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STRATEGY
GLOSSARY Industry: a group of businesses involved in a set of similar activities. Competitors: other producers supplying similar goods or services. Demutualise: to convert from a mutual organisation into a public limited company (plc). Windfall: the payout received by members when an organisation demutualises. This can take the form of a cash sum, shares in the newly created plc, or a mixture of both. Secured loan: if a borrower does not repay as agreed the lender can take the security (in the case of a mortgage loan, the house) and sell it in order to repay the loan. Mortgage: a long-term loan secured against a property. Interest: the cost of borrowing money or the reward for lending money, depending on whether one is the borrower or the lender. Asset: something that is of worth to an organisation e.g. people, cash, financial claims on others, machinery, buildings. Public limited companies: companies with shares quoted (priced, bought and sold) on a stock exchange. Shareholders: persons owning or holding a share or shares of stock. Mutual organisations: Organisations with no shareowners traditionally established by groups of people to provide a range of services that serve the interests of their members. Sole trader: a business organisation which has a single owner.
Types of organisation
There are several different types of organisation: The simplest way to start up a business is to be a sole trader. One person provides the funds, takes the decisions and keeps any profit. The owner is also the boss and controls the business. The main disadvantage is that the owner is also totally responsible for any debts and has unlimited liability for these debts.
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B U I L D I N G S O C I E T I E S A S S O C I AT I O N
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GLOSSARY Partnership: a business organisation usually owned by between 2 and 20 people. Risks: a financial term that describes variability associated with investment returns. Limited liability: responsibility to meet a debt of an organisation is limited to the investors original investment. Private limited company: where shares are only available privately. Capital: money, buildings, machinery, equipment and tools used in the course of production. Shares: equities or part ownership in a company. Dividends: a share of the companys profit paid to shareholders. Public Limited Company (plc): a business whose shares can be bought from share dealers and resold on the Stock Exchange. Stock Exchange: Marketplace in which stocks are bought and sold. Economies of scale: reductions in average costs that stem from operating on a large scale. Margin: the difference between the interest rate paid to savers and that charged to borrowers.
An alternative is to form a partnership. This involves between 2 and 20 people combining their finances and expertise. They run the business with joint powers and responsibility. They take decisions and share profits according to the legal terms of the partnership. The advantages are that the responsibilities are shared and more capital can be released to invest in the business. The owners can specialise in their area of expertise, improving the efficiency of the business. The disadvantages are that partners can disagree on important decisions and consulting all partners takes time. All partners have unlimited liability for debts and so selecting a partner needs to be done carefully. Many partnerships break up because the partners cannot agree. If a business expands, it needs more capital. The opportunities for profit grow but so do the risks of failure. The solution to these challenges may be to form a company. A company enjoys privileged status in law. It exists as a legal entity that can own property and be named in legal actions. It also enjoys the privilege of limited liability. This means that only the company's assets are at risk to settle debts, not the individuals employed by, or the investors in, the company. A private limited company (Ltd) involves a group of between 2 and 50 people supplying capital finance and sharing in the management of the organisation. This capital is divided into shares. These represent units of ownership units (for example 1 shares) that individuals in the company can hold. Shareholders elect directors to run the company according to their wishes. Shareholders hold voting power in the company's decision-making process depending on the number of shares they hold and receive profits in the same proportion in the form of dividends. Some enterprises outgrow this format and need access to much wider sources of share capital. This may mean becoming a public limited company (plc). This involves offering shares to the general public and to financial institutions. Shareholders enjoy voting rights on a 'one share, one vote' basis, so larger shareholders have more power. The directors employ professional managers to run the business. The company may retain profits or distribute it as dividends for each share held. The selling of shares in a private company needs the directors' approval. The shares in a plc can be bought and sold on the Stock Exchange where their value will rise or fall according to the performance of the market. A mutual organisation is organised differently to this.
Large businesses like banks may enjoy economies of scale. By having more customers and so lower unit costs, they might appear to outperform building societies in attracting customers. However, this is not the case. So why do people choose a building society over a bank? Each building society invests its profit back into the society's business. Unlike banks, mutuals do not pay dividends (for example, Lloyds TSB pays out nearly 2 billion each year in dividends). This enables the building society to offer competitive rates of interest on both savings and mortgages. It sets the rates it pays savers just less than the rate charged to borrowers. This margin gives the society a profit.
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Customers choose to do business with a building society because many find them more personal, approachable and more trustworthy than banks. An independent survey during 2007 found significantly higher levels of saver and borrower satisfaction with customer service in building societies. Borrowers often rely on advice about mortgages or other financial services. Many banks have closed local branches or replaced personal, counter service with call centres. The personal service gives customers a sense of value for money. Customer satisfaction survey -% customers extremely or very satisfied Savers Mortgages Building societies 71% Building societies 72% All other providers 56% All other providers 62%
Source: GfK NOP Financial Research Survey, 2007
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GLOSSARY Stakeholders: individuals or groups with an interest in the decisions made by an organisation. Corporate social responsibility (CSR): the responsibility of an organisation to wider society, to a range of stakeholders including the community at large.
Media
Employees
o eh
rs lde
Competitors
Community
Suppliers
Shareholders
ers old
Government
eh
Members
s
A building society's primary stakeholders are its members. Members collectively own the business and are entitled to information on the business and to vote on important issues, such as who is on the board of directors, or whether to merge with another society. Members want the highest possible interest rates on their savings and the lowest possible interest rates on their mortgages. Building society rates are carefully set for each type of customer account. Their level depends on interest rates in the economy (set by the Bank of England) and the rates and terms offered by competitors. Because they are run for their members, building societies also have a focus on corporate social responsibility (CSR) that is integral to their business. Most societies have a strong regional identity and many are committed to assisting community initiatives and local charities.
rs Stakehold olde e r s keh Sta Sta k
Customers Creditors
Accountability Mutual status Owned by members No dividends to shareholders Better interest rates
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Raising finance
www.thetimes100.co.uk Every business needs finance: As a plc, a bank raises part of its long-term capital from selling shares. It rewards shareholders with dividends. Funds also come from savers who are not usually shareholders. As a mutual, a building societys owners and customers (members) are the same. Savers provide the society's long-term capital and its main source of funding for its mortgage services.
GLOSSARY Wholesale money markets: banks borrowing and lending money between themselves. Differentiate: to distinguish a business from its competitors.
supply funds
Savers/ Shareholders
repay interest/ dividends
Borrowers
repay funds plus interest
In both cases, people depositing money as savings expect to be able to withdraw their money at short notice. Lending money against the security of a property is long-term. In order to meet withdrawals from savings accounts, there must be enough cash readily available. Building societies keep about 20% of all money they raise in cash or in assets they can easily sell so that they can repay any savers who need to withdraw their savings. Banks and building societies both raise money from wholesale money markets. This is where banks borrow and lend money between themselves. Building societies, by law, may borrow only up to 50% of their total funding from money markets. The average amount societies fund themselves from the money markets is around 30%. Banks are not constrained in the same way. For example, in 2007 the Northern Rock bank had taken this ratio of borrowing to 75%. It faced collapse when the amount of credit available in the money markets dried up. Building societies keep the margin between saving and borrowing rates narrow. This allows them to compete for funds and continue to offer competitive rates to their members.
Conclusion
There are different types of organisations, from sole trader to plc. Each has different levels of liability, risk and benefits.
The Times Newspaper Limited and MBA Publishing Ltd 2007. Whilst every effort has been made to ensure accuracy of information, neither the publisher nor the client can be held responsible for errors of omission or commission.
Banks are typical plc organisations, which source funds from shares and pay dividends to shareholders. Building societies are mutual organisations. Their members are both owners and customers. They compete with banks for their share of the market in savings and mortgages by highlighting their advantages as mutuals. To continue serving their members, building societies need to differentiate themselves from the high street banks. There is a growing emphasis on the values of participation, personal service and locality in their brands. By not paying dividends to shareholders, they are able to provide more favourable interest rates and better terms for their members.
Questions
1. Name three types of organisation and describe one advantage for each type. 2. Explain the difference between a shareholder and a stakeholder. 3. How does a mutual organisation differ from a public limited company? 4. Evaluate the benefits a mutual organisation provides to its customers.
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