have been given their share of the profit. Firms can invest this profit back in the businesses.
Advantages:- Does not have to be repaid, unlike, a loan.
- No interest has to be paid
Disadvantages:
- A new business will not have retained profit
- Profits may be too low to finance
- Keeping more profits to be used as capital will reduce owner’s share of profit and they may resist the decision.
- Sale of existing assets: assets that the business doesn’t need anymore, for example, unused buildings or spare equipment can be sold to raise finance
Advantages:- Makes better use of capital tied up in the business
- Does not become debt for the business, unlike a loan.
Disadvantages:
- Surplus assets will not be available with new businesses
- Takes time to sell the asset and the expected amount may not be gained for the asset
- Sale of inventories: sell of finished goods or unwanted components in inventory.
Advantage:- Reduces costs of inventory holding
Disadvantage:
- If not enough inventory is kept, unexpected increase demand form customers cannot be fulfilled
- Owner’s savings: For a sole trader and partnership, since they’re unincorporated (owners and business are not separate), any finance the owner directly invests from his own saving will be internal finance.
Advantages:- Will be available to the firm quickly
- No interest has to be paid.
Disadvantages:
- Increases the risk taken by the owners.
External finance is obtained from sources outside of the business.
- Issue of share: only for limited companies.
Advantages:- A permanent source of capital, no need to repay the money to shareholders
- no interest must be paid
Disadvantages:
- Dividends have to be paid to the shareholders
- If many shares are bought, the ownership of the business will change hands. (The ownership is decided by who has the highest percentage of shares in the company).
- Bank loans: money borrowed from banks
Advantages:- Quick to arrange a loan
- – Can be for varying lengths of time
Large companies can get very low rates of interest on their loans
Disadvantages:
- Need to pay interest on the loan periodically
- It has to be repaid after a specified length of time
- Need to give the bank a collateral security (the bank will ask for some valued asset, usually some part of the business, as a security they can use if at all the business cannot repay the loan in the future. For a sole trader, his house might be collateral. So, there is a risk of losing highly valuable assets)
- Debenture issues: debentures are long-term loan certificates issued by companies. Like shares, debentures will be issued, people will buy them, and the business can raise money. But this finance acts as a loan- it will have to be repaid after a specified period of time and interest will have to be paid for it as well.
Advantages:- Can be used to raise very long-term finance, for example, 25 years
Disadvantage:
- Interest has to be paid and it has to be repaid
- Debt factoring: a debtor is a person who owns the business money for the goods they have bought from the business. Debt factors are specialist agents that can collect all the business’ debts from debtors.
Advantages:- Immediate cash is available to the business
- Business doesn’t have to handle the debt collecting
Disadvantage:
- The debt factor will get a percent of the debts collected as reward. Thus, the business doesn’t get all their debts
- Grants and subsidies: government agencies and other external sources can give the business a grant or subsidy
Advantage:- Do not have to be repaid, is free
Disadvantage:
- There are usually certain conditions to fulfill to get a grant. Example, to locate in an under-developed area.
- Micro-finance: special institutes are set up in poorly-developed countries where financially-lacking people looking to start or expand small businesses can get small sums of money. They provide all sorts of financial services.
Short-term finance provides the working capital a business needs for its day-to-day operations.
- Overdrafts: like loans, the bank can arrange overdrafts by allowing businesses to spend more than what is in their bank account. The overdraft will vary with each month, based on how much extra money the business needs.
Advantages:- Flexible form of borrowing since overdrawn amounts can be varied each month
- Interest has to be paid only on the amount overdrawn
- Overdrafts are generally cheaper than loans in the long-term
Disadvantages:
- Interest rates can vary periodically, unlike loans which have a fixed interest rate.
- The bank can ask for the overdraft to be repaid at a short-notice.
- Trade Credits: this is when a business delays paying suppliers for some time, improving their cash position
Advantage:- No interests, repayments involved
Disadvantage:
- If the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse to supply at all.
- Debt Factoring: (see above)
Long-term finance is the finance that is available for more than a year.
- Loans: from banks or private individuals.
- Debentures
- Issue of Shares
- Hire Purchase allows the business to buy a fixed asset and pay for it in monthly installments that include interest charges. This is not a method to raise capital but gives the business time to raise the capital.
Advantage:- The firms don’t need a large sum of cash to acquire the asset
Disadvantage:
- A cash deposit has to be paid in the beginning
- Can carry large interest charges.
- Leasing: this allows a business to use an asset without purchasing it. Monthly leasing payments are instead made to the owner of the asset. The business can decide to buy the asset at the end of the leasing period. Some firms sell their assets for cash and then lease them back from a leasing company. This is called sale and leaseback.
Advantages:- The firm doesn’t need a large sum of money to use the asset
- The care and maintenance of the asset is done by the leasing company
Disadvantage:
The total costs of leasing the asset could finally end up being more than the cost of purchasing the asset!
Factors that affect choice of source of finance
- Purpose: if a fixed asset is to be bought, hire purchase or leasing will be appropriate, but if finance is needed to pay off rents and wages, debt factoring, overdrafts will be used.
- Time-period: for long-term uses of finance, loans, debenture and share issues are used, but for a short period, overdrafts are more suitable.
- Amount needed: for large amounts, loans and share issues can be used. For smaller amounts, overdrafts, sale of assets, debt factoring will be used.
- Legal form and size: only a limited company can issue shares and debentures. Small firms have limited sourced of finances available to choose from
- Control: if limited companies issue too many shares, the current owners may lose control of the business. They need to decide whether they would risk losing control for business expansion.
- Risk- gearing: if business has existing loans, borrowing more capital can increase gearing- risk of the business- as high interests must be paid even when there is no profit, loans and debentures need to be repaid etc. Banks and shareholders will be reluctant to invest in risky businesses.
Finance from banks and shareholders
Chances of a bank willing to lend a business finance is higher when:
- A cash flow forecast is presented detailing why finance is needed and how it will be used
- An income statement from the last trading year and the forecast income statement for the next year, to see how much profit the business makes and will make.
- Details of existing loans and sources of finance being used
- Evidence that a security/collateral is available with the business to reduce the bank’s risk of lending
- A business plan is presented to explain clearly what the business hopes to achieve in the future and why finance is important to these plans
Chances of a shareholder willing to invest in a business is higher when:
- the company’s share prices are increasing- this is a good indicator of improving performance
- dividends and profits are high
- the company has a good reputations and future growth plans
5.2 – Cash Flow Forecasting and Working Capital
Cash Flow
Why is cash important?
If it doesn’t have any cash to pay its workers, suppliers, landlord and government, the business could go into liquidation– selling up everything it owns to pay its debts. The business needs to have an adequate amount of cash to be able to pay all its short-term payments.
The cash flow of a businesses is its cash inflows and cash outflows over a period.
Cash inflows are the sums of money received by the business over a period. Eg:
- sales revenue from sale of products
- payment from debtors– debtors are customers who have already purchased goods from the business but didn’t pay for them at that time
- money borrowed from external sources, like loans
- the money from the sale of business assets
- investors putting more money into the business
Cash outflows are the sums of money paid out by the business over a period. Eg:
- purchasing goods and materials for cash
- paying wages, salaries and other expenses in cash
- purchasing fixed assets
- repaying loans (cash is going out of the business)
- by paying creditors of the business- creditors are suppliers who supplied items to the business but were not paid at the time of supply.
The cash flow cycle:
Cash flow is not the same as profit! Profit is the surplus amount after total costs have been deducted from sales. It includes all income and payments incurred in the year, whether already received or paid or to not yet received or paid respectfully. In a cash flow, only those elements paid by cash are considered.
Cash Flow Forecasts
A cash flow forecast is an estimate of future cash inflows and outflows of a business, usually on a month-by-month basis. This then shows the expected cash balance at the end of each month. It can help tell the manager:
- how much cash is available for paying bills, purchasing fixed assets or repaying loans?
- how much cash the bank will need to lend to the business to avoid insolvency (running out of liquid cash)
- whether the business has too much cash that can be put to a profitable use in the business
Example of a cash flow forecast for the four months:
The cash inflows are listed first and then the cash outflows. The total inflows and outflows must be calculated after each section.
The opening cash balance is the amount of cash held by the business at the start of the month
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
The net cash flow is added to opening cash balance to find the closing cash balance– the amount of cash held by the business at the end of the month
Uses of cash flow forecasts:
- when setting up the business the manager needs to know how much cash is required to set up the business. The cash flow forecast helps calculate the cash outflows such as rent, purchase of assets, advertising etc.
- A statement of cash flow forecast is required by bank managers when the business applies for a loan. The bank manager will need to know how much to lend to the business for its operations, when the loan is needed, for how long it is needed and when it can be repaid.
- Managing cash flow– if the cash flow forecast gives a negative cash flow for a month(s), then the business will need to plan and apply for an overdraft so that the negative balance is avoided (as cash come in and the inflow exceeds the outflow). If there is too much cash, the business may decide to repay loans (so that interest payment in the future will be low) or pay off creditors/suppliers (to maintain healthy relationship with suppliers).
How can cash flow problems be overcome?
When a negative cash flow is forecast (lack of cash) the following methods can be used to correct it:
In the long-term, to improve cash flow, the business will need to attract more investors, cut costs by increasing efficiency, develop more products to attract customers and increase inflows.
Working Capital
Working capital, the capital required by the business to pay its short-term day-to-day expenses. Working capital is all the liquid assets of the business– the assets that can be quickly converted to cash to pay off the business’ debts. Working capital can be in the form of:
- cash needed to pay expenses
- cash due from debtors – debtors/credit customers can be asked to quickly pay off what they owe to the business for the business to raise cash
- cash in the form of inventory – Inventory of finished goods can be quickly sold off to build cash inflows. Too much inventory results in high costs, too low inventory may cause production to stop.
5.3 – Income Statements
Accounts are the financial records of a firm’s transactions.
Final Accounts are prepared at the end of the financial year and give details of the profit or loss made as well as the worth of the business.
Profit
Profit = Sales Revenue – Total cost
When the total costs exceed the sales revenue, then a loss is made.
How to increase profit?
- Increase sales revenue
- Cut costs
Why is profit important to a business?
For social enterprises, profit is not one of their primary objectives, but welfare of the society is. However, they will also strive to make some profit to reinvest it back into the business and help it grow.
Income Statement
An income statement is a financial document of the business that records all income generated by the business as well as the costs incurred by the business and thus the profit or loss made over the financial year. Also known as profit and loss account.
This is a summarized Income statement
Sales Revenue = total sales
Cost of Sales = total variable cost of production + (opening inventory of finished goods – closing inventory of finished goods)
Gross Profit = Sales Revenue – Cost of Sales
Expenses: all overheads/fixed costs
Net Profit = Gross Profit – Expenses
Profit after Tax = Net Profit – Tax
Dividends: share of profit given to shareholders; return on shares
Retained Profit for the year = Profit after Tax – Dividends. This retained earnings is then kept aside for use in the business.
Only a very small portion of the sales revenue ends up being the retained profit. All costs, taxes and dividends must be deducted from sales.
Uses of Income Statement
Income statements are used by managers to:
- know the profit/loss made by the business
- compare their performance with that of previous years’ and with that of competitors’. If profit is lower than that of last year’s, why is it falling and what can they do to correct the issue? If it is lower than that of competitors’ what can they do to be more profitable and be competitive in the market?
- know the profitability of individual products by preparing separate income statement for each product. They may decide to stop production of products that are making losses.
- help decide what products to launch by preparing forecast income statement for the first few years. Whichever product is forecast to have a higher profit, the business will choose to launch that product
5.4 – Balance Sheets
The balance sheet, along with the income statement is prepared at the end of the financial year. It shows the value of a business’ assets and liabilities at a time. It is also known as ‘statement of financial position’.
Assets are those items of value owned by the business.
Fixed/non-current assets (buildings, vehicles, equipment etc.) are assets that remain in the business for more than a year – their values fall over time in a process called depreciation every year.
Short-term/current assets (inventory, trade receivables (debts from customers), cash etc.) are owned only for a very short time.
There can also intangible (cannot be touched or felt) non-current assets like copyrights and patents that add value to the business.
Liabilities are the debts owed by the business to its creditors.
Long-term/non-current liabilities (loans, debentures etc.)- they do not have to be repaid within a year.
Short-term/current liabilities (trade payables (to suppliers), overdraft etc.)- these need to be repaid within a year.
CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL
This is because the liquid cash a company has with them will be the liquid (short-term) assets they own less the short- term debts they must pay.
Shareholder’s Equity is the total amount of money invested in the company by shareholders. This will include both the share capital (invested directly by shareholders) and reserves (retained earnings reserve, general reserve etc.). Shareholders can see if their stake in the business has risen or fallen by looking at the total equity figure on the balance sheet.
Check to see if the equations mentioned below are satisfied on this balance sheet
SHAREHOLDERS EQUITY = TOTAL ASSETS – TOTAL LIABILITIES
TOTAL ASSETS = TOTAL LIABILITIES + SHAREHOLDERS EQUITY
CAPITAL EMPLOYED = SHAREHOLDERS EQUITY + NON-CURRENT LIABILITIES
This is because non-current liabilities like loans are also used for permanent investment in the company.
5.5 – Analysis of Accounts
The data contained in the financial statements are used to make some useful observations about the performance and financial strength of the business. This is the analysis of accounts of a business. To do so, ratio analysis is employed.
Ratio Analysis
- Profitability Ratios: these ratios are used to see how profitable the business has been in the year ended.
- Return on Capital Employed (ROCE): this calculates the return (net profit) in terms of the capital invested in the business (shareholder’s equity + non-current liabilities) i.e. the % of net profit earned on each unit of capital employed. The higher the ROCE the better the profitability is. The formula is:
- Gross Profit Margin: this calculates the gross profit (sales – cost of production) in terms of the sales, or in other words, the % of gross profit made on each unit of sales revenue. The higher the GPM, the better. The formula is:
- Net profit Margin: this calculates the net profit (gross profit-expenses) in terms of the sales, i.e. the % of net profit generated on each unit of sales revenue. The higher the NPM, the better. The formula is:
- Liquidity Ratios: liquidity is the ability of the company to pay back its short-term debts. It if it doesn’t have the necessary working capital to do so, it will go illiquid (forced to pay off its debts by selling assets). In the previous topic, we said that,
working capital = current assets – current liabilities. So, a business needs current assets to be able to pay off its current liabilities. The two liquidity ratios shown below, use this concept.- Current Ratio: this is the basic liquidity ratio that calculates how many current assets are there in proportion to every current liability, so the higher the current ratio the better (a value above 1 is favorable). the formula is:
- Liquid Ratio/ Acid Test Ratio: this is very similar to current ratio, but this ratio doesn’t consider inventory to be a liquid asset, since it will take time for it to be sold and made into cash. A high level of inventory in a business can thus cause a big difference between its current and liquidity ratios. So, there is a slight difference in the formula:
Uses and users of accounts
- Managers: they will use the accounts to help them keep control over the performance of each product or each division since they can see which products are profitably performing and which are not.
- This will allow them to take better decisions. If for example, product A has a good gross profit margin of 35% but its net profit margin is only 5%, this means that the business has very high expenses that is causing the huge difference between the two ratios. They will try to reduce expenses in the coming year. In the case of liquidity, if both ratios are very low, they will try to pay off current liabilities to improve the ratios.
- Ratios can be compared with other firms in the industry/competitors and with previous years to see how they’re doing. Businesses will want to perform better than their rivals to attract shareholders to invest in their business and to stay competitive in the market. Businesses will also try to improve their profitability and liquidity positions each year.
Shareholders: since they are the owners of a limited company, it is a legal requirement that they be presented with the financial accounts of the company. From the income statements and the profitability ratios, especially the ROCE, existing shareholders and potential investors can see whether they should invest in the business by buying shares. A higher profitability, the higher the chance of getting dividends. They will also compare the ratios with other companies and with previous years to take the most profitable decision. The balance sheet will tell shareholders whether the business was worth more at the end of the year than at the beginning of the year, and the liquidity ratios will be used to ascertain how risky it will be to invest in the company- they won’t want to invest in businesses with serious liquidity problems.
Creditors: The balance sheet and liquidity ratios will tell creditors (suppliers) the cash position and debts of the business. They will only be ready to supply to the business if they will be able to pay them If there are liquidity problems, they won’t supply the business as it is risky for them.
Banks: Like how suppliers use accounts, they will look at how risky it is to lend to the business. They will only lend to profitable and liquid firms.
Government: the government and tax officials will look at the profits of the company to fix a tax rate and to see if the business is profitable and liquid enough to continue operations and thus if the worker’s jobs will be protected.
Workers and trade unions: they will want to see if the business’ future is secure or not. If the business is continuously running a loss and is in risk of insolvency (not being liquid), it may shut down operations and workers will lose their jobs!
Other businesses: managers of competing companies may want to compare their performance too or may want to take over the business and wants to see if the takeover will be beneficial.
Limitations of using accounts and ratio analysis
- Ratios are based on past accounting data and will not indicate how the business will perform in the future
- Managers will have all accounts, but the external users will only have those published accounts that contain only the data required by law- they may not get the ‘full-picture’ about the business’ performance.
- Comparing accounting data over the years can lead to misleading assumptions since the data will be affected by inflation (rising prices)
- Different companies may use different accounting methods and so will have different ratio results, making comparisons between companies unreliable.
6.1 – Government Economic Policies and Objectives
Economic Objectives
Here, we’ll look at the different economic objectives a government might have and how their absence/negligence will affect the economy as well as businesses.
- Maintain low inflation: inflation is the increase in average prices of goods and services over time. (Note that, inflation, in the real world, always exists. It is natural for prices to increase as the years go by. In the case there is a fall in the price level, it is called a deflation) Maintaining a low inflation will help the economy to develop and grow better.
Effects of high inflation:- As cost of living will have risen and peoples’ real incomes (the value of income) will have fallen (when prices increase and incomes haven’t, the income will buy lesser goods and services- the purchasing power will fall).
- Prices of domestic goods will rise as opposed to foreign goods in the market. The country’s exports will become less competitive in the international market. Domestic workers may lose their jobs if their products and firms don’t do well.
- When prices rise, demand will fall and all costs will rise (as wages, material costs, overheads will all rise)- causing profits to fall. Thus, they will be unwilling to expand and produce more in the future.
- The living standards (quality of life) in the country may fall when costs of living rise.
- Low unemployment: unemployment exists when people who are willing and able to work cannot find a job. A low unemployment means high output, incomes, living standards etc.
Effects of high unemployment:- Unemployed people do not produce anything and so, the total output/GDP in the country will fall. This will in turn, lead to a fall in economic growth.
- Unemployed people receive no incomes, thus income inequality can rise in the economy and living standards will fall. It also means that businesses will face low demand due to low incomes.
- The government pays out unemployment benefits to the unemployed and this will rise during high unemployment and government will not enough money left over to spend on other services like education and health.
- Economic growth: economic growth occurs when a country’s Gross Domestic Product (GDP) increase i.e. more goods and services are produced than in the previous year. This will increase the country’s incomes and achieve greater living standards.
Effects of reducing GDP (recession):- As output falls, fewer workers will be needed by firms, so unemployment will rise
- As goods and services that can be consumed by the people falls, the standard of living in the economy will also fall
- Balance of Payments: this records the difference between a country’s exports (goods and services sold from the country to another) and imports (goods and services bought in by the country from another country). The exports and imports need to equal each other, thus balanced.
Effect of a disequilibrium in the balance of payments:- If the imports of a country exceed its exports, it will cause depreciation in the exchange rate– the value of the country’s currency will fall against other foreign currencies
- If the exports exceed the imports, it indicates that the country is selling more goods than it is consuming- the country itself doesn’t benefit from any high output consumption.
- Income equality: the difference/gap between the incomes of rich and poor people should narrow down for income equality to improve. Improved income equality will ensure better living standards and help the economy to grow faster become more developed.
Effects of poor income equality:- Inequal distribution of goods and services- the poor cannot buy as many goods as the rich- poor living standards will arise.
The Business/ Trade Cycle
An economy will not always go through an economic growth; there is usually a cycle, as shown below.
Growth– when GDP is rising, unemployment is falling and there are higher living standards in the country. Businesses will look to expand and produce more and will earn high profits.
Boom– when GDP is at its highest and there is too much spending, causing inflation to rapidly rise. Business costs will rise, and firms will become worried about how they are going to stay profitable in the near future.
Recession– when GDP starts to fall due of high prices, as demand and spending falls. Firms will cut back production to stay profitable and unemployment may rise as a result.
Slump– when GDP is so low that prices start to fall (deflation) and unemployment will reach very high levels. Many businesses will close as they cannot survive the very low demand level. The economy will suffer.
(When the government takes measures to increase demand and spending in the economy to take it from a slump to growth, it is called as the ‘recovery’ period). The cycle repeats.
Government Economic Policies
Government can influence the economic conditions in a country by taking a variety of policies.
FISCAL POLICY
Using taxes and government spending to influence the demand conditions in the economy.
- GOVERNMENT SPENDING
Governments can change their spending on education, health, defense, law and order, transport and communications infrastructure etc. to influence demand. Higher spending on these services can boost demand in the economy as jobs and GDP increase. Reducing government spending will reduce demand. - TAXES
- Direct Taxes are paid directly from incomes. There are different types of direct taxes.
- Income tax: paid from an individual’s income. Disposable income is the income left after deducting income tax from it. When income tax rise, there is little disposable income to spend on goods and services, firms will face lower demand and sales and will cut production, increasing unemployment. Lower income taxes will encourage more spending and thus higher production.
- Corporation Tax: tax paid on a company’s profits. When the corporation tax rate is increased, businesses will have lower profits left over to put back into the business and will thus find it hard to expand and produce more. It will also cause shareholders/owners to receive lower dividends/returns for their investments. This will discourage people from investing in businesses and economic growth could slow down. Reducing corporation tax will encourage more production and investment.
- Indirect Taxes are added to the prices of goods and services and it is paid while purchasing the good or service. Some examples are:
- GST/VAT: these are included in the price of goods and services. Increasing these indirect taxes will increase the prices of goods and services and reduce demand and in turn profits. Reducing these taxes will increase demand.
- Import tariffs and quotas: an import tariff is a tax on imported goods and services; an import quota is the physical limit to the quantity of a product that can be imported into a country. Increasing tariffs will reduce demand for foreign products and imposing quotas will mean there are lesser foreign goods in the market to be sold and so demand is reduced.
MONETARY POLICY
Using interest rates (as well as money supply and the exchange rate) to influence the demand conditions in the economy.
The interest rate is the cost of borrowing money. When a person borrows money from a bank, he must pay an interest (monthly or annually) calculated on the amount he borrowed. Interest can also be earned by depositing money in the bank.
A higher interest rate will thus discourage borrowing (as more interest will have to be paid to the bank) and encourage saving (people will get more interest from saving) – thus, investing and spending will fall respectively- demand in the economy will fall. A lower interest rate will increase demand.
From a business’ point of view, a higher interest rate means more interest must be paid on existing loans, reducing profits; as well as suffer low demand levels. They may have to delay expansion plans that involve borrowing from the bank. A lower interest rate will be more favorable to a business.
SUPPLY-SIDE POLICIES
Both the fiscal and monetary policies directly affect demand, but the policies that influence supply are very different. It can include:
- Privatization: selling government organizations to private individuals- this will increase efficiency and productivity that increase supply as well encourage competitors to enter and further increase supply.
- Improve training and education: governments can spend more on schools, colleges and training centers so that people in the economy can become better skilled and knowledgeable, helping increasing productivity.
- Increased competition: by acting against monopolies (firms that restrict competitors to enter that industry/having full dominance in the market- refer xxx for more details) and reducing government rules and regulations (often termed ‘deregulation’), the competitive environment can be improved and thus become more productive.
*EXAM TIP: Remember that economic conditions and policies are all interconnected; one change will lead to an effect which will lead to another effect and so on, like a chain reaction in many ways. In your exams, you should take care to explain those effects that are relevant and appropriate to the business or economy in the question*
How might businesses react to policy changes? It will depend varying on how much impact the policy change will have on the business/industry/economy. Here are a few examples:
6.2 – Environmental and Ethical Issues
Business’ Impact on the Environment
Social responsibility is when a business decision benefits stakeholder other than shareholders i.e. workers, community, suppliers, banks etc.
This is very important when coming to environmental issues. Businesses can pollute the air by releasing smoke and poisonous gases, pollute water bodies around it by releasing waste and chemicals into them, damage the natural beauty of a place and so on.
| WHY BUSINESSES WANT TO BE ENVIRONMENT- FRIENDLY | WHY BUSINESSES DO NOT WANT TO BE ENVIRONMENT-FRIENDLY |
| Sense of social responsibility that comes from the fact that their activities are contributing to global warming and pollution | It is expensive to reduce and recycle waste for the business. It means that expensive machinery and skilled labour will be required by the business – reducing profits. |
| Using up scarce non-renewable resources (such as rainforest wood and coal) will raise their prices in the future, so businesses won’t use them now | Firms will have to increase prices to compensate for the expensive environment-friendly methods used in production- higher prices mean lower demand. |
| Consumers are becoming socially-aware and are willing to buy only environment friendly products. | High prices can make firms less competitive in the market and they could lose sales |
| Governments, environmental organizations, even the community could act against the business if they do serious damage to the environment | Businesses claim that it is the government’s duty to clean up pollution |
Externalities
A business’ decisions and actions can have significant effects on its stakeholders. These effects are termed ‘externalities. Externalities can be categorized into six groups given below and we’ll take examples from a scenario where a business builds a new production factory.
Private Costs: costs paid for by the business for an activity.
Examples: costs of building the factory , hiring extra employees, purchasing new machinery, running a production unit etc.
Private Benefits: gains for the business resulting from an activity.
Example: the extra money made from the sale of the produced goods etc.
External Costs: costs paid for by the rest of the society (other than the business) as a result of the business’ activity.
Examples: machinery noise, air pollution that leads to health problems among near residents, loss of land (it could have been a farm land before) etc.
External Benefits: gains enjoyed by the rest of the society as a result of a business activity.
Example: new jobs created for residents, government will get more tax from the business, other firms may move into the area to support the firm-helping develop the region, new roads might be built that can be enjoyed by residents etc.
Social Costs = Private Costs + External Costs
Social Benefits = Private Benefits + External Benefits
Governments use the cost-benefit-analysis (CBA) to decide whether to proceed with a scheme or not and businesses have also adopted it. In CBA, the government weighs up all the social costs and benefits that will arise if the scheme is put into effect and give them all monetary values (this is not easy- what is the value of losing natural beauty?). They will only allow the scheme to proceed if the social benefits exceed the social costs, if the costs exceed the benefits, it is not allowed to proceed.
Sustainable Development
Sustainable development is development that does not put at risk the living standards of future generations. It means trying to achieve economic growth in a way that does not harm future generations. Few examples of a sustainable development are:
- using renewable energy- so that resources are conserved for the future
- recycle waste
- use fewer resources
- develop new environment-friendly products and processes- reduce health and climatic problems for future generations
Environmental Pressures
Pressure groups are organizations/groups of people who change business (and government) decisions. If a business is seen to behave in a socially irresponsible way, they can conduct consumer boycotts (encourage consumers to stop buying their products) and take other actions. They are often very powerful because they have public support and media coverage and are well-financed and equipped by the public. If a pressure group is powerful it can result in a bad reputation for the business that can affect it in future endeavors, so the business will give in to the pressure groups’ demands. Example: Greenpeace
The government can also pass laws that can restrict business decisions such as not permitting factories to locate in places of natural beauty.
There can also be penalties set in place that will penalize firms that excessively pollute. Pollution permits are licenses to pollute up to a certain limit. These are very expensive to acquire, so firms will try to avoid buying the pollution permit and will have to reduce pollution levels to do so. Firms that pollute less can sell their pollution permits to more polluting firms to earn money. Taxes can also be levied on polluting goods and services.
Ethical Decisions
Ethical decisions are based on a moral code. It means ‘doing the right thing’. Businesses could be faced with decisions regarding, for example, employment of children, taking or offering bribes, associate with people/organizations with a bad reputation etc. In these cases, even if they are legal, they need to take a decision that they feel is right.
Taking ethical/’right’ decisions can make the business’ products popular among customers, encourage the government to favor them in any future disputes/demands and avoid pressure group threats. However, these can end up being expensive as the business will lose out on using cheaper unethical opportunities.
6.3 – Business and the International Economy
Globalization
Globalization is a term used to describe the increases in worldwide trade and movement of people and capital between countries. The same goods and services are sold across the globe; workers are finding it easier to find work by going abroad for work; money is sent from and to countries everywhere.
Some reasons how globalization has occurred are:
- Increasing number of free trade agreements– these are agreements between countries that allows them to import and export goods and services with no tariffs or quotas.
- Improved and cheaper transport (water, land, air) and communications (internet) infrastructure
- Developing and emerging countries such as China and India are becoming rapidly industrialized and so can export large volumes of goods and services. This has caused an increase in the output and opportunities in international trade, allowing for globalization
Advantages of globalization
- Allows businesses to start selling in new foreign markets, increasing sales and profits
- Can open factories and production units in other countries, possibly at a cheaper rate (cheaper materials and labour can be available in other countries)
- Import products from other countries and sell it to customers in the domestic market- this could be more profitable and producing and selling the good themselves
Import materials and components for production from foreign countries at a cheaper rate.
Disadvantages of globalization
- Increasing imports into country from foreign competitors- now that foreign firms can compete in other countries, it puts up much competition for domestic firms. If these domestic firms cannot compete with the foreign goods’ cheap prices and high quality, they may be forced to close operations.
- Increasing investment by multinationals in home country- this could further add to competition in the domestic market (although small local firms can become suppliers to the large multinational firms)
- Employees may leave domestic firms if they don’t pay as well as the foreign multinationals in the country- businesses will have to increase pay and conditions to recruit and retain employees.
When looking at an economy’s point of view, globalization brings consumers more choice and lower prices and forces domestic firms to be more efficient (in order to remain competitive). However, competition from foreign producers can force domestic firms to close and jobs will be lost.
Protectionism
Protectionism refers to when governments protect domestic firms from foreign competition using trade barriers such as tariffs and quotas; i.e. the opposite of free trade.
Import quota is a restriction on the quantity of goods that can be imported into the country.
Tariffs are taxes on imports.
Imposing these two measures will reduce the number of foreign goods in the domestic market and make them expensive to buy, respectively. This will reduce the competitiveness of the foreign goods and make it easy for domestic firms to produce and sell their goods. However, it reduces free trade and globalization.
Free trade supporters say that it is better to allow consumers to buy imported goods and domestic firms should produce and export goods and services that they have a competitive advantage in. In this way, living standards across the globe will improve.
Multinationals
Multinational businesses are firms with operations (production/service) in more than one country. Also known as transnational businesses. Examples: Shell, McDonald’s, Nissan etc.
Why do firms become multinationals?
- To produce goods with lower costs– cheaper material and labour may be available in other countries
- To extract raw materials for production, available in a few other countries. For example: crude oil in the Middle East
- To produce goods nearer to the markets to avoid transport costs.
- To avoid trade barriers on imports. If they produce the goods in foreign countries, the firms will not have to pay import tariffs or be faced with a quota restriction
- To expand into different markets and spread their risks
- To remain competitive with rival firms which may also be expanding abroad
Advantages to a country of a multinational setting up in their country:
- More jobs created by multinationals
- Increases GDP of the country
- The technology that the multinational brings in can bring in new ideas and methods into the country
- As more goods are being produced in the country, the imports will be reduced, and some output can even be exported
- Multinationals will also pay taxes, thereby increasing the government’s tax revenue
- More product choice for consumers
Disadvantages to a country of a multinational setting up in their country:
- The jobs created are often for unskilled tasks. The more skilled jobs will be done by workers that come from the firm’s home country. The unskilled workers may also be exploited with very low wages and unhygienic working conditions.
- Since multinationals benefit from economies of scale, local firms may be forced out of business, unable to survive the competition
- Multinationals can use up the scarce, non-renewable resources in the country
- Repatriation of profit can occur. The profits earned by the multinational could be sent back to their home country and the government will not be able to levy tax on it.
- As multinationals are large, they can influence the government and economy. They could threaten the government that they will close and make workers unemployed if they are not given financial grants and so on.
Exchange Rates
The exchange rate is the price of one currency in terms of another currency.
For example, €1=$1.2. To buy one euro, you’ll need 1.2 dollars. The demand and supply of the currencies determine their exchange rate. In the above example, if the €’s demand was greater than the $’s, or if the supply of € reduced more than the $, then the €’s price in terms of $ will increase. It could now be €1= $1.5. Each € now buys more $.
A currency appreciates when its value rises. The example above is an appreciation of the Euro. A European exporting firm will find an appreciation disadvantageous as their American consumers will now have to pay more $ to buy a €1 good (exports become expensive). Their competitiveness has reduced. A European importing firm will find an appreciation of benefit. They can buy American products for lesser Euros (imports become cheaper).
A currency depreciates when its value falls. In the example above, the Dollar depreciated. An American exporting firm will find a depreciation advantageous as their European consumers will now have to pay less € to buy a $1 good (exports become cheaper). Their competitiveness has increased. An American importing firm will find a depreciation disadvantageous. They will have to buy European products for more dollars (imports become expensive).
In summary, an appreciation is good for importers, bad for exporters; a depreciation is good for exporters, bad for importers; given that the goods are price elastic (if the price didn’t matter much to consumers, sales and revenue would not be affected by price- so no worries for producers).
