Industrial Management

Modern Industrial
Management
MATS ENGWALL ANNA JERBRANT BO KARLSON PER STORM

'
Modern Industrial Management
MATS ENGWALL
ANNA JERBRANT
BO KARLSON
PER STORM
Translation: Ida Stefansson
~ Studentlitteratur
Original title: Modern industriell ekonomi
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CONTENTS
Preface 9
About the authors 11
Part I Industrial Management
1 I NTRODUCTION 15
1.1 Industrial Management as an academic field 15
1.2 Industrial Management - yesterday, today, tomorrow . . . 18
1.3 The economic cycle of the company 23
1.4 The structure of the book 26
References 27
2 SWEDISH TRADE AND INDUSTRY 29

2.1 Swedish industry is dependent on technology and exports 29
2.2 The economic structure of Sweden 31

2.3 The companies in Sweden 33
2-4 The structure of the business sector 35
2.5 An industrial structure in transformation 45
Summary 47
References 47
3 BUSINESS OPERATIONS AS PO I NT OF DEPARTURE 49

3.1 The value proposition: goods and services 49
3.2 The value creation 55
3.3 Value capture 62
3.4 The business operations in the value chain 64
3.5 Efficiency, effectiveness, productivity, and profitability 69
Summary 71
References 72
© THE AU T HORS AND STUDENTLITTERATUR 3

CONTENTS
4 TECHNOLOGY-DRIVEN DEVELOPMENT 73
4.1 Sources of innovation and technological development 73

4.2 The S-curves of technological development 75
4.3 How innovations diffuse 77
4.4 From product innovation to process innovation 81
4.5 Technology shifts 84
4.6 Service innovations and new business models 86
4.7 The challenge: balancing short-term efficiency and long-term
innovation 87
Summary 89
References 90
Part II The value creation system
5 MARKETING 93
5.1 Marketing on different markets 93
5.2 Strategic marketing 96
5.3 Tactical marketing 101
5.4 Operational marketing and sales 107
5.5 Rules and regulations for doing business 111
Summary 114
References 115
6 PRODUCTION 117
6.1 Production under different conditions 117
6.2 Production strategy 120
6.3 Tactical production management 133
6-4 Operational production management 142
Summary 154
References 156
7 PRODUCT DEVELOPMENT 157
7.1 Product development in different types of businesses 157

7.2 The innovation strategy of the company 159
7.3 The tactical level of product development 167
7.4 Operational level: methods and techniques 175
Summary 183
References 184
4 © THE AUTHORS AND STUDENTLITTERATUR
CONTENTS
Part Ill The financial system
8 PRODUCT COSTING AND ANALYSIS 187

8.1 The basic concepts of accounting and costing 187
8.2 Contribution costing 194
8.3 Step costing 196
8.4 Full costing 198
8.5 Activity-based costing (ABC) 203
8.6 Operations determine the costing methods 207
8.7 Calculations - before and after 209
Summary 210
References 211
9 CAPITAL INVESTMENTS AND INVESTMENT ANALYSIS 213
9.1 What is a capital investment? 213

9.2 How are investments evaluated? 216
9.3 Investment calculations 217
9.4 How is the required rate of return calculated? 232
9.5 Capital investment analysis in practice 236
Summary 237
References 238
10 ACCOUNTING 239
10.1 What is bookkeeping? 239
10.2 T-accounts and double-entry bookkeeping 244
10.3 Systematic order of the accounts 250
10-4 Bookkeeping for VAT 253
10.5 Accurate bookkeeping is not easy in practice 254
Summary 254
References 255
11 FINANCIAL ACCOUNTING 257

11.1 Financial accounting 257
11.2 The annual financial statements - balance sheet and income
statement 259
11.3 Administration report, cash flow analysis, interim report, and the
auditor's report 268
0 THE AUTHORS AND STUDENTLITTERATUR 5

CONTENTS
11.4 Preparation of the financial statements 269

11.5 Taxed profit compared with accounting profit 279
11.6 What do the financial statements tell us? 280
11.7 Consolidated financial statements 286
Summary 288
References 289
12 CORPORATE FINANCE 291
12.1 Capital requirements 291

12.2 Capital structure 298
12.3 Financing the operations 301
12.4 Cash flow analysis 305
12.5 Financial risks 308
12.6 Two sides of financing 314
Summary 315
References 316
13 MANAGEMENT ACCOUNTING AND FINANCIAL CONTROL 317
13.1 Financial control 317

13.2 Distributing responsibilities and measuring performance 318
13.3 Management accounting 319
13.4 Balanced scorecard - a performance measurement tool 323
13.5 Budgeting 325
13 .6 The effects of financial control 330
Summary 331
References 332
Part IV Management and organizing
14 BUSINESS STRATEGY AND STRATEGY MODELS 335
14.1 There needs to be a business idea 335

14.2 The strategy realizes the business idea 337
14.3 Models for strategic analysis 345
14-4 After the development of the strategy: the implementation 355
Summary 359
References 360
6 0 THE AUTHORS AND STUDENTLITTERATUR
-
CONTENTS
15 LEADERSHIP AND HUMAN RESOURCE MANAGEMENT (HRM) 361

15.1 A company and its employees 361
15.2 The employee and the work 368
15.3 Working groups 376
15.4 Management and leadership 380
15.5 A company's HRM and its HR department 383
Summary 384
References 385
16 ORGANIZING THE BUSINESS OPERATIONS 387

16.1 The juridical form 387
16.2 The company as an organization 391
16.3 Organizing an organization 395
16.4 Organizational structure 397
16.5 Various organizational forms 399
16.6 To coordinate operations 404
Summary 410
References 411
17 PROJECT MANAGEMENT 413

17.1 What is a project? 413
17.2 The goal - the very core of the project assignment 414
17.3 The project process 418
17.4 Project organization 422
17.5 Project management methods 425
17.6 Projects - short-term and flexible 432
Summary 432
References 433
18 CSR AND SUSTAINABLE OPERATIONS 435

18.1 A company's social responsibility 435
18.2 The environmental issue and climate change 441
18.3 Ethical responsibility 444
18-4 Standards, systems, and guidelines 449
Summary 453
References 454
© THE AUTHORS AND STUDENTLITTERATUR 7

CO NTENTS
Appendix
Glossary: English-Swedish 457

Glossary: Swedish-English 463
Interest tables 469
Index 473
0 THE AUTHORS AND STUDENTLITTERATUR

8
PREFACE
This book is written by a group of teachers and researchers, present and former, at the
Department oflndustrial Economics and Management (Indek) at KTH Royal Institute
of Technology, Stockholm, Sweden. As we are engineers, we have written a book on
Industrial Management for engineers and engineering students. Therefore, the book
deals with a great many management, business, and financial concepts as well as the
tools and techniques engineers need to understand so that they can plan, develop, and
control industrial operations and businesses.
The book is a development and update of the book Industriell ekonomi that (partly)
the same group of authors published in 1998, and a development of the more limited
books Industriell ekonomi - metoder och verktyg and Industrial Management - tools
and techniques published thereafter. In the years since 1998, practices in the area of
Industrial Management have continued to develop. Similarly, our understanding of
the area has also increased. Today the subject is more relevant than ever.
The book is primarily aimed for use in basic courses in Industrial Management for
engineering students in Sweden and the other Nordic countries. Thus, without claiming
to provide the complete picture, the book presents the most fundamental concepts,
tools, and techniques in the Swedish tradition of Industrial Management. However,
despite local differences compared with other national traditions or juridical systems,
the basic models and principles are generally the same in various parts of the world.
The Swedish business terminology was translated into English using FARs engelska
ordbok (14th ed., FAR Akademi 2011), which is the official English dictionary of the
Swedish Institute of Authorized Public Accountants (FAR).
Writing a book such as this requires a great deal of support. We especially thank our
author-colleagues from the earlier book project: Magnus Aniander, Henrik Blomgren,
Fredrik Gessler, Jacob Gramenius, Fredrik Lagergren and Paul Westin. Without your
help, this new book would not have been possible. In the 1998 book, Professor Albert
Danielsson (Head of the Department for Industrial Economics and Management at
KTH Royal Institute of Technology from 1969 to 1996) was the main inflence on the
e THE AUTHORS AND STUDENTLITTERATUR 9

PREFACE
book that reflects his approach to management and business studies. We also send our
thanks to Eric Rehn and Carina Blohme, at our publisher, for their excellent assistance.
Their enormous patience made this book possible.
Stockholm, June 2018

Mats Engwall, Anna Jerbrant, Bo Karlson, Per Storm

ABOUT THE AUTHORS
Mats Engwall is a Professor of Industrial Management at KTH Royal Institute of

Technology in Stockholm. He holds a Master of Science in Aeronautical Engineering
and a PhD in Industrial Engineering and Management from KTH, and made his
habilitation (docent) in Business Administration at the Stockholm School ofEconomics.
His research interests include project-based management, innovation management,
and the development of new business models related to servitization and technology
shifts. He is a fellow of the Royal Swedish Academy ofEngineering Sciences, the Swed-
ish Project Academy, and the European Academy for Industrial Management. He is
chairman of the Scandinavian Academy of Industrial Engineering and Management.
Anna Jerbrant is an Associate Professor and Head of Division at the Department

of Industrial Economics and Management at KTH Royal Institute of Technology in
Stockholm. She has a PhD in Industrial Engineering and Management from KTH, and
her research focus is on the management and organizing of project-based organiza-
tions. Between 2010 and 2016 she was the Program Director ofKTH's Master of Science
in Engineering program (focused on Industrial Engineering and Management), and
since 2017 she is the Dean of Education at the School of Industrial Engineering and
Management at KTH. She has been the teacher responsible for the Organization course
at the Stockholm Business School's executive MBA. She is also a member of the Swed-
ish Project Academy, and part of the management team for the education Qualified
Purchaser at the Institute of Business Administration (FEI) in Stockholm.
Bo Karlson is a Senior Lecturer and Director of Studies at the Department oflndustrial

Economics and Management at KTH Royal Institute of Technology in Stockholm. He
has a Master of Science in Aeronautical Engineering and a PhD in Industrial Engi-
neering and Management from KTH. In addition to his many years of teaching and
researching in the area of industrial management, he has had many roles at KTH
such as Business Developer and Project Manager for KTH Professional Education and
C> THE AUTHORS AND STUDENTLITTERATUR 11
'
ABOUT THE AUTHORS
Manager of KTH Business Liaison. He has also been Manager of the research centre
Wireless@KTH. For a few years he worked with a small start-up company in the mobile
communications industry.
Per Storm is Managing Director ofEIT RawMaterials North AB, a part of the European
Institute oflnnovation and Technology. He did his habilitation (docent) in innovation
in the field of Material Sciences at KTH Royal Institute of Technology and holds a PhD
in Industrial Engineering and Management and a Master of Science in Metallurgy and
Materials Science, both from KTH Royal Institute of Technology, as well as a Bachelor
of Science in Business Administration from Stockholm University. He is currently the
Chairman of EccaNordic AB and a Board Member of the Institute for Security and
Policy Development (ISPD). He has previously been CEO of a listed exploration firm,
Copperstone Resources AB (pub!.), CEO and Principal for Iron and Steel at the mining
strategy and policy company Raw Materials Group RMG AB, and a Board Member of
two exploration and mining development companies: Norrliden Mining AB and Nordic
Iron Ore AB. He is a fellow of the Royal Swedish Academy of Engineering Sciences.
12 0 THE AUTHORS AND STUDENTL ITTERATUR

·· ································································································•
INTRODUCTION
The ability to conduct business, make economic analyses and understand the
interrelationship between technology and business is crucial for anyone engaged
in technologically intensive operations. Therefore, Industrial Management has
long since been established as an academic field, under slightly different names,
at virtually every significant university of technology in the world. This chap-
ter discusses what the subject Industrial Management covers and why it is an
important academic field for professional engineers and students of technology.
The operations of an industrial company constitute an economic cycle, which
consists of a value creation system and a financial system, both of which have
to function in order for the company to run long-term sustainable operations.
1.1 Industrial Management as an academic field

Knowledge of interactions between business and management on the one hand, and
technology and engineering on the other, is in great demand. Engineers must have the
competence to understand the technical implications of management and financial
decisions, as well as an understanding of the business and managerial implications of
various technical decisions. This requires the ability to understand and cooperate with
technical specialists as well as accountants and financial experts and, not least, manage
relevant methods and models to, for example, create budgets, estimate production costs,
perform economic analyses, identify business opportunities, implement production
changes, execute projects, and market products and services. Moreover, all engineers
today are expected to be able to explain and promote their operations using financial
terminology, to read and write financial reports, to estimate costs using established
accounting techniques, etc. The academic field oflndustrial Management can, thus, be
said to concern the business and managerial challenges that an engineer is expected to

PART I • INDUSTRIAL MANAGEMENT
face and handle in his or her professional life. In Sweden, Industrial Management was
established as an academic field at the Royal Institute of Technology, KTH, back in 1912.
Industrial Management revolves around how to design, develop, and implement
effective and efficient value creation processes. Etymologically, the term management
derives from the Latin word manus (hand), meaning "to handle", for instance to
handle a tool or a piece of equipment. However, when we talk about "management" or
"management studies" today as an academic field, we usually refer to studies of how
to handle an organization (firm, public agency, business, production facility, project,
etc.), specifically with respect to how to forecast, plan, structure, command, coordinate,
and control the organization's resources (employees, finance, equipment, etc.) so that
they together contribute to the its success. In most organizations, these resources have
to be managed under conditions of scarcity; in other words, the resources are limited
in relation to needs and wishes, meaning that managers within the organization have
to make choices.
Industrial Management is an applied, transdisciplinary subfield within management
studies, encompassing concepts, theories, models, and techniques which are also found
in, or originate from, other disciplines, such as business administration, sociology, eco-
nomics, and psychology. Thus, Industrial Management does not propose any different,
or unique, models or theories. Instead, the difference between Industrial Management
and other disciplines relates to its starting point, emphasis, and engineering context.
Industrial Management typically takes the business operations of industrial com-
panies and the value creation processes associated with these operations, as the starting
point. While related fields of general management and business administration focus
on a company's or an organization's resources and systems for resource management
(e.g., financial accounting), Industrial Management primarily focuses on the processes
of product development, production, and marketing, which together constitute the
company's core operations. The purpose of these processes is to create value for some-
one, such as a customer or a user. However, this value creation usually also includes
consumption of different resources. Consequently, the value creation processes have
to be efficient. If the value of the goods and services created is greater than the value
of the resources consumed, the company will generate a surplus, enabling long-term
sustainability. If, however, the value created is less than the value of the consumed
resources, the company has a problem and will probably struggle to continue its oper-
ations in the long run. Thus, developing, improving, and controlling this type of value
creation processes are key issues in Industrial Management.
In its simplest form, value can be translated into money, that is, revenue and costs.
However, the concept of value includes more than money. Creating value means creat-
ing resources, providing utilities, and producing goods and services that are in demand
and useful. What is considered value is, thus, not an objective matter, but is defined by
the customers, users, or owners. Sometimes the value can be expressed in monetary

CHAPTER 1 • INTRODUCTION
Three related fields
Economics - in Swedish, nationalekonomi:

includes the study of the economy of society as a whole, as well as of individual markets. It also
includes studies of societal problems based on economic theory, i.e., based on the assumption
that it is impossible to fulfill every need, which means that stakeholders always have to make
choices and prioritize between their needs. Economics typically addresses groups of stakeholders
making choices in an abstract, stylized market. A sub-discipline of economics deals with the
structures and development of industries and markets and is therefore sometimes referred to as
Industrial Organization or Industrial Economics.
Business Administration, sometimes also Business Studies or Management Studies - in Swedish,

foretagsekonomi:
is the general term for a number of subjects that relate to the way a company manages its limited
resources, for example accounting, corporate finance, management control, marketing, and
organization theory. In most countries outside the Nordic region, Business Administration is not
treated as a cohesive field; instead each sub-discipline is perceived as a separate subject in its
own right. Business Administration usually takes the company, and its general management, as a
starting point.
Industrial Management, sometimes also Technology Management or Industrial Engineering

and Management- in Swedish, industrie/1 ekonomi:
is the umbrella term for the fields which revolve around the business and managerial challenges
that an engineer is expected to face and handle in his or her professional life. Industrial Manage-
ment focuses on the value creation processes in business operations, typically product devel-
opment, production, and marketing in industrial and technology-based organizations. Subjects
belonging to Industrial Management are taught, under different labels, at most of the significant
technical universities in Europe. Educational programs in Industrial Engineering and Management
typically integrate business and management (about 1h of the education) with in-depth studies of
technology and engineering (about 2h of the education).
terms, sometimes it has to be expressed in other, more qualitative terms, for example
good health care, fair courts, well-functioning infrastructure, good quality oflife, or
high-quality university education.
Another characteristic of Industrial Management as an academic field, besides
the focus on value creation, is its close connection with technology and engineering.
The term "industry" derives from the Latin word industria which means "diligence",
"activity", "zeal"; today typically understood as being performed in an organized form.
The adjective "industrial" in Industrial Management has its historical roots in the
technological development and industrial revolution that took place in the decades
C THE AUTHORS AND STUDENTLITTERAT U R 17

PART I • INDUSTR IAL MANAGEMENT
before and after the turn of the 20th century. The field is closely associated with the
emergence of the mass-producing manufacturing industry, which today constitutes
the basis of our material welfare.
It is, thus, no coincidence that Industrial Management was first established as a
specialist field of the mechanical engineering curricula, or that much of its early focus,
at KTH as well as other universities of technology, looked at managerial and organi-
zational measures to achieve efficient, industrial manufacturing processes. However,
as the concepts of industry and industrial engineering have developed and changed
over time, the field has also developed and broadened. Today, the field addresses more
dynamic aspects of development, innovation and change in industrial operations, as
well as comprising more and more industries and types of operations. Over the years,
the field of Industrial Management has, thus, come to include a growing number of
issues and disciplines, such as innovation, marketing, work science, strategy, industrial
dynamics, globalization, organization theory, gender studies, supply chain manage-
ment, logistics, project management, product development, and entrepreneurship. Thus,
in many respects the development oflndustrial Management follows the development
of the industrial, technology-based companies as well as the engineering profession.
In reality, Industrial Management concerns the type ofbusiness and the management
issues that engineers need to master in order to be successful in their work.
1.2 Industrial Management - yesterday, today, tomorrow ...

As indicated by the name, the field oflndustrial Management is closely associated with
its origins in the manufacturing industry of the early 20th century, i.e., in the challenges
faced by companies that were manufacturing physical products through the processing
of different types of raw materials, for example, ore, wood, and textile. The largest and
most complex industrial companies at the time were mainly focused on the produc-
tion of mechanical and electro-mechanical products and raw materials for further
processing (e.g., separators, electrical power equipment, trains, telephone switches,
ball bearings, and iron ore), as well as the operations of large technical systems (e.g.,
telecommunication, railroad traffic, and electric power supply services). In Sweden,
it was also around this time that many of the largest and most well-known industrial
companies began to grow, for example, ABB, Alfa Laval, Atlas Copco, Electrolux, Erics-
son, LKAB, Sandvik, Scania, SKF, and Volvo. At the same time, public utilities laid the
foundation of the technical infrastructure of Sweden, several of which were converted
into enterprises at the end of the 20th century, for example, SJ, Telia, and Vattenfall.
A typical industrial company in this sense was characterized by large-scale process-
ing of raw materials to mass-produce physical products (goods). In relation to other
contemporary operations, both the products and the production were often techni-
cally advanced. The production was usually capital. intensive as the companies used
18 <i:> THE A U THORS AND STUDENTL ITT ERATUR

FIGURE 1.1
Example of modern
industria l operations
- a production line for the
assembly of mobile phones.
Photo: asharkyu/shutter-
stock.com
advanced technical equipment in the manufacturing and employed technically trained

staff, engineers, to design and develop new products, as well as to manage and develop
the production processes. Internationally, the main role model for modern production
management at the start of the 20th century was the U.S. based automaker Ford Motor
Company, which through its manufacturing of the Ford Model T not only transformed
the car from an extreme luxury product into a product that people in general could
afford, but also became an iconic symbol oflarge-scale and highly efficient (and to some
critics, inhumane) mass production processes.
Over time, many industrial companies have transformed to comprise a number
of other value creation operations than just processing of raw materials. Although
production is still important and often defines the conditions for competitive business,
many industrial companies have significantly more employees engaged in other val-
ue-creating processes than traditional manufacturing. This could involve, for example,
research and product development, project management, system integration, operation
and maintenance of complex systems for different clients, or other types of services
and service offers.
Nowadays, many industrial companies offer a number of services which support,
supplement, and sometimes even replace the physical product. A well-known example
is the aircraft engine manufacturer Rolls Royce, which already in the 1960s offered
customers maintenance services at a fixed price under the famous slogan "Power by
C> TH E A UTH O RS A N D STU D ENTLITTE RA T UR 19

Ford Motor Company and the Ford Model T
When Henry Ford opened the Highland Park factory in Detroit in 1910, it was a milestone in
the development of what we today refer to as mass production. The way the production plant
looked a few years after the opening, is probably the closest anyone has ever gotten to realizing
"the perfect production flow", with highly advanced standardization and integration, from raw
material producers to end users. One of the most important innovations in the production was
the introduction of the moving assembly line for the assembly of components as well as the final
assembly of the Ford Model T. When the first moving assembly line was introduced in 1913,
it reduced the lead time to assemble
flywheel magnets by 50 percent.
The first moving assembly line for
the final assembly of the Ford Model
Twas introduced the following year
and resulted in the assembly time
being reduced from 12 to 1.5 hours.
FIGURE 1.2 The first moving

assembly line for final assembly of
the Ford Model T, 1913.
the Hour". Instead of paying for repairs of the engines in the event of a breakdown,
the airplane owner could buy a maintenance "subscription" based on the number of
flying hours; in other words, the customers paid for functioning engines, not repairs.
Another example is the Swedish telecommunications company Ericsson, which orig-
inally manufactured telephones, but which today, besides developing and producing
telecommunication systems, also operates these systems for several of its customers.
A third example is the American company Apple, which offers the customer not only
computers, mobile phones and tablets, but an entire system of different services, which
can be purchased from Apple's online stores iTunes and App Store. Thus, even though
the terms "industry" and "industrial company" still have the exact same spellings as
they did 100 years ago, the meaning of the terms are significantly more multifaceted
than when they were first coined.
In some contexts, the term industry refers to all forms of business, which in turn can
be divided into different sectors, for example, mining, manufacturing, pharmaceuti-
cals, construction, movie production, and the experience industry. However, when we
label certain business operations as industrial or industrialized, it usually implies that

they are large-scale, that they are systematically managed and organized, and usually
based on a high level of specialization. Thus, the concept is implicitly associated with
mass production, standardization and repeatability, which in turn create conditions
for automation and efficient utilization of machinery and technical equipment (cf. the
origins of the concept in Section 1.1).
Art and handicraft are typical examples of operations that are not industrial in the
above sense. These types of operations require that the work processes, as well as the
finished products, are more or less unique; if the artistic process becomes too industri-
alized, the produced piece of art usually loses its value. Other examples of traditionally
non-industrialized businesses are law firms, architect firms, school education and
various types of consumer services, such as hairdressing and massage. The common
denominator for these operations is that each project, customer, or case is unique and
that the work is always tailored to meet the specific needs of each separate situation.
A number of operations which traditionally are not included in the (manufacturing)
industry category can still be seen as highly industrialized; in other words, they have
a large-scale and systematic value creation based on specialized and standardized
processes. Today, there are, for example, a number of large-scale service businesses
that operate more or less in line with the same principles as the traditionally industrial
mass production of manufacturing companies. McDonald's, H&M, Ikea, Zara and
Media Markt are all examples of companies that run low-cost operations in which
they produce and sell their products in very large volumes. Among other things, this
requires highly efficient production, advanced logistics systems, convenient access for
customers, standardized products, reliable suppliers, and major marketing programs.
In the same way, other large-scale service providers work to systematically develop
their processes in order to offer competitive products. One example is the Danish
company ISS, which has developed into one of the world's leading facility service com-
panies with over 500,000 employees working in, for example, facility management,
cleaning, office services, restaurant operations, and outsourcing. Another example
is the Swedish company Securitas, one of the world's largest security companies with
over 300,000 employees working in, for example, guard services, security controls, and
parking monitoring, as well as alarm systems and security consulting. By utilizing their
economy of scale, these providers oflabor-intensive services are constantly looking to
become more efficient by systematically making use of their experience, and designing
and standardizing their operations processes.
Similar examples can also be found in the complex and knowledge-intensive ser-
vice operations of the health care sector. With the aim of making patient flows more
efficient, reducing waiting times, and improving care quality, a number of traditional
industrial methods and management principles are today applied at, for example,
health care centers, emergency rooms, and different types of operation wards.
In summary, we can conclude that the term industrial in Industrial Management is

closely associated with technology-intensive operations, that is, technology development,

technical systems, advanced calculations and engineering designs, the use of advanced
machinery in production, etc. In other words, the value-creating operations in the
types of companies and organizations where engineers usually work. These are the
roots of the academic field and the reason why it is taught at universities of technology.
On the other hand, we can also conclude that the boundaries oflndustrial Man-
agement are continually changing and developing, and that methods and perspectives
gathered from Industrial Management are applied, or rather could be applied, to a
number of types of operations. At the same time as many traditional industrial com-
panies are developing their operations towards a greater degree of service content,
many traditional service companies are struggling to industrialize their operations
in order to become more efficient and enable growth. The academic field oflndustrial
Management includes both of these aspects.
Industrial Management - its academic history in Sweden
1912 - Mr. Erik Forsberg, senior engineer at Separator (today Alfa Laval), is hired as a specialist
teacher (Adjunct Professor) in Industrial Economics and Management at KTH Royal Institute of
Technology
1916 - Erik Forsberg publishes the textbook: Industrial Management: General Foundations
and Principles as well as Applications on Practically Important Cases (in Swedish: lndustrie/1
ekonomi: al/manna grunder och principer jiimte tilliimpningar pa praktiskt viktiga fall)
1939 - Mr. Tarras Sallfors (a student of Erik Forsberg) joins KTH as the first chaired Professor of
Industrial Economics and Management in Sweden
1969 - Linkoping University introduces the first comprehensive MSc Program in Industrial
Engineering and Management in Sweden
1972 - Mr. Sven Ake Johansson earns Sweden's first PhD in Industrial Economics and
Management at KTH
1980s - Chalmers University ofTechnology and Lu lea University ofTechnology introduce
comprehensive MSc Programs in Industrial Engineering and Management
1990s - KTH and Lund University introduce MSc Programs in Industrial Engineering and
Management
• 2010s - Industrial Engineering and Management is the most popular field in Swedish
engineering education and is offered (at basic and/or advanced level) at the engineering
faculties at most Swedish (as well as European) universities
--
1.3 The economic cycle of the company

Industrial Management revolves around the company's operations, that is, "what is
being done" in the company, the content of its business and how value is created. We
will discuss this in more detail in Chapter 3. The company's operations create a financial
system, a kind of economic cycle of the company, in which revenue is generated through
the value created, at the same time as this value creation requires the use of resources.
Furthermore, this value creation usually requires an organization of human resources,
raw materials, warehouses, different types of equipment, investments in production
facilities, etc., which means that the company has to have enough financial strength for
the operations to run at all. It is from this perspective that we need to understand the
concepts and models for production, marketing, product development, organization,
project management, costing, capital investment analysis, accounting, financing, etc.
that are described in this book. The methods, concepts and tools do not constitute the
operations, but they are crucial in order to understand the prerequisites, planning and
management of the operations.
Figure 1.3 presents a stylized economic cycle for a traditional manufacturing com-
pany. Starting a company requires initial capital. This can either be financed by the
owners through investments in the company or via loans from banks or other finan-
ciers. This will provide the company with financial assets to initiate its operations.
Investments coming from the owners are referred to as equity and constitute the basic
capital of the company, while money from other financiers are loans, meaning that the
company will have debts. In order to make these investments and grant these loans, the
owners and other financiers will demand a financial return in the form of dividends
for the owners and loan interest for the lenders. How the company should be financed,
who will finance it and in what way, are strategic decisions which often have long-term
implications for the operations.
11
Owners and financiers
Interest and
Financial principal payments,
capital dividends
Costs (expenses)
!....................... .. ..... .................!
~ Revenues
~
Input Output
markets markets
~
FIGURE 1.3
The economic cycle of
Resources Value creation Goodsand the company (based on
................................................................ services Danielsson, 1983).
© THE A UTHORS AND ST U DENTLITTERATUR 23

The company uses its initial financial capital to acquire resources, such as employ-
ing personnel and buying raw materials, equipment and other items needed for the
operations. These resources are acquired in different input markets. Some resources,
such as raw materials, are used to produce the final products, which are then sold to
customers in one or several output markets. In order to make sound purchases and
set appropriate sales prices, the company needs to be able to estimate the costs and
volumes of the different resources included in the production. In order to also enable
cost-efficient control of the production, the costs of the operations need to be allocated
to the different products. In other words, the company has to do product costing.
Other resources, such as machinery and equipment, are essential components of
the company's production. These resources are often expensive and long-lived and
therefore often define both the operational and financial framework of the company's
operations well into the future. Purchases of machinery and equipment are called
capital investments. The management and control of these investments through capital
investment analysis is crucial for the company's development ..
In order to manage the production, the company also has to have a relevant organ-
izational structure. This is often described in an organization chart. An essential part
in this structure is also to monitor the employees so the operations develop in line with
the management's intentions, for example by clearly specifying the division of labor,
defining responsibilities and authorities, stating job descriptions, and specifying how
the company assesses employee performance.
The value creation of an industrial company includes three different processes: prod-
uct development, production, and marketing. Most companies (unless they are very
small) are structured in different functional units that are responsible for each of these
processes. The units can have various names and be structured in different ways, but
in principle there is always one or several units for research and development (product
development), for manufacturing, production, and/or operations (production), and for
sales, marketing, and/or external communication (marketing) (see Figure 1-4).
1
Product development
FIGURE 1.4 Production

Three value creation
processes - three organi-
zation units in the industrial
company. Research and Development Manufacturing Sales
24 C> TH E AU TH O RS A N D STU O ENTLI TTERAT UR

CHAPTER 1 a INTRODUCTION
As described in Figure 1.4, neither of the processes takes place only within the
functional unit, rather they cut across the entire company. For example, the production
process is affected by activities that take place in other parts of the company, outside
of the production unit. The sales unit affects the production, for example, regarding
delivery times for different customers, and the technical designs that are created by
the product development organization have a great impact on what the company's
production apparatus looks like. Nor is the marketing process being run solely within
the sales organization. The design solutions, performance and features of the products
naturally affect how the products are marketed (consider, for example, Intel's slogan
"Intel inside", or that clothes made from Gore-Tex material always have a visible Gore-
Tex label). In the same way, the marketing activities affect the company's product
development process by channeling information about customer demands and new
business opportunities.
Moreover, the personnel are sometimes involved in these processes without neces-
sarily being aware of it. In so-called "front office-oriented" operations, the production
and marketing processes often mix: for example, a service technician who works on
site, at the premises of various customers, will influence the customers' impression of
the company. The same applies to, for example, janitors, transport personnel, waiters,
chauffeurs and consultants. At an advertising agency, the marketing work constitutes
the actual production of the company. In the same way, consulting work constitutes
the production at a consultancy firm, research constitutes the production at a research
agency, and product development work constitutes the production at a Research and
Development (R&D) department.
Thus, by product development, production, and marketing, we refer to processes
which cover all operations of the company, from raw materials bought on input mar-
kets, via production, to finished goods and/or services sold on output markets. The
processes can be described separately, and will then provide three different pictures of
the company's operations with slightly different focus: the product development process
emphasizes the products and their properties (the value proposition), the production
process emphasizes the resource transformation (the value creation), while the mar-
keting process emphasizes the customers, the users, and the use of the products and
the revenue they generate (the value capture). However, it is important to understand
all three perspectives and the way they complement each other.
The company's products - goods and/or services - are sold on an output market and
generate revenue, which is used to pay for salaries, raw materials, equipment, interest
on the company's loans, etc. This way, the company's cycle comes full circle. If the
business has generated a surplus, the company needs to pay taxes and the owners will
be reimbursed for their invested capital. For this purpose, annual financial statements
are presented every year. Once the company has paid its taxes and repaid its creditors
for any loans, the remaining surplus during the year, the profit, can either be paid as

dividends to the owners, or be retained in the company as part of its equity (which,
in principle, constitutes the owners' financial share of the company's total business).
This economic cycle can be described as consisting of a value creation system (the
bottom part of Figure 1.3) and a financial system (the top part of Figure 1.3), both of
which have to function in order for the company to run long-term sustainable opera-
tions. Thus, understanding business includes much more than money, accounting, and
financing. It is about understanding the big picture and how the various value creation
aspects and financial aspects interact. It is also this economic cycle that an engineer
needs to understand in order to develop products, manage projects and do business in
today's industrial context. Even though most engineers do not participate in all steps
of the economic cycle, they can greatly benefit from understanding its dynamics and
how it works. It is essential to understand how different management concepts, tools,
and techniques can be used in order to develop and control the company's operations.
1.4 The structure of the book

Industrial Management takes the company's operations, in other words, the company's
value creation processes, as its starting point. This is also the point of departure of this
book. However, in Chapter 2, we start with an overview of the industry structure of
Sweden. By briefly describing the types of industries and businesses we have in Sweden
and using that as an example, we provide a context for the concepts and methods that
are discussed in the other chapters of the book. s used. Most of the businesses described
in this chapter also exist in other countries, even if their industrial structure and evo-
lution is different from Sweden. Next, we broadly describe the company's value creation
system (Chapter 3), based on its value proposition, value creation processes and value
capture, three concepts which sometimes are summarized as the company's business
model. The first part of the book ends with a discussion of how the dynamics of tech-
nological and industrial development result in existing structures and business models
constantly being challenged by new innovations (Chapter 4). There is no guarantee
that what is efficient and effective value creation today will be in demand tomorrow.
The second part of the book delves deeper into the discussion of the value creation
processes of the company. In three chapters, we discuss the strategic, tactical and oper-
ative aspec_ts of the company's marketing (Chapter 5), production (Chapter 6) and
product development (Chapter 7).
In the third part of the book, we look at the financial systems of the company. Even
though the financial and the value creation systems are closely connected, the chapters
in this part of the book focus on the monetary aspects of the company's operations, that
is, the questions which usually are emphasized in the academic fields of accounting
and corporate finance. We discuss product costing and capital investment analysis
(Chapters 8 and 9), bookkeeping and financial accounting (Chapter 10), the company's

CHAPTER 1 • INTRODUCT ION
annual report and financial statements (Chapter 11), the company's need for capital
and financing (Chapter 12), and management accounting and budgeting (Chapter 13).
The fourth part of the book discusses how industrial companies are managed and
organized. First, we look at the company's corporate strategy and the most common
models in strategic analysis (Chapter 14). Then we move onto human resource manage-
ment (Chapter 15), the organizing ofbusiness operations (Chapter 16) as well as project
management (Chapter 17), which is an important element in modern working life. The
book concludes with a chapter on the role of the industrial company as a corporate
citizen of the surrounding community (Chapter 18). In the appendix, you will find
glossaries (English to Swedish, and Swedish to English) and interest tables for capital
investments calculations.
References
Bailey, D. E. & Barley, S. R. (2005). Return to work: Toward post-industrial engineering. IIE
Transactions, 37, 737-752.
Berggren, U. & Bergkvist, T. (2006). Invadiirerna, Nutek 2006=7.
Berggren, U., Bergkvist, T. & Hedby, U. (2008). De nya affiirsinnovationerna, Nutek 2008:1.
Chandler, A. D. (1977). The visible hand: The managerial revolution in American business.
Harvard University Press.
Danielsson, A. (1983). Fiiretagsekonomi: en iiversikt. Studentlitteratur.
De Geer, H . (1978). Rationaliseringsriirelsen i Sverige: effektivitetsideer och socialt ansvar
under mellankrigstiden. SNS forlag.
Engwall, L. (Ed.) (1995). Fiiregangare inom fiiretagsekonomin. SNS forlag.
Fagerfjall, R. (2005). De gjorde Sverige rikt: 1900-talets entrepreniirer, fiiretagsledare och
riskkapitalister. Kalla kulor forlag.
Forsberg, E. (1916). lndustriell ekonomi: Al/manna grunder och principer jiimte tilliimpningar
pa praktiskt viktiga fall. Stockholm.
Giertz, E. (Ed.) (2008). Da fiiriindrades Sverige. Studentlitteratur.
Hounshell, D. (1985). From the American system to mass production, 1800-1932: The devel-
opment of manufacturing technology in the United States. JHU Press.
Sandberg, A. (2003). Ledningfiir alla? Perspektivbrytningar i arbetsliv och fiiretagsledning.
SNS forlag.
Schon, L. (2007). En modern svensk ekonomisk historia. Studentlitteratur.
Tarras Sallfors, C. (Ed.) (1945). Handbok i industriell driftsekonomi och organisation. Natur
och kultur.

········ ··························································································•
SWEDISH TRADE AND
INDUSTRY
Sweden is an advanced industrial nation with many successful companies and

world-famous innovations. From an international perspective, Sweden is rela-
tively unique with a great number of large global corporations in relation to its
small population. This makes Sweden a country heavily dependent on exports,
where the economy is determined by international demand rather than domestic
consumption. For some time now, the industry in Sweden and large parts of the
Western world has been going through a radical transformation. Products are
becoming more and more complex and the service content is increasing. At the
same time, digitalization and the development within IT, telecommunications,
and the Internet are enabling more opportunities to create new products and
services, new business models, and new ways of working. This chapter provides
an overview of the industry in Sweden and describes the leading companies
and their operations. The same types of businesses can be found in most of the
developed industrial countries, albeit to a varying extent.
Swedish industry is dependent on technology and

2.1
exports
Sweden is characterized as being a small, advanced nation, heavily dependent on
international trade. Even though the service industry is growing, the advanced export
industry still constitutes the backbone of the Swedish economy in many ways. There is
a strong tradition of technological innovation and development, and many of the largest
Swedish companies today have their roots in inventions and technologies developed at
the end of the 19th century. While the economy in many other countries has been based
on trade, the economic welfare in Sweden has to a great extent been based on industrial

PART I • INDUSTRIA L MANAGEMENT
TABLE 2.1 Examples of innovations with Swedish origins.
The AGA lighthouse The scratch test for diagnosis of allergies

The cash machine The propeller
The zipper The rol lator
The bolt cutter The separator
The Johansson gauge blocks The adjustable spanner
The Celsius scale The snowmobile
The airbag helmet Hovding Streamed music over the Internet (Spotify)
The dynamite The safety match
The styrofoam Telephone ca lls over the Internet (Skype)
The High Voltage Direct Current (HVDC) technology The tetrahedron shaped package (Tetra Pak)
The ball bearing The lap-diagonal belt
The refrigerator Ultrasound examinations
Losee The Wettex sponge cloth
Minecraft Xylocaine
Large-scale furniture manufacturing (Ikea) The steam turbine
The pacemaker
and technological development. There are many examples of innovations with, at least
to some extent, Swedish origins (see Table 2.1). Many of them are purely technical, but
others are what you would sometimes refer to as service and business model innovations.
Today, the largest companies in Sweden belong to large corporations with operations
and representation in many parts of the world. Some of these groups have their head office
in Sweden, others abroad. In many cases, these types of multinational companies locate the
rest of their operations in the places in the world which are considered most advantageous.
For many years, the trend has therefore been to move operations from Sweden to low-cost
countries in Asia and Eastern Europe, so-called offshoring. In many Swedish companies,
the manufacturing takes place more or less exclusively abroad, even though there is a small
shift taking place at the moment where several companies have begun to move operations
back to Sweden. In many companies, a significant share of the manufacturing also takes
place with the help of contracted suppliers located in different parts of the world.
Swedish industrial companies are known for manufacturing high-quality and,
consequently, relatively expensive products (see Figure 2.1 for a few examples). The
market has been global for a long time, but today this also applies to competition. As
the economy has developed in Asia, to use an example, new competitors have emerged
who produce similar products, of close to the same quality, but significantly cheaper.
To manage this global competition, many Swedish companies therefore strive to cut
production costs, at the same time as they invest in products with more knowledge
content and try to develop new value propositions, for example by offering various
types of services and product systems.
30 © T H E A U T H OR S A N D ST U D EN TL I TTERATUR
CHAPTER 2 • SWEDISH TRADE AND INDUSTRY
HOLMEN J/ AkzoNobel SCANA

!SANDVIK]
-ihlson
All VATTENFALL - -
STORAENSO ,,,1
Nee* sKANsKA
l(larna ~
~ ~ · ~ ' Telia ERICSSON ~

a ABLOY 8J Electrolux
...co
~
AstraZeneca 4 SSAB
II r.:Delaval II FIGURE 2.1
Exam ples of compa nies
and brands developed in
1/.M Sweden.
2.2 The economic structure of Sweden

At the beginning of the 20th century, Sweden was a typical agricultural society and one
of the poorest countries in Europe. Compared to the rest of Europe, the industrializa-
tion of Sweden began relatively late. However, the development into a prosperous and
advanced industrialized nation was rapid. The agricultural sector gradually decreased
and today it represents only two percent of the Swedish gross domestic product (GDP),
that is, the total value of all goods and services produced in the country. As Sweden
remained neutral in both the First and Second World War, Swedish industrial compa-
nies also gained a more advantageous position in relation to their European compet-
itors. The post-war era saw the start of an especially quick expansion where Swedish
exports to other countries grew rapidly. At the start of the 1970s, growth leveled off
within the goods manufacturing industry, and during the last decades of the 20th
century there was instead a rise in service production in the private and public sector.
Figure 2.2 accounts for different sectors' contributions to Swedish GDP 1900-2014.
In a way, Sweden was at the peak of its industrialization in the 1960s. The decline in
GDP contributions coming from the manufacturing industry in the mid-196os, and
the years to follow, was initially due to the fact that production actually stagnated. The
continuing decline, after the structural changes during the 1970s and early 1980s, was
however due to, among other things, the fact that many industrial companies gradually
specialized their operations and transferred different service operations that previously
had been carried out inhouse to external contractors and consultants (a transfer which
O THE AUT H O RS A ND STUDE NTL I TTER A TUR 31

Percent
60 - -- --- -- --- - -- --- - - ------------ - --- -- - --- - - -- - ----------------- - --- ----- - - ---------
50
40
30
20
10
FIGURE2.2
The structure of the
Swedish economy
oL-~---~-~-~------------.--:=::::::~:::::::==-
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
1900- 2014, contributions to
GDP (%). Source: Statistics - Agriculture, forestry, fishing industry - Goods manufacturing industry
Sweden, 201 ?. - Service production of the private sector - Service production of the public sector
nowadays often is referred to as outsourcing). IT-operations, facilities management,

and office support services are typical examples of such outsourced activities, but now-
adays more qualified work is also being outsourced, such as engineering and software
development. This is one of the reasons why the production of the service sector has
increased in recent decades. As the public welfare systems expanded during the 20th
century, public service production increased. The 1960s and 1970s saw a particularly
large expansion of public services at the municipal level, for example public nursery
schools and elderly care services. At the beginning of the 21st century, however, there
was a wave of incorporations and privatizations of public services, which meant that
public service production, for example within education, transport, health and elderly
care, dropped in the statistics, while service production in the private sector corre-
spondingly increased.
If we look at society as a whole today (2016), just over 50 percent of Swedish GDP
comes from the private service sector, somewhat less than 30 percent from the man-
ufacturing industry, just over 18 percent from the public sector and roughly 2 percent
from agriculture and forestry. The number of people in employment is approximately
4.6 million. Out of these, roughly 3.3 million are working in the private sector and just
over 1.3 million are working in the public sector, mostly within local authorities and
county councils. Sweden has a large public sector, consisting of government authorities
and agencies, county councils and local authorities, but this sector is not included in
the following discussions in this chapter.
32 0 T H E A U T H OR S AND ST U DENTLITTERAT U R
2.3 The companies in Sweden

Toe Swedish industry today (2016) consists of just over 1 million companies and out
of these, barely 550, i.e., a very small portion, are listed on the stock exchange. Most of
the companies in Sweden are small. No less than 97 percent of the Swedish industry
consists of companies with less than 10 employees. It could be different types of self-em-
ployment, for example people working as farmers, shopkeepers, carpenters, journalists,
or consultants. Some work full-time and make a living out of their business, others
run their company as a sideline job. Only 0.5 percent of the companies in Sweden are
so-called mid-sized companies, that is, companies with 50-249 employees (see Figure
2.3). Even less, not more than 0.1 percent, are large-sized companies, that is, have more
than 250 employees. Financially, however, the mid- and large-sized companies (i.e.,
o.6 percent of all Swedish companies) represent no less than 56 percent of the business
sector's total value added (value added is defined as the difference between the sales
revenue of the finished products and the cost of necessary resources to manufacture
the products). In addition, the large companies usually function as growth engines in
that they demand products from sub-suppliers and require various types of support
services and infrastructure, which provide employment far beyond the limits of the
company. Many public organizations have the same function. Government agencies
and authorities, the public healthcare system, and the local authorities are in fact the
largest individual customers of the goods and services produced by the private sector
in Sweden (the same situation applies to most advanced economies).
However, despite the large number of small companies, most people in Sweden work
in large organizations. Sometimes the structure of the Swedish industry is depicted
as an hourglass (see Figure 2.3). At the top, we have a very small number of large
250+ employees - ---------

0%
: '•
50-249 employees 1,--_ _.....,..,.
0%
10-49 employees
3%
FIGURE2.3
The structure of the
0-9 employees business sector: value
added, employees, and
companies per size category
- Share of total value added (2012). Source: Statistics
- Share of the total number of employees Sweden, Structural Business
Share of the total number of companies Statistics 2012.
C> THE AU THOR S AND STUDENTLITTERATUR 33

international companies that stand for a significant portion of the employment in the
country, but which have operations in large parts of the world and do not expand much
more within the borders of Sweden. At the bottom, we find a large number of small
companies with local operations. It could be local printing works, car repair shops, con-
tract manufacturers, small retailers, and small-sized construction companies. Between
these two extremes there are a limited number of mid-sized companies that over time
could become the companies which grow and take over the role of the established large
companies as engines in the labor market and the economy. It has, however, been a
national problem that small and mid-sized companies do not grow fast enough.
The Swedish industry is, thus, dominated by large companies, of which the majority
were founded before the Second World War. The list of the 10 largest companies in
Sweden consists, with a few exceptions, primarily of companies within manufacturing
and commerce (see Table 2.2). Out of the 28 companies in the table, 16 are usually
categorized as industrial companies, 4 are trading companies, 3 companies are previ-
ous government agencies that have been corporatized, 2 are construction companies,
2 are private service companies, and 1 is the parent company of the companies which
Stockholm County Council use for their operations.

The largest company in Sweden in terms of turnover (i.e., invoiced sales) is AB Volvo,
which, among other things, manufactures trucks, buses, engines, and construction
equipment. AB Volvo, with its head office in Gothenburg, is also the second largest
Swedish export company, the third largest Swedish company in terms of the number
of employees and the second largest employer in Sweden outside of the public sector.
The telecommunications company Ericsson has a similar position as the second largest
Swedish company in terms of turnover. Ericsson is the largest exporter in Sweden, the
second largest Swedish company in terms of the total number of employees and the
third largest company if you look at the number of employees in Sweden.
It is also worth noting that among the industrial companies in Table 2.2, some
belong to the capital-intensive process industry (e.g., Preem, SSAB, and Sandvik). These
companies are large in terms of exports, but not in terms of employees. Among the 12
companies that belong to the manufacturing industry, only three (Volvo Car Group,
Electrolux, and Assa Abloy) produce products which are aimed, at least partly, at the
consumer market.
In Tabl.e 2.2 you will find one of the largest security companies in the world, Securi-
tas, with its corporate headquarters in Sweden, but less than 5 percent of its employees
in Sweden. The same applies to Hennes & Mauritz, one of the three largest clothing
retailers in the world, with more than 90 percent of its employees abroad. One company
which is not, however, on the list is Ikea. Even though Ikea is seen and marketed as a
Swedish company, and has its roots in Sweden, the headquarters is registered in the
Netherlands. If it were to be included in the list, it would have the same position as
Ericsson in terms of the total number of employees.

TABLE 2.2 The largest Swedish companies, i.e., the largest compan ies registered in Sweden, 2013 . Sou rce:
Nordic Netproducts AB.
Turnover (MSEK) Export (MSEK) Employees in Sweden Total number of

employees
AB Volvo Ericsson PostNord AB Securitas AB

272,622 108,944 23,721 275,769
2 Ericsson AB Volvo AB Volvo Ericsson

227,376 88,560 22,096 116,630
3 Vattenfall AB Preem AB Ericsson AB Volvo

171,684 43,649 17,090 94,832
4 Skanska AB AstraZeneca AB Axel Johnson Holding AB Hennes & Mau ritz AB

136,488 41,048 16,577 81,099
5 Hennes & Mauritz AB SSAB AB Volvo Car Group AB Electrolux

128,562 28,189 15,786 60,754
6 Volvo Car Group Sandvik AB Attendo AB Skanska AB

122,245 26,000 14,572 57,105
7 AB Electrolux LKAB Scania AB Sandvik AB

109,151 18,000 12,939 48,040
8 TeliaSonera AB Bil lerud Korsnas AB Landstingshuset i SKF, AB

101,700 17,023 Stockholm AB 45,220
11,923
9 ICA Gruppen AB AB Tetra Pak Peab AB Assa Abloy AB

99,456 15,160 11,659 42,556
10 ICAAB Saab (group) Saab (group) Atlas Copco

96,863 13,000 11,144 40,159
2.4 The structure of the business sector

The business sector is usually divided into different industries. However, the definitions
of what constitutes an industry are rarely unambiguous; on the contrary, they are often
historically conditioned and connected to company origins, trade associations and
interest groups, or different collective agreements. The traditional definitions of indus-
tries can consequently be problematic since they do not provide adequate descriptions
of the character or development of the businesses. For educational purposes, we attempt
in the following to roughly divide the activities of Swedish trade and industry into
different sectors. The division is not flawless, but functions as an overall introduction.
In practice, there are strong connections between the companies within the different
C> THE A UTH ORS AND STUDENTL I TTE RA TUR 35

sectors. For example, IT-consultants work on behalf of companies in every sector and
the process industry is one of the largest customers in the construction sector. Below,
we structure the companies in Sweden into six sectors and sub-industries (compare
Figure 2-4) :
1 Extraction of raw materials:

agriculture, forestry, mining, and utilities such as energy and water
2 Production of goods:
process industry and manufacturing industry
3 Built environment:
building, construction, and real estate companies
4 Business services:
consulting and labor-intensive business service
5 Distribution:
commerce and transports
6 Other services:
hotels, restaurants, tourism, healthcare services, etc.
[
Agriculture and forestry
Extraction of raw materials Mining
Utilities
Production of goods [ Goods manufacturing industry

Building construction and
Built environment
[ civil engineering
Real estate management
Business services
[ Consulting
Labor-intensive business services
Distribution
[ Commerce
Transports
Hotels, restaurants, tourism
O,hme~;"' [ Production of werfare services
Others
0 5 10 15 20 25
- Share of the total number of employees in the private industry

Share of the total value added of the private sector
FIGURE 2.4 The industry structure of the Swedish business sector (2012) Source: Statistics Sweden,
Structural Business Statistics 2012.

Extraction of raw materials:

The extraction of raw materials sector includes companies that operate in agriculture,
forestry, mining, energy, and water. Together, they account for just over 3 percent of
the employment in the Swedish business sector and barely 8 percent of the value added.
Almost a quarter of all Swedish companies operate in agriculture and forestry. How-
ever, many entrepreneurs in this industry work part-time and only a fraction of the
companies are large enough to bear the costs of an employee. Just like the companies
in the other industries of this sector, large farms require big investments in facilities
and machinery.
From having played a central role in the Swedish economy and constituting the
cradle ofindustrialization in Sweden, there are only around ten active mines in Sweden
today. Mining in Sweden is characterized by extremely large-scale operations and
requires considerable investments. Production is highly automated and the industry
is sensitive to global economic fluctuations and price variations on the international
mineral markets.
Most of the utility companies (energy, water, sewage, and waste) are also highly
automated with a capital-intensive process production. Many of them have their roots
in the public sector, where the main interest has been to deliver important public ser-
vices rather than maximizing profits for the owners. Even though there have been some
privatizations, the majority of these companies are still publicly owned, mostly by local
authorities and federations. What these companies have in common is that production,
distribution, and consumption take place via large-scale technical infrastructures.
These infrastructures require large initial investments, but once the infrastructure
is in place, the cost of adding another client to the established system is very small (a
business logic they share with, e.g., telecom operators and banks).
Production of goods
The production ofgoods sector includes companies in the process and manufacturing
industries that produce goods, components, products, and technical systems for both
the business and consumer markets. It is mainly these companies (sometimes together
with mining and energy companies) that are traditionally referred to as "industrial
companies". Together, the goods producing companies account for 20 percent of the
total employment in the business sector and just over 22 percent of the value added.
The process industry includes, for example, forestry, pulp and paper mills, steel and
metal works, refineries, and chemical industries (see Figure 2.5). As these companies
are capital-intensive, they have their own logic. They require expensive production
plants, which lead to high capital costs at the same time as the labor costs are relatively
low. Accessibility, reliability in the production, and high capacity usage, as well as
the cost of energy and raw materials, are key factors to achieving profitability. The
Q THE AUTHORS A ND STUDENTLITTERATUR 37

FIGURE 2.5
Sodra Cel l paper and pulp
mill - a typical example of
a capital -intensive process
industry. Photo: lmfoto/
shutterstock.com.
production typically constitutes an automated material flow which makes it difficult

and expensive to implement changes without great loss. The products are usually sold
at wholesale prices on a global market. The production flow is divergent, that is, from
one type of raw material a number of different semi-finished and finished products
are produced. These products are often of standard quality and sold on a market where
demand varies, at the same time as the manufacturing capacity only can change in
leaps through large capital investments (i.e., no gradual change is possible). It is also
typical that investments are made in times of prosperity, while the results of these
undertakings cannot be assessed until much later (a logic these companies share with
both mining and energy companies).
The manufacturing industry is the industry which has had the biggest impact on
Swedish industrialization. It includes a number of different operations, for example
producti9n of metal goods, machines, electronic products as well as cars, trucks, and
other vehicles. In addition, many manufacturing companies design and build large
and complex technical systems. The Swedish manufacturing industry, in particular,
is dominated by products and systems sold to other companies, so called business-to-
business (B2B). The producers of consumer goods in Sweden are far fewer.
The Swedish manufacturing industry is dominated by large companies, which by
using components produced by themselves or bought from autonomous suppliers, pro-
duce more or less complex technical products. In this way, many large companies func-
38 I:> THE AUT H ORS A N D ST U DENTL ITTERATUR

tion as market channels, under their own specific brands, for various products of a large
number of companies (for example different raw materials, components, sub-systems,
and consultancy services). Traditionally the manufacturing companies are labor-inten-
sive, but today many companies have highly automated manufacturing. The production
flow is typically convergent, that is, a large number of components and sub-systems are
assembled to a smaller number of finished products (see Figure 2.6). Materials manage-
ment is important and the companies tie up capital in supplies and inventory to manage
deliveries and possible disruptions. Having short throughput times, high inventory turn-
over, high delivery service and being able to produce to order are becoming more and
more important. Today, an increasing share of the companies' turnover is often produced
by sub-suppliers. The production manager sometimes turns into a sourcing manager,
where the company's own production plant sometimes is regarded as one among many
other production units in the supply chain (see Chapter 3 and Chapter 6).
Behind these large-sized companies there are a great number of Swedish and foreign
suppliers with their own products, and contract manufacturers that produce on order
without owning any products themselves. These suppliers can be very large compa-
nies with strong brands (German Bosch is one example). Contract manufacturers are
usually smaller in size, while they in terms of numbers are the most common type of
company in the manufacturing industry. Swedish contract manufacturers face tough
competition from low-cost countries, at the same time as close proximity to the cus-
tomer often is an important competitive advantage for them.
FIGURE 2.6
Robot welding of body
components in a vehicle
factory - a typical example
of advanced manufacturing .
Photo: xieyul iang/shutter-
stock.com .
C> THE AUTHORS A ND STU D ENTLI TTERATUR 39

For many of the more advanced manufacturing companies, the historical evolution
has meant that the label "manufacturing" no longer accurately describes their opera-
tions. The introduction of electronics, computer development, and digitalization have
led to more complex products, at the same time as mechanics and hardware have been
gradually replaced by software and algorithms. For a classic industrial product like the
private car, raw materials and manufacturing operations account today for less than
a fifth of the total cost, while the rest is constituted by different types of services. In
the typical "industrial company" of today, more than half of the employees work with
different kinds of services. Many manufacturing companies also offer a wide range of
additional and complementary services that accompany their physical products (this
will be discussed further in Chapter 3).
The pharmaceutical industry can, at least partly, be included in the goods production
sector since it shows similarities with both the process industry and the manufac-
turing industry. This used to be a relatively large sector in Sweden but has decreased
significantly since the start of the 21st century. The development of a new drug is
very expensive and can take over 10 years. The international pharmaceutical groups
are therefore very research-intensive. Large resources are spent on different tests to
guarantee the effect of a new drug and to minimize the risk of unwanted side effects.
Before sales can start, a new drug also needs to be approved by the responsible authority.
Since large resources are invested several years before the product begins to generate
revenue, it is important that a pharmaceutical company earns as much money as pos-
sible during the limited period from the approval of the drug until the patent runs out.
This way the company can generate enough capital to finance the development of the
next generation of drugs.
Built environment
The built environment sector includes building, construction as well as real estate com-
panies and accounts for roughly 13 percent of the employment in the business sector
and 16 percent of the value added.
The construction industry is, to a great extent, governed by political decisions and
contracts for large public projects like roads, tunnels, bridges, and other types of infra-
structure. Governmental agencies, county councils, and local authorities are thus large
clients of the construction industry, as are the mining and process industry companies.
Private construction however, is a typical small-business industry, especially when
it comes to maintenance and repairs. A fifth of the people working in the industry
run their own company, even though they often collaborate in networks to execute
different projects.
Construction is typically conducted in the form of contracts, i.e., in projects (see
Chapter 17), localized where the building, plant, or facility is to be built. The typi-
40 C> T H E A U T H OR S A N D STU D E NTLI TTERATUR

FIGURE 2.7
Construction engineering.
Photo:Pavel L Photo and
Video/shuttterstock.com .
cal construction site is led by a contractor with relatively few employees. The use of
sub-contractors is common. Larger construction projects are usually led by a large
construction company, which in turn engages a great number of different compa-
nies, sometimes chains of contractors, sub-contractors, and sub-sub-contractors, to
carry out the projects (see Figure 2.7). The construction companies seldom employ
architects or construction engineers; these are instead hired as consultants for each
specific project.
The real estate industry consists of companies that manage, rent out, and develop
commercial facilities and/or residential housing. These companies usually have rela-
tively few employees, but a substantial amount of capital tied up in their properties.
The revenue is primarily based on rents and real estate sales. The business idea of some
larger real estate companies is to acquire cheap properties and then increase their value
by repairing and upgrading them as well as offering different types of support services
to the tenants. Most of the largest real estate companies in Sweden are, however, publicly
owned (e.g., housing companies owned by local authorities), with other aims than
maximizing their financial profits.
Bu siness services
The business services sector includes knowledge-intensive consulting in, for example,
IT, construction, product development, engineering, management, accounting, and
recruitment, as well as different types of labor-intensive services that are produced on
behalf of other companies. In terms of the scope of the business services sector, it is
O THE AUTHOR S AND STUDENTLITTER A TUR 41

PART I a INDUSTRIAL MANAGEMENT
0 CONSULTING 0
PA JECTS , a~-=-- SUCCESS T _ --~
·~1 "&&@ ~- . ·, ~
~~-=-- ':ml ]& '"=:;ai --=- o .. ~ : ANALYSIS
. I:IR\ CONSULTING ·- r,,..
o ...~ •
m •:, r~~ a
FIGURE 2.8
IT consulta ncy business.
TEAM #
~~--, ••
r- .J g;Q AESULT -.:.·- • ~~
-
1.i,t PLAN
..r---=~
=:._, ~
o - n o /4n - -
~
•
Illustration: ka rpenko_ilia/
shutterstock.com. l.:-:.-=J SEAVICE ~-·'"E3-:--A ~Lu:ioN ~=---: ~ ~---· STA:T'f!v
more or less as big as the entire goods production in Sweden and equals about 22 percent
of the employees in the business sector and just over 21 percent of the value added.
The consultancy industry is growing and constitutes today (2016) one of the largest
employers of new graduates from business schools and engineering schools in Sweden.
Industrial companies are buying successively more services from different consultancy
firms, and sometimes entire sections are outsourced, for instance regarding accounting
or the operations and maintenance ofIT systems and servers (see Figure 2.8). Another
growing trend is that companies, not least in the industrial sector, hire staff from
external staffing agencies instead of employing new in-house employees for specific
tasks. In other words; at the same time as the large industrial companies specialize and
gradually reduce their number of employees, the number of employees in the service
companies serving them is increasing.
The operations of the consultancy firms are based on the employees' ability to apply
and combine skills from different areas of expertise and seldom on capital-intensive
equipment. It is about making use of experiences from previous client contracts and,
at the same time, finding solutions that meet the unique needs of each client. Being
a manager in this type of company usually means being responsible for sales and
adminis_tration while the actual consulting is coordinated by a contract leader or project
manager. The younger members of staff do the groundwork while the senior con-
sultants are responsible for more advanced analyses, quality control, sales, and client
relationships. Most consultancy firms are small and the industry is person-dependent.
It is not uncommon for clients to choose a specific person (a senior consultant), rather
than a specific firm. Larger consultancy firms, especially in technology and IT, provide
consultants as extra resources to work on site within the clients' organizations. As
such, these consultancy firms share a similar business logic with the staffing agencies.
42 10 THE AUTHOR S A ND STU D ENTLITTER ATUR

CHAPTER 2 • SWEDISH TRADE AND IND USTRY
Labor-intensive business service includes what is sometimes referred to as facility

management, that is, services related to an estate or a building, for example janitorial
services, energy optimization, and security, or services which support the operations
in the facilities, such as cleaning, reception, telephone, and mail handling services.
Most companies in this segment are also small, with local and tight relationships with
specific companies or property owners. However, as the large-scale companies are
becoming more and more specialized, the trend is to centralize procurement of this
type of services, which is one of the reasons behind the rise of very large, global com-
panies in this sector, for example ISS and Securitas.
Distribution
The distribution sector includes companies in distribution, transport, and commerce.
Together, the companies represent just over 22 percent of the value added in the Swedish
business sector and 26 percent of the number of employees. The distribution sector is
thus about as big as the goods production and business services sectors.
There are a number of different types of distribution and transport companies. One
type works with goods transports, where goods are transported by trucks, freight cars,
planes, and ships. They often have regular clients with well-defined transport needs, and
there are often strict requirements to meet delivery times. The transporters function as
integrated parts of the production and supply chains and are, in practice, responsible
FIGURE 2.9
A logistics and trans-
shipment center. Photo:
Petinov Sergey Mihilovich/
shtterstock.com.
O THE AUTHORS AND STUDENTLITTERATUR 43

for parts of their clients' stockholding and inventories (see Figure 2.9). These companies
must make use of their full capacity to manage their costs of capital and labor.
Another type of company works with the transshipment and redistribution of goods.
This includes, for example, harbors, airports, dock companies, terminals, transship-
ment centers, central warehouses, and distribution terminals of wholesalers or large
corporations. The operations involve unloading, restowing, storing, and loading goods
on different transport vehicles. Today, much of the work is mechanized and automated.
Advanced information systems enable the tracking of goods throughout the delivery
and supply chain.
Commerce is also a large and extensive sub-industry, which traditionally is struc-
tured into wholesale and retail. The wholesalers function as a link between the man-
ufacturers and the retailers and assist the latter with repackaging, assortment, and
sometimes also the design of the products (some products are, however, delivered
directly without the involvement of a wholesaler). The retail business, that is, shops
and department stores, is essential for the consumer market. However, when it comes
to producer goods, the industrial companies usually trade directly with each other.
The functions of the wholesaler and retailer are, however, not always carried out by
separate companies, but can make up vertically integrated segments within the same
larger corporation (see Chapter 5).
The retailers normally sell products to consumers within a geographical area. Sales
take place via department stores, supermarkets, or smaller shops. For retailers, it is
important to have a clear profile and meet the customers' expectations. The operations
are labor-intensive and profitability is dependent on the retailer's ability to combine
a wide range of products and good service with a low level of inventory. In Sweden,
retail is dominated by large corporate chains, whose logistics and distribution chains
show great similarities with the materials management in the manufacturing industry.
The growth of electronic commerce over the Internet, so-called "e-commerce", is
today competing with the traditional distribution channels. Through e-commerce,
the number of steps in the distribution chain is rationalized and the geographical
limitation of the shop is removed. This type of commerce is growing, but it has proved
to be relatively difficult for e-commerce companies to out-compete traditionally strong
retailers. Today, most of the larger retailers also complement their physical shops with
shopping online.
E-commerce also includes e-service companies such as the music streaming com-
pany Spotify and video game companies like Mojang and King. These types of compa-
nies, which have replaced the sales of products with completely Internet-based services,
have attracted extensive media attention during the 2010s. Several of these companies
are financially successful and generate relatively large sales revenues, but in terms of
number of employees these companies employ relatively few people.

Other services
Alongside the sectors described above, other services represent about 15 percent of
the employment in the business sector and roughly 10 percent of the value added.
These services include, for example, companies in the tourism industry (hotels, travel,
restaurants, etc.) and the creative industries (culture, media, publishing).
Another important industry in this category is the production ofwelfare services, which
in these statistics only includes services in healthcare, education, elderly care, and social
care, run by private or public companies. Since the turn of the century, this industry has
seen the rise of new, large stakeholders. The main part of the welfare services in Sweden
are, however, produced by the local authorities and county councils, which have more
than 1 million employees (and thus go beyond the scope of these statistics). With an aging
population and rapid technological and medical development, the costs of healthcare
and elderly care are rising faster than the growth in GDP in many countries. This will be
a major challenge for Sweden, and the whole of the Western world, in the future.
2 .5 An industrial structure in transformation

Sweden is sometimes described as a "post-industrial information and knowledge soci-
ety". It is, however, more correct to understand the industrial evolution since the early
20th century as a change in the very meaning of the concept of industry. Today, it is not
only physical products that are being mass-produced but also a number of qualified
services. Many industrial companies have evolved in such a way that the distinction
between traditional industry and service production has been erased. By investing in
automated production technology, the need for blue workers, in the classical sense,
is gradually decreasing. At the same time, the number of white-collar jobs within
the industrial sector has increased. Manufacturing is still important, but today it is
often one out of several important elements in the company's operations. In addition,
many of the largest industrial companies are experiencing a gradual rise in financial
turnover, at the same time as the number of employees has dropped. The global trend
is that companies specialize, which means that a larger portion of the companies' value
added is generated by sub-contractors, often located far beyond the Swedish borders.
Today, many large-scale companies could be described more as coordinators of major
networks of suppliers, sub-contractors, and consultants, rather than organizations that
run their own, internal operations.
Nowadays, the most common work for a recently graduated engineer in Sweden is
not as an employee in an industrial company but as a consultant, often within industrial
engineering or IT. The first managerial role to which an engineer is appointed is usually
not as head of a functional unit but as a project manager. The limits of the company and
the traditional physical workplace are loosening up. Today's project and work groups

PAR T I • INDUSTRIAL MANAGEMENT
UBER The world's largest taxi company doesn't own any cabs - Uber
The world's largest retailer doesn't have any inventories - Alibaba

a,
Alibaba.com·
G Spotify The world's most popular music store doesn't own any records - Spotify
FIGURE 2 .10 The world 's most popular media company doesn't create any news - Facebook
Exampl es of dematerial -
ization through digital The world's largest movie company doesn't own any cinemas - Netflix
services.
often include both internal and external co-workers, who in addition can be localized
at a number of different places of the world.
Today, we are also in the middle of a new period of radical industrial change, driven
by, for example, digitalization, mobility, Internet, e-services as well as hyper-fast micro-
processors and software algorithms that can manage very large amounts of data. Many
speak of a new industrial revolution which has increased gradually in strength since the
development began with the breakthrough of computers in the 1960s and 1970s. The
development in IT and computer technology has also brought a transition from hard-
ware to software, a dematerialization of both products and production. Furthermore,
digitalization is penetrating an increasing number of areas. Many physical products
are being replaced by Internet-based services, and more and more trading is taking
place online. Through the rise of new companies with Internet-based business models,
for example Spotify, Uber, Netflix, Facebook, and Alibaba, there is a separation taking
place where the service is distributed by a company that is not the owner of the original
product, for example, the CD, the private car, or the holiday home (see Figure 2.10).
The development in automation, sensors, and software development enables the
collection and analysis of large amounts of data about products and users, big data
analytics. It also allows for machines and technical systems to take over cognitive
tasks from humans to an increasing extent. By using the Internet to connect different
technical systems and components in the Internet of Things (IoT), it is possible to collect
data and run automated control remotely so that machinery and devices can become
integrated into closely interconnected systems. Sensors can also be included in many
everyday objects, like mobile phones, clothes, refrigerators, bags, vehicles, and packages
so that user patterns and behavior can be analyzed and optimized.
Many argue that we are only at the start of this transformation. The same way that
the success of music streaming services online via, for example, Spotify and YouTube,
radically changed the rules of competition in the music industry, the current digi-
talization will probably result in profound changes for many industries, companies,
and professions. Being able to handle this radical transition will be one of the biggest
challenges for Swedish companies in the future.
46 © THE AUTH O RS AN D STU D ENTLITTERATU R

Summary
The chapter has discussed Swedish trade and industry. Swedish companies have a
history of being innovative, from de Laval's separator to Spotify, and high-quality
products have for a long time been a Swedish trademark. Many internationally leading
companies have Swedish roots.
Up until about the 1970s, the Swedish economy was dominated by goods-manufac-
turing industrial companies. Since then, the service sector has increased in scope and
by 2010 roughly 2/3 of all workers were employed in this sector. The number of people in
employment is approximately 4.6 million. Out of these, approximately 70 percent work
in the private sector and approximately 30 percent in the public sector. The business
structure in Sweden distinguishes itself with "a small waist" with a relatively small
number of mid-sized companies (50-249 employees) which also employ a relatively
small portion of all employees in Sweden. Most Swedish companies are instead either
small (46 percent of all employees work in companies with 0-49 employees) or very
large (35 percent work in companies with more than 249 employees).
Swedish trade and industry can be divided into six main sectors: extraction of raw
materials, production of goods, built environment, business services, distribution,
and other services. The sectors can then be divided into industries and sub-industries.
The structure is, however, not fixed and changes constantly. Today, digitalization and
automation are the most significant drivers for industrial change, with forerunners such
as Uber, Alibaba, and Spotify, which do not, as the traditional industrial companies
did, own large physical assets in the form of, for example, production plants.
References
Berggren, U., Bergkvist, T. & Hedby, U. (2008). De nya affiirsinnovationerna, Nutek 2008:1.
Blomgren, H . (Ed.) (2007). Sil jobbar Sverige. Studentlitteratur.
Brynjolfsson, E. & McAfee, A. (2014). The Second Machine Age: Work, Progress and
Prosperity in a Time of Brilliant Technologies. W.W. Norton & Company.
Fagerfjall, R. (2013) . Sveriges niiringsliv. Studentlitteratur.
Giertz, E. (Ed.) (2008). Dil foriindrades Sverige. Studentlitteratur.
Lager, T. (20n). Managing Process Innovation : From Idea Generation to Implementation .
Imperial College press.
Nordic Netproducts AB, www.nordicnet.net
Statistics Sweden (2017). Customised statistics.
Sodergren, B. (2016). Flaggskeppsfabriken: Styrkor i svensk produktion. Vinnova 2016:07.

-------
..................................................................................................•
BUSINESS OPERATIONS AS
POINT OF DEPARTURE
The main focus of Industrial Management is the business operations of a com-

pany or an organization, i.e., the way they develop, produce, and market their
goods and services. One important aspect is to understand the different condi-
tions of different companies, for instance with respect to their customers, prod-
ucts, and production processes (i.e., how different companies create value for
their customers). What the company offers, how these offers are created, and
how revenue is generated from the company's operations constitute the core of
Industrial Management. In this chapter we discuss three fundamental concepts
of Industrial Management: the value proposition, value creation, and value
capture. Taken together, these three concepts describe a company's business
model, which is a powerful model for understanding how various elements of
the business operations interact and influence each other.
3 .1 Th e value proposition: goods and services

Industrial companies create value by developing, producing, and marketing products.
When speaking of products in a general sense, we are usually referring to physical
objects. However, if we take a closer look, a product can refer both to a good (tangible
product) and a service (intangible product). As discussed in Chapter 1, the academic
field of Industrial Management has traditionally revolved around the production of
physical goods; however, with time, the production of services has become increas-
ingly important. Thus, to avoid the traditional notion that a product is restricted to a
tangible object, it is today more common to speak of the company's value proposition.
This concept refers to the value of what a company is offering to its customers, both
products and/or services.
0 THE AUTHOR S AN D STUDENTLITTERATUR 49

PART I • INDUSTRIAL MA NAGEMENT
Various types of value propositions

Some companies sell their products directly to consumers, often called "busi-
ness-to-consumer" (B2C). Other companies sell their products to other companies,
often called "business-to-business" (B2B) (see Table 3.1). This is a simple classification
since some products are sold to both consumers and producers. Still, the customer type
is often of critical importance for the company's strategy and operations.
Goods and services differ in many ways. Tangible products (goods) can be devel-
oped, produced, stored, and delivered. Often, the development, production, and storage
of goods occur before the customer is involved or even identified. In addition, the
quality of material products is often possible to assess and measure in a precise and
objective way. It is a different matter for intangible products (services). Because of their
intangibility, pure services are produced and consumed simultaneously in a direct,
close producer-consumer relationship. Moreover, services cannot be stored and deliv-
ered (however, the actual storage and delivery can be a type of service). Evaluating the
quality of services is often a highly subjective matter.
In practice, however, most products are a mix of goods and services. Many tangible
products, such as advanced machinery, are sold together with a service agreement.
Mobile phone contracts (services) are sometimes marketed with the offer of a new phone
TABLE 3.1 Examples of various product types.
Business-to-consumer (82() goods Business-to-business (828) goods Services

Books Steel Education
Automobiles Wood pulp Machinery service
Toothpaste Trucks Maintenance
Groceries Engines Consulting
Mobile telephones Power stations Telecommunications
Medicines Mobile telephone systems Computer service
Dishwashers Machine tools Industrial cleaning
Clothes Electronic components Electronic payments
Houses Factories Transportation
Furniture Office furniture Heating
Computers Computers Web-based games
Software Software Mobile applications
Electricity Electricity Streaming media
50 © THE A UTH ORS AND STUDE N TL I TTE RATUR

CHAPTER 3 • BUSINESS OPERATIONS AS POINT OF DEPARTURE
FIGURE 3.1
Val ue propositions: Most are
a mix of manufactu ring an d
service operations.
(goods) "for free". The installation of a large computerized business system requires
considerable work to adapt the system according to the customer's specifications. In
short, when we as consumers purchase a tangible product, the chain of operations
in order to provide us with the product consists of a number of services (intangible
products). For example, if we purchase a computer via the Internet, we would regard
this as buying a physical product. The physical computer and its components were
all manufactured and then assembled at different factories somewhere in the world.
However, many of the activities that enabled the delivery of the computer are different
types of services; for instance, picking up the order, installing software and configuring
the operating system, and transporting the computer to our home (see Figure 3.1).
The various services that industrial companies offer their customers can be divided
into two types. Firstly, there are services that complement the company's physical
products by facilitating the sale and delivery of the product (e.g., by offering a service
agreement) or by adapting the product to the customer's operations for a smooth tran-
sition (e.g., through customization of a new IT-system). Secondly, there are services
where companies replace the physical product with a service, i.e., instead of purchasing
a product, the customer leases the product, subscribes to use it, or even purchases the
functions of the physical product. For example, instead of purchasing and operating
their own data center for their IT systems, many companies buy these services from
external suppliers. Similarly, many companies purchase a set of specified copier and
printing services provided by a supplier, instead of purchasing the physical office
equipment. The suppliers then provide maintenance and make repairs. In fact, many
industrial companies today are trying to develop these kinds of business models as a

TABLE 3.2 Functions of industrial services (based on Cusumano et al., 2015) .
Services that simplify Services that adapt the product, improve Services that replace the sale of
sa les or use of a product the product's functionality, or help the the product.
but do not significantly customer develop new ways to use it.
affect the product's Closely linked to the product.
fu nctionality. Requires close cooperation with the
customer.
Examples: Examples: Examples:

• Financial services • Tailored customization • Computer/IT services
• Warranties • Systems integration • Internet data storage
• Insurance • Technical updates , Rentals and leases
, Technical support • Development of the customer's • Functional sales "Power by the
, Training business processes hour"
• Operations support
way to expand their offering and promote long-term and closer customer relationships.
Many customers also prefer making regular, fixed, and smaller payments for the ser-
vices they use instead of making a large investment (see Table 3.2).
Value propositions and the corporate strategy

How the value proposition is formulated is closely associated with the company's busi-
ness concept (sometimes called business idea) and its strategy. The company's business
concept reflects its overall goals, the reason for its existence, and the owners' vision.
A good business concept also reflects more aspirations for the company's operations
than those reflected by its financial goals. The company's strategy reflects the company's
plans for how it intends to realize its business concept - that is, how the company will
provide value to the customers, how it will compete with other companies, and how it
will develop its operations in the long term.
De~igning the value proposition is a strategic decision that will influence the compa-
ny's operations - for example, which market segment to focus on, what type of expertise
will be required, which equipment will be needed and, not least, how the operations
are managed and organized. Regardless of whether the company offers goods and/or
services, there are three principal competitive strategies to choose from (see Figure 3.2):
1 Competitiveness by product leadership: The value proposition is based on

superior products, i.e., goods and/or services. Through the high quality of the
52 © THE A UTHOR S A ND ST U DENTL I TTE RA TUR

CHAPTER 3 a BUSINESS OPERATIONS AS POINT OF DEPARTURE
Product leadership
High
Innovation
Product functions
Product qualities
Differentiation
Premium price Economies of scale
Efficient operations
Standardized solutions
Well-known technologies
Customer relationships Low costs
Unique products Low
Operational
Customized
Flexibility Low High excellence
Service and support
Customer loyalty FIGURE 3.2
Three different competitive
High strategies (based on Treacy
Customer intimacy & Wiersema, 1993).
products' properties and their sophisticated functions, the company creates a

distinctive brand. To maintain this level of quality, the company must invest
heavily in innovation and product development. The company is based on its
ability to command relatively high (premium) prices for its products.
2 Competitiveness by operational excellence: The value proposition is based on low
prices. Because operations processes are efficient and products are standardized,
products are manufactured at low cost and in high volume. Sales prices are low
(in relation to the product quality offered). The company is based on its ability to
maintain low production costs.
3 Competitiveness by customer intimacy: A company manufactures custom-made
products for its customers. Each unique product is produced to order. Customer
loyalty and relationships are very important. The company is based on its ability
to maintain operational flexibility in meeting specific customer requirements.
In practice, of course, many companies combine these strategies in one way or another.
However, it is important to remember that there are inherent conflicting logics between
these three strategies. High operational efficiency is usually incompatible with high
flexibility and highly customized production. Similarly, it is very difficult to develop
sophisticated product properties, premiere features, and high-quality functionalities
and at the same time offer these products at low prices. Thus, a company's value prop-
osition and its overall strategy must match the company's three major value-creating
processes: innovation, production, and marketing. We will return to these processes
further on in this chapter.
C THE AUTHORS AND STUDENTLITTERATUR 53

PART I • INDUSTRIAL MA NAGEMENT
The box below describes the way Atlas Copco (an equipment supplier to the manufacturing
and construction industries) does its business (Atlas Copco, 2018).
Atlas Copco - this is how we do business
Sales and service

Customer focus is a guiding principle for Atlas Copco. The ambition is to build close relationships with
customers to help them increase their productivity in a sustainable way. Customer engagement, sales and
service take place through direct and indirect channels (mainly distributors) as well as through digital channels,
in order to maximize market presence. The Group has a global reach and sales in more than 180 countries.
Sales of equipment is performed by engineers with strong application knowledge and the ambition to
offer the best solution for the customer's specific application. Service and maintenance performed by skilled
technicians is an integral part of the offer. Service is the responsibility of dedicated divisions in each business
area. The responsibility includes development of service products, sales and marketing, technical support as
well as service delivery and follow-up.
More than 40 % of revenues are generated from service (spare parts, maintenance, repairs, consumables,
accessories, and rental). These revenues are more stable than equipment sales and provide a strong base for
the business.
Manufacturing and logistics

The manufacturing philosophy is to manufacture in-house those components that are critical for the perfor-
mance of the equipment. For non-critical components, Atlas Copco leverages the capacity and the competence
of business partners and cooperates with them to continuously achieve product and process improvements.
Approximately 75 % of the production cost of equipment represents purchased components and about 25 o/o
are internally manufactured core components, assembly costs and overhead. Equipment represents less than
60 % of revenues and Atlas Copco has organized its manufacturing and logistics to be able to quickly adapt to
changes in equipment demand. The manufacturing of equipment is primarily based on customer orders and
only some standard, high volume equipment is manufactured based on projected demand.
The assembly of equipment is to a large degree carried out in own facilities. The assembly is typically lean
and flow-oriented and the final product is normally shipped directly to the end user. The organization works
continuously to use human, natural or capital resources more efficiently, while ensuring highest quality.
Innovation
Atlas Copco believes that there is always a better way of doing things. Innovation and product development
are very important and all products are designed internally. A key activity is to design new or improved
products that provide tangible benefits in terms of productivity, energy efficiency and/or lower lifecycle cost
for the customer, and at the same time can be efficiently produced. Atlas Copco protects technical innovations
with patents.
Innovation also includes better processes to improve the flow and utilization of assets and information.
Innovation will improve customer satisfaction and contribute to strengthening customer relations, the brand,
as well as financial performance. Overcapacities and inefficiencies must always be challenged.
54 0 THE AUTHORS AND STUDE N TL ITTERATUR

3 .2 The value creation

The company's transformation of resources
A classic model of value creation in industrial companies describes industrial opera-
tions as the transformation of various resources (inputs) to products (outputs). A com-
pany's valu e added is the difference between the economic value of its output (sales
price for finished products) and the economic value of its input (cost of the resources
that make up the products).
The value creation process is different for different types of operations. In the pure
manufacturing company, various inputs are transformed to outputs; that is, to the
physical products (goods) sold to customers (see Figure 3.3). Inputs may be raw materi-
als, semi-finished goods, and various other components. The resource transformation
process also requires production plants, technical equipment, the knowledge and skills
of personnel, and (sometimes) external contractors.
In a pure service business (Figure 3-4), the transformation and logic of the value cre-
ation process are different. The customer is often directly involved in the service opera-
tions (e.g., as the passenger of an airplane). Sometimes the service includes changes in
the customer's operations or property (e.g., car repairs, installing a computer system
or transporting goods). Services can also involve knowledge development, for example
training and consulting in different areas, or collecting information, for example by
gathering data on behalf of different customers for different types of statistical analyses.
There are many factors that influence this resource transformation, and exactly how
the system should be designed to be efficient differs from company to company. There
Resource transformation
Technical equipment
Raw materials Input
Semi-finished goods
Components
Output •- • ••
FIGURE 3.3
Value creation in manufac-
Employees
turing operations.
Resource transformation
Technical equipment
~
-----N&.@
Input
Output
-- . -
FIGURE 3.4
Value creation in service
Employees
operations.
C> THE AUTHOR S A N D STUDEN TLI T TE RA T U R 55

are, however, four factors that are of particular importance in order to understand
the logics of different resource transformations, sometimes referred to as "the 4 Vs":
• Volume - the size of the business operations

• Variety - the variety of products produced
• Variation - the variation in customer demand
• Visibility- the level of customer interaction.
Volume of business operations

The volume of operations is one of the most important factors that influence the logics
of the value creation process. A high production and sales volume enables operations
with low costs, which in turn is among the most important competitive factors. This
is often referred to as economies of scale, which means that a company through high
operating volumes is able to utilize labor, equipment, and production facilities in a
cost-efficient manner so that the fixed costs of the operations can be shared between
many units of output. To achieve this, however, it is necessary that the activities of the
process are predictable and repeatable, that the process is designed and organized in a
systematic way, and that the included sub-processes, activities, and components have
a high level of standardization. Standardization also enables specialization of staff and
equipment, which in turn creates conditions for greater economies of scale (cf. the char-
acteristics associated with the concept of"industrialization" described in Chapter 1).
High-volume production is often capital-intensive. High operating volume enables
the purchase of expensive and specialized equipment which will increase efficiency even
more. On the other hand, competing with high volume and low costs usually requires
large investments in specialized equipment and expensive production facilities.
High volume is, thus, closely linked with the strategy to compete through oper-
ational excellence described in Section 3.1, and there are a number of examples of
companies where the ability to maintain a high operating volume is a prerequisite for
their existence. Traditional process industries such as extraction of raw materials (oil
and gas, iron, etc.) and production of goods such as steel, paper, chemicals, and food,
are completely dependent on high operating volumes (cf. Chapter 2). The same applies
to the manufacturing of, for example, vacuum cleaners, cars, computers, and electronic
components, not to mention train companies, fast food restaurants, movie theaters, and
retail companies like Ikea, H&M, Primark, Wal-Mart, and the Swedish retailer Clas
Ohlson. A perfect example of high-volume service operations is McDonald's, whose
restaurants in Sweden alone (according to McDonald's themselves) serve approximately
400,000 guests on a daily basis.
The standardization and specialization which enable high volume do, however, come
at a price: operations become less flexible, which means that standardized products and

services only can be offered within a limited range. Moreover, the process is often both
difficult and expensive to change. If there is a shift in market demand, or if certain custom-
ers wish to customize or complement the standardized products, it can be problematic.
Variety of products produced

In companies with high variety in their value proposition (the strategy to compete
through customer intimacy in Section 3.1), the production processes usually include a
significantly lower level of repeatability, which in turn leads to less predictability and
specialization and higher demands on flexibility. The result is higher average costs
for each product or service, which in turn means that the company has to create an
extra value for the customer that will justify the higher prices in relation to a low-cost
company with high operating volumes. Compare a fine-dining restaurant with a fast
food restaurant. The fine-dining restaurant usually offers a much more varied menu,
which requires a wider range of products as well as more skilled and experienced chefs.
Normally, the meals also take longer to prepare and are more expensive, which needs
to be justified, for example by offering food of higher quality and ensuring that the visit
to the restaurant is a pleasant experience.
There is, in other words, a classic opposition between high volume in the production
and high variety in the value proposition. High volume requires high repeatability,
specialization, and standardization, while high variety requires a high level of flexibility
and the ability to manage a more complex production process.
In practice, many companies have to compromise between the two opposing logics.
Different companies use different strategies for this. As an example, many businesses
with high variety often try to offer their customers package deals. Other companies
try to combine different processes, for example by using mass-produced components
or sub-processes, which later can be combined into a unique product or service from
the customer's perspective.
Variation in demand
Demand can vary in more ways than different customers requesting a varied and
customized product range. While, for example, insurance companies, water treatment
plants, energy producers, and nursing wards in a hospital have a relatively regular
demand where shifts can be predicted relatively far in advance, other types of opera-
tions, for example, fire departments or emergency rooms, have a demand which is close
to impossible to predict, which leads to different types of effects. The fire department
has, on one hand, long periods of excess capacity when the firefighters have nothing
to do. Emergency rooms, on the other hand, usually have insufficient capacity during
long periods, where low-priority patients might have to wait a long time because the
medical staff are preoccupied with patients with more acute conditions.
C> THE AUTHORS A ND STUDE NTLITTERATUR 57

Other sectors have seasonal variations in demand, for example, the demand for ice
cream is higher in the summer, the demand for hotel rooms at a ski resort is higher in
the winter, and the demand for toys is at its peak during the Christmas shopping season
in December. An industrial example is the Swedish company Camfil (a world-leading
manufacturer of filters for ventilation systems). Since the demand for filters from real
estate owners is significantly higher during the summer months than the winter months,
Camfil often have excess capacity in the autumn, while they have to build up large stocks
before the summer in order to meet the demand which they know is coming.
In sectors where the demand does not vary, but is stable over time, there are of
course greater opportunities to standardize production and optimize the efficiency
of machinery and labor during production. Consequently, many companies try to
forecast the demand in advance so that they can adapt accordingly. Some companies
hire seasonal, part-time, or temporary staff to manage the peaks in demand. Many
companies also strive to even out the demand over time in different ways, for example
by offering lower prices during periods of lower demand and/or higher prices when
the demand is at its peak. Another way is to create complementary products with a
different demand variation, like when conference and business hotels offer "romantic
weekends" on the weekends or when restaurants serve "Sunday brunch" on Sunday
afternoons when they have fewer guests. In the same way, there are also many lunch
restaurants that combine their lunch service with catering services and thus try to
utilize their staff and kitchen resources outside of lunch hours.
Visibility: level of customer interaction

In most cases, value creation results from a mix of goods and service production. Figure
3.5 presents a simplified illustration of this resource transformation process. The arrow
in the upper box represents the operations. The lower box represents the customer
experience. As the figure illustrates, some areas of the two boxes overlap although other
areas do not. This overlap differs according to the type of operations (see Figure 3.5).
Normally customers are not involved in traditional product manufacturing (e.g., the
manufacture of automobiles or computers). Thus, there is no overlap of the two boxes.
The same is true of certain kinds of services (e.g., delivery of mobile telephone services
via the Internet). Similarly, banks and travel bureaus conduct many of their activities in
the "ba:ck office". Their customers have no contact or involvement with such activities.
Typically, however, a great deal of the operations in the service sector requires direct
contact with customers. Examples are the "front office" activities of banks and travel
bureaus in which the customer experience is part of the sproduct that is purchased.
In such cases, the value proposition is a sum of the outcome (end result) plus the
customer experience.
Traditional manufacturing and the back-office activities of service operations often

CHAPTER 3 • BUS INESS OPERATIONS AS PO INT OF DEPA RTURE
Production
Back office Front office . Outcome

Customer
experience FIGURE 3.5
The product as the sum
of the outcome and the
customer experience (based
on Johnston and Clark,
Product 2005),
show many similarities. Generally, value creation is independent of the customer,

who only evaluates the final outcome. However, sometimes the two boxes overlap.
Toe greater the overlap between the boxes, the more direct contact the customer has
with the production process and the more important the customer's experience of the
production process is for the evaluation of the product as a whole. At a restaurant, for
example, the quality of the produced food (the back office) is fundamental. However,
from the customer's perspective, the restaurant's service, atmosphere, and hospital-
ity (the front office) are at least as important. The same applies to the installation
of technical systems or the provision of technical consulting services. Naturally, the
technical outcome is the most important aspect, but the customer's impression of the
technicians or consultants also matters. Were they easy to work with? Did they meet
the time schedule? Were they friendly and reliable?
In addition, there are service-based value propositions in which the very process
constitutes the product, and where there are almost no back-office activities at all (see
Figure 3.6 on the next page in which the boxes merge). An example of this kind of
service is different types of therapies, for instance massage. However, such activities
are rarely considered as industrial operations.
Based on the customer interaction, the value creation process can be divided into
three principal categories (we will come back to the strategic consequences of these later):
1 Goods-dominant logic: Value creation is independent of interactions with the

customers.
2 Back office-dominant logic: The main value creation is independent of interac-
tions with the customers, but the interactions take place in central parts of the
process (often at the start and the end of the process).
3 Front office-dominant logic: The main value creation occurs in direct contact
with the customers; most of the value creation involves the customer experience.
C> THE AUTH O RS ANO STU DEN TLITTERATUR 59

Goods-dominant logic
~ .BackotLdomioa;;;;;,,; · · ~
FIGURE 3.6
Va rious degrees of customer ······ ················-··-··--
involvement in value Front office-
creation . dominant logic
The four Vs summarized

The four factors volume of business operations, product variety, variation in demand,
and level of customer involvement have a strong impact on the factors that are impor-
tant to take into account in order to achieve effective value creation. Low operational
volume, high product variety, high variation in customer demand, and high level of
customer interaction tend to involve higher production costs than high operational
volume, low product variety, low variation in customer demand, and low level of cus-
tomer interaction (see Figure 3.7). High production costs mean that the company has
to be able to charge high prices for their products on the market. Consequently, many
companies search for ways to reduce production costs per product, for example, by
increasing volumes by modularizing the products to reduce product variability, or to
even out variations in demand through alternative use of the production equipment
during periods oflow occupancy. In fact, high volume, low variety, low variation, and
low customer involvement are the four typical characteristics of business operations
that usually are labeled as industrial or industrialized.
Diff~rent emphasis in different business operations

Above, we have discussed value creation by focusing on the company's production pro-
cess. However, the company's innovation and marketing processes are equally impor-
tant. Product development, production, and marketing are the three sub-processes that
together constitute the company's value creation. The product development process
involves developing business and value propositions, creating new ideas and utilizing
them. The production process is about realizing the company's value proposition as
efficiently as possible. The marketing process involves bringing the value proposition

Unique products High repeatability

Wider individual tasks Volume Specia Iization
Low High
Less systemization Capital intensive
High unit costs Low unit costs
Flexible output Well defined output

Complex production Variety Routine
High Low
Match customer needs High degree of standardization
Changing capacity Predictable capacity needs

Unsure forecasts Variation in demand High degree of standardization
Low utilization High Low High utilization
Short waiting tolerance Time lag between production

Satisfaction governed by and consumption
Visibility High degree of standardization
by customer perception High Low
Customer contact skills needed High staff utilization
High unit costs Centralization
Low unit costs
FIGUR E 3.7 The four Vs and their impact on value creation (after Slack et al., 2010).
to the market, getting the products sold, and influencing the customers' perception of
the value of the goods and services that the company provides.
The value creation of different companies consists of different combinations of these
three processes, which means that they are of different importance in a company's
operations. One way to understand this is to analyze how the costs are divided between
different types of value creation. Figure 3.8 gives some examples of how the cost structure
in value creation can vary between different companies and industries. Company 1, to
the left, represents a traditional manufacturing company: most of the costs, and thus
most of the operations, are in production. Company 2 has the largest share of its costs
in the form of purchases, such as raw materials and components. Today, many manu-
facturing companies have this cost structure: instead of doing everything themselves,
the trend has for a long time been to purchase increasingly more work from various
types of suppliers (see Section 3.4). Company 3 is a company dominated by (product)
development and research, something which is common in the pharmaceutical indus-
try. Company 4, on the other hand, is dominated by various marketing activities, such
as advertising, promotion, and customer relations. Fashion, perfume, and cosmetics
are some examples of businesses which often report this type of cost structure.
In practice, however, the cost allocation may vary considerably between different
companies. The cost allocation, of course, does not have to be in line with the customer
value, but it provides a rough idea of what the company's value creation revolves around.
C THE AUTHOR S AND STU DE N TL ITTER A TUR 61

FIGURE 3.8
The cost structure in va lue
creation va ries between
different industries and
companies. Company 1 Company 2 Company 3 Company4
3 .3 Value capture
To survive in the long term, a company must retain some of the value it creates for its
customers in the form of revenues to generate profit. This is referred to as value capture.
The way this is done, the so-called revenue model, is often closely associated with the
value proposition the company offers its customers.
Most of the traditional revenue models are built around unit sales - that is, the
company receives payment for each unit sold based on the cost of producing the unit,
plus a profit margin. Because cost-based pricing is easy for everyone to understand,
companies tend to price their goods and services on a per unit basis. Thus, sales prices
reflect the cost of raw materials, labor, and overhead, plus a profit. However, the price
that customers are willing to pay for a product cannot be objectively determined.
Market conditions set sales prices based on rather vague ideas about the value of the
product for the customer, the price competitors set for an equivalent product, and the
alternative products the customer could have purchased at the same price.
There are, nevertheless, a number of other ways to generate revenue and to "capture"
a share of the value created for the customers. One way is through additional sales in
what is often called the aftermarket. This means that the company sells additional
equipment, spare parts, maintenance, or other product-specific services to customers
who have bought the company's products and thus become somewhat dependent on
them (from the supplier perspective this is often called the company's "installed base").
Typical examples are car retailers that often provide original spare parts and accesso-
ries, or car workshops dedicated to specific automotive brands.
A common version of this revenue model is sometimes called "Razors and Blades".
The name comes from the now famous strategy used by Gillette for its brand of men's
safety razors. The razors were cheap, but the replacement blades were relatively costly. In
62 Cl THE AUTHORS AND ST UDENTLITTER A TUR

CHAPTER 3 • BUSINESS OPERATIONS AS PO INT OF DEPARTURE
a nutshell, this strategy tempts consumers to buy an inexpensive product that requires
more expensive consumables. This revenue model is commonly used with both consumer
and producer goods. For example, compare the price of a desk printer with the price
of its ink cartridges, which of course are specifically designed for each type of printer.
Another version of this revenue model, which is often associated with luxury
products, is to sell accessory products and add-on services under the same brand even
though these products/services have no direct connection to the original products. For
example, the luxury automobile manufacturers, Porsche and Ferrari, also sell clothes
collections under their brands. The idea is to strengthen customer loyalty through
brand identification as well as generating significant additional revenues.
A third type of revenue model is to rent or lease out products instead of selling them.
Although the company retains ownership of the product, the customer pays for the
right to use the product. This model is often combined with various kinds of mainte-
nance and warranty contracts that guarantee a certain level of product performance.
A fourth revenue model is licensing. In this model, the customer purchases the right
to manufacture or sell a product, to use a technology, or to use a company-owned intan-
gible asset (e.g., patents and trademarks). A prime example of this is the Danish brewery
Carlsberg, which, among other things, does business by licensing the production of its
Sol beer to other breweries all around the world. Other examples are famous fashion
companies, such as Armani, Hugo Boss, and Prada, which gain revenue by licensing
their brands to cosmetics, perfumes, and other beauty products manufactured and
sold by L'Oreal, and others.
There are several other types of revenue models. In one model, the supplier com-
pany receives revenue from the customer's product use. One example is "pay-per-view"
in which customers pay to watch events via private broadcasting. Another model is
freemium ("free" + "premium") in which customers pay for digital products such as
software, games, and other Internet services. Adobe and Spotify, among others, use
this revenue model in which the customer receives the basic product free of charge, but
typically must pay a fee to get access to some of the product's key features, to improved
fu nctionality, or to related Internet services.
Furthermore, in affiliated marketing, used by for example Google and Facebook,
the products (goods or services) are offered free of charge to users while the com-
pany receives revenue through the sale of advertisements targeted at particular users.
Publishers of free newspapers, commercial radio/television companies, and telecom-
munication companies (in the latter case, the so-called "free telephony") also use this
revenue model.
While this list of revenue models is not all-inclusive, it does reveal the breadth,
ingenuity, and diversity of such models. The point is that these models are very often
as strategically important as the company's product design. Development of new
Q THE AUTHORS AND STUDENTLITTERATUR 63

advanced technologies, including mobile payment systems, keyword recognition, and

big data analysis capabilities, make new types of revenue model increasingly important.
In summary, the way a company generates revenue is a key component of its business
strategy. The different components of the company's business model, i.e., the value
proposition, the value creation, and the value capture, form an integrated whole that
must be consistent and function together.
3.4 The business operations in the value chain

So far, we have addressed the business operations of an individual company. The indi-
vidual company usually only includes one or a few of the production steps from raw
materials to finished products. Thus, we can identify a number of links in a product's
value chain. For example, the production of a loaf of bread can be traced from planting
and harvesting, to the flourmill, to the wholesaler, to the retailer, to the baker, and to
the consumer. Although the value really only appears when the consumer eats the
bread, value is added at each step of the value chain value (for example, a loaf of bread
has more value than the wheat seeds, than the flour, than the yeast, etc.).
Position in the value chain

A company's position in the value chain and the various steps in the chain that are
covered by its operations raise strategic questions that influence the company's long-
term development and competitiveness. In some industries, individual companies
control the entire value chain. An example is the oil and gas industry in which large
companies control exploration, extraction, refining, and local petrol stations. In other
industries, individual companies specialize in only one link in the value chain. There
are, for instance, carpenters that are specialized in the assembly of ready-to-assemble
furniture from companies like Ikea, for different companies.
Figure 3.9 illustrates a simplified value chain in the clothing industry. The figure
shows the links in which an article of clothing (e.g., a pair of jeans) originates with
raw materials and moves through the various production steps before reaching the
retail store. The clothing industry is an illustrative example of how structural changes
in an industry can cause changes in the value chain. Historically, the apparel sewing
factories controlled the clothing industry to a great extent. In Sweden, for example,
textile companies with brands such as Algots controlled large parts of the chain. Today,
-----·
FIGURE 3.9
The traditional value chain
in the clothing industry.
64 C THE A UTHOR S AN D ST U DE N TLITTER A T UR

CHAPTER 3 • BUSINESS OPERATIONS AS PO INT OF DEPA RTURE
however, it is more common that there are companies between the factories and the
retailers that control the chain. These companies do not manufacture clothes but have
developed strong brands through which they control large parts of the value chain
through marketing, distribution, and design.
One example is H&M. This large Swedish retail corporation controls the design,
purchase, and sales of its clothes. With its many stores, H&M ensures that it has a sales
volume large enough to support the relatively low prices of its clothes. By contrast, the
Italian clothing retailer Benetton does not own the Benetton stores, which are separate
legal entities. Despite this structure, Benetton still maintains considerable control over
its brand. Benetton has contracts with the stores that require them to sell only Benetton
clothes and to follow certain rules on store fittings, etc. In return, the stores benefit
from company-wide, joint marketing campaigns. In this way, Benetton enjoys both
large and small company advantages.
Another example, also from the clothing industry, is the Spanish company Zara,
which is known for owning all steps in the chain: from factories to the stores. Zara very
effectively collects customer data from stores and operates a highly efficient logistics
system that can produce relatively small collections at low prices.
Ikea, the Swedish home furnishings corporation, is an example from a different
industry. Important links in Ikea's value chain include design, engineering, manufac-
turing, sales, transport, and assembly. Ikea controls the entire value chain but is not
directly involved in all activities. For example, while Ikea has its own product designers,
it also uses external designers. Also, the engineering part of their operations is very
important because of the many functional requirements of the Ikea products. Ikea's
ready-to-assemble furniture, which is of relatively high quality, must be engineered so
that they fit in a (preferably flat) cardboard box. It is important that the cardboard boxes
are as flat as possible so that they can be piled on pallets during transport. Subcontrac-
tors in various parts of the world usually manufacture the furnishings and their com-
ponents. Ikea has stores worldwide - essentially store-warehouse combinations - that
sell their products. Typically, customers transport their purchases themselves and then
assemble them at home. One reason behind Ikea's enormous international success is
its creation of a new type of value chain that has changed the entire furniture industry.
Structural changes in the value chain

A value chain may change when a new company enters an industry or when existing
companies change their position in the chain. For example, a company might buy
another company that is located somewhere along the chain, either "downstream"
(in front of it) or "upstream" (in back of it). This is known as vertical integration. By
contrast, horizontal integration occurs when a company buys a competitor positioned
in the same part of the value chain. This type of structural change is relatively common.
THE AUTHORS AND STUDENTLITTERAT U R 65

PART I • IND USTRIA L MANAGEMENT
Ownership changes, however, are not the only way in which the value chain may
change. In the past, large industrial companies often controlled many of the links in
the value chain; there was a high degree of vertical integration. In this way, companies
could control the quality and delivery of their components by manufacturing them
in-house. A well-known example comes from the automotive industry. In the early 20th
century, Ford Motor Company owned all the production steps for the Model T - from
iron mines to steelworks, to metal works, to manufacturing of components, to final
assembly. The only step not owned by Ford was the retailers, i.e., the dealers. Several
such vertically integrated companies exist also today. Zara (see above), for example,
has a high vertical integration.
However, in recent decades, the trend has moved towards vertical disintegration.
This means that companies are specializing more in their core business and leaving
earlier steps in the value chain, for example manufacturing, to external suppliers
and consultants.
Outsourcing
The purchase of products and services that a company has previously produced itself,
from another source (e.g., a subcontractor), is called outsourcing. Originally, companies
would outsource support services such as printing, transport, the company canteen,
computer operations, and facilities management. Today, however, companies com-
monly acquire many more goods and services for their core business from external
sources. In this way, some of the largest and most advanced industrial companies have
become systems integrators that orchestrate a wide range of goods and services in their
production systems, without "owning them".
Thus, there is a trend today of outsourcing internal operations and never even invest-
ing in internal expertise and resources for certain steps in the value chain. Many large
companies employ external consultants who work at the company's premises, use the
company's engineering equipment and IT systems, and, to some extent, are perceived
as colleagues among the company's employees. Similarly, personnel from employment
agencies may today work in any number of capacities at a company (although they are
employees of the agency, not the company). These include people working in produc-
tion, storage, reception, administration, etc. Thus, the boundaries between a company's
operations and the company as a legal entity may differ.
Insourcing
At the same time as many companies specialize in some activities and outsource other
activities, there is still a strong desire to take control of the value chain by controlling
what were traditionally regarded as the customer's operations. This is called insourc-
ing. Thus, many companies have employees working on site with the customer, doing
maintenance and service work and installing equipment and systems. Companies

Outsource lnsource
Facilities Operations &

IT maintenance
Components Financing
Manufacturing
Design +-----
Increased flexibility
Add-on services
etc.
Using existing systems

FIGURE 3.10
The current trend forward in
Increased economies of scale Create additional value industrial value chains.
often develop and manage facilities and systems for their customers - services that
they previously outsourced. See Figure 3.10.
One example is the Swedish company Ericsson, which not only develops telecommu-
nication equipment and builds telecommunication systems but also manages system
operations for various telecom operators. Borrowing a word from the computer indus-
try, people sometimes talk of a company's installed base (i.e., the equipment and systems
that the company has delivered and are used by various operators). This installed base
creates new opportunities for the development and sale of other items, for example
spare parts, other equipment, and supplies, and, most importantly, various services
that add to the value creation for the customer (and increase revenues for the supplier).
In this way, a company ties its customers closer.
Thus, constant changes, movements, and trends influence the value chain. Different
strategic trends have been popular at different times. One reason why many companies try
to position themselves further down the value chain is that the value added in operations
with convergent production flows is typically greater in the later links than in the earlier
links. The value added in the earlier links is usually low. Furthermore, to integrate forward
in the value chain is for many companies an attempt to avoid competition based on low
prices and instead offer something unique in the value proposition to its customers.
Although the value added is usually at its highest in the later production stages, i.e.,
downstream in the value chain, the same might not be true for a company's profitability.
Very often the competition is fierce and the marketing costs high at the end of the
value chain, for example in the clothing industry). However, in other industries there
might be a different situation. For example, in the oil and gas industry, the greatest
value added occurs in the early production stages, upstream in the value chain. As a
result, many petrol stations, which used to be owned by the oil and gas companies,
are now owned by financial investors and professional trading companies. Today, the
range of products and services offered at large petrol stations is quite different from
how it looked 30 years ago.
THE AUTHORS AND STUDENTLITTERATUR 67

- PART I • INDUSTRIAL MANAGEME NT
Offshoring and re-shoring

In recent decades, a strong trend has emerged oflocating both manufacturing and engi-
neering activities in low cost countries. The development in IT and telecommunications
and the increased globalization of trade have removed the spatial limitations of industrial
operations. Geography is no longer the barrier it once was. For example, now it is possible
to send technical information immediately to partners on the other side of the globe.
IT and telecommunication technology have, in many ways, made business opera-
tions location-independent. Service operations such as call centers and telecommu-
nication-based service centers may be located thousands of miles from the customers
who use them. Similarly, many labor-intensive production operations have moved from
the old, rich industrialized countries to countries in Asia, Africa, and Eastern Europe.
The same is true of software design and development. Asian and Eastern European
countries now have at least as many qualified engineers as Western Europe and the
United States. The physical movement of operations such as these is called offshoring
(not to be confused with outsourcing, explained above).
The advantages and disadvantages of offshoring are much debated. While the
short-term economic benefits of offshoring are often obvious, critics emphasize that a
company's long-term capacity for innovation and development usually benefits from
geographic proximity to product development, production, and marketing. In recent
years, a counter-trend has emerged in which companies return operations (that were
previously "off-shored") to their home countries. There are several reasons for such
re-shoring. For example, the benefits of a low-cost country may have disappeared
because the country has grown wealthier. A second reason could be that a company may
find the complexity of managing operations and maintaining high-quality production
in distant regions or countries too difficult. Thirdly, technological development may
have advanced to the point where the costs of machinery and equipment have dropped
low enough to restart production in the company's home country. Consequently, off-
shoring and re-shoring will probably exist in parallel in the future: global companies
will choose production locations on the basis of efficiency and economic considerations,
wherever these locations are in the world.
Value creation as a boundary-spanning activity

So far, we have discussed rather sequential and isolated value chains. In practice, how-
ever, value chains are much more complex, partly because they are often linked to each
other. Moreover, a single company may be part of several value chains. If a company's
finished products consist of many different components, the value chain easily becomes
very complex. Thus, a network is another way to describe these interactions between
companies. Many times it is possible to identify extensive networks of companies that
are, in some way, integrated in each other's business operations.
68 <> THE AUTHORS AND STUDENTLITTER A T U R

Furthermore, value networks or business ecosystems are other ways of depicting these
relationships. The key is to understand that a company's operations are not isolated,
rather they are interconnected with other companies. The value creation of some compa-
nies is totally dependent on goods and services provided by other companies, sometimes
to the company itself (e.g., in the form of technical components or special expertise),
sometimes to common customers who without the other companies' efforts would never
buy the company's product. Competing companies can, sometimes, collaborate in dif-
ferent development and delivery projects, and some companies are also subcontractors
to other companies. Many companies crossbreed in different ways. For example, a large
share of today's IT consultancy industry works with installations and customizations
of standardized IT-systems from major suppliers such as SAP, Visma, and Agresso.
Without these IT-system suppliers, the consultants would not get any assignments. At
the same time, the reveres also applies: the major IT suppliers are entirely dependent on
the existence of a wide range of consultants who can install and customize their software.
All of these approaches manifest an important characteristic of modern industrial
operations: value creation extends often far beyond the legal limits of the individ-
ual company. Important activities in the development, production and marketing of
goods and services included in the value propositions are performed by external actors.
From a customer perspective, the company may be just one of many companies in the
network of actors who together create the value the customer wants. It is central for
companies to understand their own role in this value-creating business ecosystem.
3.s Efficiency, effectiveness, productivity, and

profitability
There are several ways to determine if a company's operations are "good" or "poor", or
if they are managed "well" or "poorly". We often talk about the efficiency, effectiveness,
productivity, and profitability of a company or an organization.
Efficiency and effectiveness are closely related. Efficiency refers to how well the
company's internal operations and activities perform the transformation of various
resources to finished products - that is, whether this transformation is performed in
the right way. This (internal) efficiency can be measured in different ways including
the number of products manufactured per a specific unit of time, or the number of
labored hours, or amount of energy consumed, for each product.
Effectiveness refers to the company's capability to meet external demands such as
those from shareholders and customers. Does the company produce products that
satisfy the customers? Consequently, a company's environment determines whether
an activity has good effectiveness. Thus, efficiency relates to how well an activity is
performed, while effectiveness refers to the usefulness of the activity.
Efficiency has no value if the effectiveness is poor. In other words, efficiency deals

- PART I • INDUSTRIAL MANAGEMENT
with doing things right, effectiveness deals with doing the right things. However, there
is a constant dilemma in that high efficiency in relation to specific objectives is often
accomplished at the cost ofless flexibility and increased difficulties in adapting to exter-
nal changes, for instance, in customer demand. Consequently, a successful company
has to be "ambidextrous", i.e., both efficient and effective at the same time.
Efficiency, effectiveness, and productivity
Efficiency ("Doing things right")= amount of ~utput

amount of input
Effectiveness ("Doing the right things")= degree of goals achievement
Productivity= value of output value of output

value of input amount of input
Another commonly used concept in economics and business is productivity. There

are several productivity measures, but they are all relating produced value (output)
to consumed resources (input). Examples are labor productivity (value produced per
labor hour), capital productivity (value produced per monetary unit), or total pro-
ductivity (value produced in relation to all resources consumed during the resource
transformation process).
There are two additional concepts of importance that are often used in performance
measurement and financial control: profit and profitability. These are financial concepts
and relate to efficiency, effectiveness, and productivity only indirectly. In a market
economy, the fundamental assumption is that only effective companies have a chance
oflong-term survival and profitability. However, this does not mean that operations
that are efficient and effective automatically also are profitable.
Profitability is about financial effectiveness. It is a measure of whether the com-
pany's profit satisfies the market's or the owners' required return on their financial
investments. Does a company produce a reasonable profit given the amount of capital
invested? There are many measures of profitability (see Chapter 7), but they have one
thing in common: the profit from the business (i.e., revenues less costs) is assessed in
rela_tion to the financial capital invested (such as facilities, equipment, cash, etc.). From
the owners' perspective, a company with high efficiency, satisfied customers, and a profit
Profit and profitability
Profit= Revenues - Costs

p fit b Tt Profit
ro a 1 1 Y = Financial Capital
70 © THE A UTHORS AND STUDENTLITTER A TUR

CHAPTER 3 a BUSINESS OPERATIONS AS POI NT OF DE PA RTURE
may not necessarily be profitable (enough). The owners may require a larger return
on their investment than the company's profit produces, and there might be other
investment alternatives that provide a higher return than the company in question.
How do we determine if a company is efficient, effective, and productive enough to be
rofitable? The answer to this question requires continual control and follow-up of the
~ompany's activities so that gradual changes are noted. This means using measurements
(e.g., labor productivity) and comparing the results of these measurements to company
goals and objectives, as well as developing the appropriate analytical metrics. These
are all key elements in operations management.
Sum mary
Industrial Management takes its starting point in the business operations of the technol-
ogy-intensive company, that is: its value proposition, value creation, and value capture.
The company's value proposition includes the products (i.e., goods and services)
that the company offers on the market. Depending on whether the company turns to
other companies or consumers, the propositions look different. The value proposition
is intimately associated with the company's strategy. A company can strive to com-
pete through product leadership (the products are superior to competitors'), through
operational excellence (production is more efficient than the competitors'), or through
customer proximity (the products are more customized than competitors').
The value of a company's value creation depends on four main conditions: opera-
tional volume (high or low), product variety (high or low), variation in product demand
(high or low), and degree of customer involvement in the operations (high or low).
The company's value capture revolves around what the company is paid for and
how. A common model is unit sales, where the company sells a product unit and is
paid for it. However, many companies try to generate additional revenues through the
sales of, for example, additional equipment and spare parts. Another model is leasing,
or rental, where the company does not sell the product itself, but the service that the
product performs. Licensing is another model, where the customer buys the right to
produce a product under its own brand. Furthermore, freemium is a common model
for digitalized products, where an initial product is provided for free, but additional
or premium features are charged for.
An individual company is usually only active in certain stages of a product's value
chain. The company's position in the value chain has an impact on the company's
business model and how the value creation processes can be engineered and designed.
Over time, different value chains evolve through outsourcing, insourcing, offshoring,
and reshoring of different production steps.
Efficiency, effectiveness, productivity, and profitability are four important concepts
for understanding and assessing a company's business operations. Efficiency is an inter-

n PAR T I a INDUSTRIAL MANAGEMEN T
nal measure based on the amount of output over the amount of input. Effectiveness is
an external measure constituted by the degree of goal fulfillment. Productivity is the
value of output in relation to the value of input or the value of output in relation to the
amount of input, while profitability is a measure of the profit (revenues minus costs) a
company makes in relation to the capital needed in order to generate this profit.
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Amit, R. & Zott, C. (2001). Value creation in e-business. Strategic Management Journal,
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Amit, R. & Zott, C. (2012). Creating value through business model innovation. MIT Sloan
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Normann, R. (1984). Service management. Wiley.
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Normann, R. & Ramirez, R (1994). Den nya affi:irslogiken. Liber-Hermods.
Osterwalder, A. & Pigneur Y. (2010). Business model generation: a handbook for visionaries,
game changers, and challengers. John Wiley & Sons.
Slack', N., Chambers S. & Johnston, R. (2010). Operations management. Pearson education.
Tongur, S. & Engwall, M. (2014). The business model dilemma of technology shifts.
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Treacy, M. & Wiersema, F. (1993). Customer intimacy and other value disciplines. Harvard
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Zott, C., Amit, R. & Massa, L (2011). The business model: recent developments and future
research. Journal of Management, 37(4), 1 019-1 042.

............................................................................•
············· ·····
TECHNOLOGY-DRIVEN
DEVELOPMENT
The business sector is in a constant state of transformation as new technology

changes customer expectations as well as the conditions for companies. This rep-
resents an ever-present challenge to established companies. Technology which
is considered new and appealing today might soon be taken for granted, only
to be left behind when new technology emerges. New products are launched
and new companies are established at the same time as established well-known
companies change, are sold, or go out of business. Information and knowledge
spread rapidly across the world. New competitors that offer similar products,
but at a significantly lower price, pose a challenge to the established companies.
And the paradox is that the more successful a company is within an existing tech-
nology and market situation, the more difficult it is to adapt if the conditions of
competition change. This chapter describes some of the most important factors
behind this industrial dynamic.
4.1 Sources of innovation and technological development

For technology-based companies, it is a never-ending dilemma to balance between
streamlining operations to maximize competitiveness here and now, and investing
resources to develop skills and innovations that are not needed today but which may
be important for the company's future, long-term, development.
There is a common notion that research and technological development have a linear
course which is divided into different sequential phases. In its simplest form, this course
starts with companies and universities investing in research, research leads to product
development, product development leads to production, and production leads to sales.
This description might be applied to certain types of technological development, such
THE AUTHOR S AN O STUD EN TLI TTE RATU R 73

PAR T I • INDUSTRIAL MA NAGEMENT
as traditional pharmaceutical development. There are, however, many researchers who

have shown that it is not as easy as investing in research at one end of the process,
and then automatically ending up with marketable goods and service at the other. In
practice, the relationship between research, innovation, technological development,
and market demand is much more complex than what this so-called technology push
perspective makes it out to be.
On the contrary, the development of new technology and products is frequently
initiated by market demand, so-called demand pull (or market pull), that is, by a need
expressed by customers and users. Many products are initiated by a demanding cus-
tomer requesting, and sometimes also co-funding, product development from their
suppliers. This is how, for example, several large industrial companies have developed
through close collaboration with public agencies procuring new technology and infra-
structure. In Sweden, there were for a long time (what some historians of technology
have referred to as) development pairs, where for example the government-owned utility
Vattenfall bought electric power technology from the Swedish company ASEA (now
ABB), the armed forces bought weapons systems and military equipment from the
company Bofors and military aircraft from Saab (today they both belong to the Saab
Group), and Televerket (now Telia) both bought and developed telecommunication
equipment together with the company Ericsson. Several other countries have used the
same model, not least the American military-industrial complex.
Demand pull does not, of course, need to be initiated by the government. Rather,
perhaps one of the most characteristic traits of a successful business entrepreneur is the
very ability to pick up on current or future market demand. By developing knowledge
about the functions the products serve for the customers, many companies try to meet
customer needs which have not always been articulated by the customers themselves.
This, however, is difficult. Many companies face a constant challenge of trying to under-
stand what the customers actually think about their goods and services and how they
could improve their products in accordance with customer demands.
Therefore, many innovative companies utilize a number of sources to gather new
knowledge and develop new ideas, for example through their own internal research and
product development, through contacts with customers and users, contacts in external
networks consisting of suppliers, competitors, and companies selling complementary
technologies, as well as contacts with other external actors regarding research and
development, such as universities and government-owned research institutes. One
of the most important reasons why many companies conduct their own research and
development is precisely to have this ability to learn and apply new technology (some-
times referred to as absorptive capacity).

CHAPTER 4 • TECHNOLOGY-DRIVEN DEVELOPMENT
Innovation
Innovation (from the Latin innovare, "to renew"): the introduction of a new, or notably improved,
product, service, process, method, or work procedure, initiation of a new market or utilization of a
new raw material, or a major restructuring of an existing industry.
4 .2 The 5-curves of technological development

The development curve which a technology follows over time is usually referred to as
its technological trajectory. These types of curves are normally used to describe either
the rate of the technology's performance development, or how fast the technology is
spreading in the market. Even though there are many factors which can influence these
trajectories for different technologies, it is possible to identify certain patterns which
seem to be recurrent regardless of industry or sector.
If we look at an industry or a technological field, the technological development
tends to follow a pattern which usually can be described using S-shaped development
curves (see Figure 4 .1): in general, the development is slow, but sometimes this pattern
can be disrupted by a period of radical and rapid technological development, which
gradually, however, levels off and stabilizes in a new phase of slower technological
development once again, but at a higher performance level than before.
Performance
FIGURE 4.1
The typical S-shaped
pattern of technological
development.
C> THE AUTHO RS A ND STUDENTLITTERATUR 75

PART I • INDUSTRI AL MANAGEMENT
Normal state: incremental innovation

The normal development in a field of knowledge or technology usually takes place in
small steps, with incremental improvements in relation to existing knowledge and
products. This is a state of incremental innovation where the knowledge development
is similar to a jigsaw puzzle, with new "pieces of knowledge" being added to the already
existing "knowledge puzzle". Thus, when a new technological field is born, the tech-
nological development is also often slow. Great investments in resources are needed to
acquire important, basic knowledge, explore different alternatives for development, and
to understand basic technological correlations. The development of an entire techno-
logical field with seemingly high potential can often be held back by inadequate skills
in a certain area of expertise or by an inability to provide an important sub-system
with sufficient technical performance. As an example, the development of electric
power technology during the 19th century was held back because they were unable
to transform the power that was generated, which meant that it was not possible to
transport electric power over long distances. Today, we can see the same problem with
energy storage technology (i.e., batteries), where shortcomings are holding back large-
scale implementation of electric cars and alternative energy sources, like solar power.
Short periods of radical innovation

In some cases, however, there is a breakthrough, which typically leads to an acceleration
in the technological development and rapid increase in performance (e.g., speed, capac-
ity, energy, and power) in relation to the resources. In these cases, a period of radical
innovation often follows, where the developers can focus efficiently on the technical
subfields and components whose development renders the greatest output per resource
unit invested. The technological development is rapid, which means that these types of
technical fields and industries often attract a lot of interest, which in turn often attracts
both private and public investors.
The industry structures are usually fluid in this phase. Different technologies and
design solutions compete with each other and it is often unclear which of the alterna-
tives will be in line with future technological development. Many stakeholders (both
suppliers and customers) can therefore experience uncertainty when faced with the new
technology since there is a risk that you invest and create a "lock-in" to the wrong alter-
native. In addition, the newly developed products are often expensive and thus usually
requested by specific customer groups with particular requirements on functionality.
Since the Second World War, for example, a number of technologies that were originally
intended for military use are now incorporated in products for civil use as well.
76 O TH E AUTHORS AND ST UDENTLITTERATUR

Radical innovation
Radical innovation: creates fundamental changes in an industry or sector. Often reduces the
value of existing expertise and increases the level of uncertainty within a sector.
Incremental innovation: includes small changes and strengthens existing expertise.
Matu re industry: back to incremental innovation

After a while, however, the rate of development begins to slow down and the perfor-
mance improvement per resource unit invested (e.g., per SEK or working hour) begins to
decline. The technology is close to its technical limits, that is, what is possible to achieve
within the existing framework. At this stage, the cost of each marginal improvement
increases and the rate of the technological development levels off. The technology is
now mature and the industry structures begin to solidify. In this phase, the price of the
products typically becomes increasingly more important to be able to compete in the
market, which means that companies need to put pressure on their production costs.
Typical of this phase is that there are fewer but larger companies. A few companies grow
large and financially strong, while others are bought up, are driven out of the market, or
pull out to invest in something else. The automotive industry is a typical example of a
mature industry: it is dominated by a small number of very large companies, competition
is fierce, and the basics of the internal combustion engine technology have not really
changed since the end of the 19th century. Today, however, when the old car manu-
facturers are being challenged by technologies like electric and autonomous cars, it is
possible that we are witnessing the emergence of a technology shift (see Section 4.5) and
with that, a new revolutionary phase of radical innovation in the automotive industry.
This type of S-shaped technological lifecycle can be identified in retrospect in a
large number of cases. However, the S-curve is not predetermined. Some technologies
never succeed. Some seemingly radical innovations only have a short lifespan, while
others which do not appear to be very radical initially, may come to reform an entire
industry. Thus, it is not possible to determine exactly where in the development curve
a technology is located until afterwards.
4.3 How innovations diffuse

However, the fact that new technical solutions emerge is one thing, another thing is that
they also diffuse among customers and users in the market. It is far from given that the
best technical innovations are the ones that actually succeed. Instead, a number of envi-
ronmental factors play a crucial role in whether, and if so, how, an innovation diffuses.
The way successful technical innovations diffuse does, however, often follow a sim-
c THE AUTHORS A N D STU D ENTLITT ERA TUR 77

ilar pattern to the technological trajectory in Figure 4.1. At the start, there is a small
group of users who have an interest in a new technology and the diffusion is slow. Once
the technology is widely used by this small group, it usually diffuses quickly to large
groups. After a while, however, the large majority have adopted the new technology
and the diffusion slows down again, to finally level off. It is, however, important to
remember that the diffusion has a certain time delay in relation to the technological
development: the really big market success normally happens once the technology has
stabilized and the prices of the new products have dropped to a level which is reasonable
for the large groups of customers.
Fro m niche market ...

The most well-known model of how different customers and users adopt new technol-
ogy over time, that is, how a technology diffuses in a market, is illustrated in Figure
4.2. According to the model, the first target group of a new technology consists of a
small group of innovators, sometimes referred to as pioneers, i.e., technology enthusiasts,
who are motivated by the technology itself. This group accept that the new technology
may have major shortcomings and are happy to help the suppliers to solve different
technical problems. One example is users of computer software who help the developers
to identify and remove bugs in beta versions of new software. Another example is how
companies can help a subcontractor with troubleshooting so that the subcontractor can
develop technology which the company wants to have access to but not own (such was
the case with the Swedish development pairs where public agencies contributed in var-
ious ways to the technological development in different private companies, described
in Section 4.1). However, this category of users rarely generates big revenues for the
suppliers, but they are often important to reach other customer categories.
Share of users
FIGURE 4.2
Technology adoption
lifecycle (based on Rogers,
2010).
78 © THE AUT H ORS A N D STUDE N TL I TTERAT UR

CHAPTER 4 • TECHNOLOGY - DRIVEN DEVELOPMENT
When the technology has improved so much that it has been established in a niche
of the market it can spread to the next category of users, so-called early adopters. These
customers are enthusiastic about innovations as long as someone else has tested them
first. Companies within this category usually want to use the new technology with the
intention to change an industry and gain competitive advantages in relation to their
competitors. The early adopters are usually advanced and experienced users. Since the
technology is new, they will accept that everything is not working perfectly and since
they expect large future profits from their investments, they are not particularly price
sensitive either. On the other hand, the functionality of the technology is absolutely
crucial. In addition, the early adopters often demand special solutions and customiza-
tions as well as highly qualified sales, support, and service. Thus, competition among
suppliers to appeal to early adopters is rarely primarily between two companies that
offer equivalent products. Since the market is growing, the important competition is
instead taking place between different product categories and is primarily about what
type of product is to be the next success on the market as a whole .
. . . to mass market
Once the technology is adopted by the next category of customers, the early majority, it
has moved across the chasm which separates the small specialized niche markets from
the mainstream of the mass market. At this stage, the customers are average users with
common demands: the technology needs to work, it should preferably improve daily
operations, but it should not be too complicated or require too many changes in the
user's operations. In other words, the early majority consists of pragmatic technical
users who do not wish to make any radical changes, but who want to use the new
technology to improve and streamline their already existing operations. Two typical
examples are a public agency that wants to rationalize its administration by imple-
menting a new IT system, or a manufacturing company purchasing a new machine
to streamline its production. The technical users in the early majority want to avoid
disruptions in their business operations, which is why they request tested technical
solutions, reliable service and support, and clear results. Uncertain and immature
technology is not accepted. In order for a technology to succeed in the market, it is also
important that it is used by well-reputed organizations, or individuals, that function as
role models for the vast majority of users. This is particularly evident with consumer
products like sporting goods, where brands like Puma, Adidas, Nike, Elan, or Fischer
use famous athletes to launch new technology and design for the mass market.
The next group, the late majority, consists of conservative technical users who do not
like to take any technological risks at all. This group of users are very price sensitive
and want fully secure technical solutions. Technologically conservative companies only
acquire new technology if they have to in order to keep up with their competitors. Tech-

nologically conservative consumers typically buy products based on a new technology

if it is as cheap as, or cheaper than, the old technology. This type of customer is, in
other words, price sensitive, skeptical, and very particular regarding the functionality
of the new technology.
Finally there is, according to this model, a small group of laggards, sometimes referred
to as technology skeptics, who are negative towards new technology and prefer to main-
tain the status quo. Consumers in this category do not, for example, see any reason to
buy a flat-screen TV as long as their old, bulky TV is still working. Another example is
that some people find cash points and credit cards unnecessary. Instead they prefer to
withdraw their money at the bank and pay cash. The only reason why this group of users
decide to purchase new technology is if all other available alternatives are worse from a
technical and/or economical perspective; for example, if it has become very expensive
to have the old TV serviced or if it is not possible to pay cash in certain stores any more.
Thus, the technology and the market develop in parallel. Technological development
influences demand and demand influences technological development. In order for large
customer groups to adopt new technology it has to be mature and standardized enough
to fit with the business customers' established operations, or the private consumers' life
pattern. At the same time, it takes a relatively large market demand for the products in
a new technical field to be produced with enough economies of scale for the price of the
products to be seen as reasonable by the majority of customers in the market. Once a new
technology has passed this stage, the rate of product development usually drops at the
same time as efficiency and low costs become more important in the competition. At this
point, the technological trajectory levels off in line with the S-curve pattern in Figure 4.1.
Expectations and technological hype

Expectations of what a new technology can achieve are often so hyped that they rarely
correspond with values that the technology could realize, at least not within a reasonable
period. The consulting company Gartner Group has therefore developed a model to
analyze emerging technologies, referred to as the Gartner Hype Cycle (see Figure 4.3).
Gartner designed the model for the IT sector, but the basic ideas can also be applied to
other industries. The idea is that the early expectations of emerging technologies, for
example autonomous cars or the Internet of Things, often become inflated. Sometimes,
these high expectations also lead to a drastic increase in the market value of the companies
behind the technology, often long before the companies have developed a commercially
viable product (peak ofinflated expectations in the model). Relatively soon, however, most
people discover that the hyped expectations will not be met, "the technological bubble
bursts", and the expectation curve drops drastically (trough ofdisillusionment). Eventu-
ally, however, usually long after what was expected initially (or rather, what many had
hoped), different technical functions might begin to appear and the slope ofenlightenment
80 0 THE AUTHORS AND ST U D EN TLITTERA TUR

CHAPTER 4 a TECHNOLOGY-DRIVEN DEVELOPMENT
Expectations
i
Connected Home Cognitive Expert Advisors
Blockchain Machine Learning
Smart Robots Software-Defined Security
Micro Data Centers Autonomous Vehicles
Gesture Control Devices Nanotube Electronics
loT P.latform Software-Defined Anything (SDx)
Commercial UAVs (b rones)
Affective Co rh puting
Smart Data Discovery
Virtual Personal Assistants
Brain-Computer lf terface Natural-Language Question Answering
Conversational User Interfaces
Volumetric Displays
Smart Workspace - - -•
Persona I Analytics
Quantum Computing _ ___,,.
Data Broker PaaS (dbrPaaS)
Neuromorphic H rdware
Context B~okering
sp2.11ax
General-Purpose Machine Intelligence
4D Printing
sm brt Dust
As of July 2016
l Innovation
Trigger
Peak of Inflated
Expectations
Trough of
Disillusionment
Slope of
Enlightenment
Plateau of
Productivity
Time
Years to mainstream adoption:
O less than 2 years O 2 to 5 years • 5 to 10 years A more than 10 years ® obsolete before plateau
FIGURE 4.3 Gartner Hype Cycle for emerging technologies 2016. Source: Gartner Group 2016.
starts. It is not until this phase that the companies who own the technology or products in
question, begin to generate revenue and, over time, profit. In the final phase (the plateau of
productivity), according to Gartner, questions of efficiency and costs become increasingly
important and the technology or the products have reached the maturity stage.
4.4 From product innovation to process innovation

In order for a technology to have a major market breakthrough it needs to stabilize. In
other words, an idea has to become established in the market about what to expect from
the new technical products. Sometimes this means that the products are formally stand-
ardized through decisions made by an authority or a standards body, like the Swedish
Standards Institute (SIS). It is more common, however, that a specific product design
THE AUTHORS ANO ST U DENTL I TTERATUR 81

achieves superior popularity to other alternative designs and that it becomes established
as an informal norm or role model, which both customers and competitors begin to
assess against other products in terms of, for example, design, price, and functionality.
Dominant design
A product design which, in this way, establishes itself as a "de facto standard" is called
a dominant design. A dominant design does not have to be technically superior to
alternative technical solutions. It simply means that a satisfactory compromise of dif-
ferent product features has gained broad market popularity. The history of technology
is filled with dominant designs, for example the Ford Model T, which still, more than
100 years after it was introduced in 1908, defines what a car is supposed to look like;
the DC-3 which set the standard for the modern passenger plane; the IBM PC which
established the norm for personal computer design; Microsoft Office which defines
the norm for software packages for office work today; and the Apple iPhone and iOS
operative system which set the standard for smartphones.
Another classic example of a dominant design is the QWERTY keyboard. It was
initially designed to solve the technical limitations of the mechanical typewriter: for
the skilled typist, the type levers of the machine had to be organized in such a way that
they would not constantly get entangled. This set of keys, which was designed for the
English language in the 1860s, still functions as the universal standard for keyboards
in many countries across the world, despite the fact that computer keyboards have
never had type levers.
In other words, a dominant design often has a crucial impact on the technological
and product development in a technical field as it will come to embody what we con-
ceptualize as a specific product, for example a telephone, a sewing machine, a keyboard,
a car, a gas station, or a passenger plane. Moreover, the influence of a dominant design
can live on for a long time since it will gradually begin to be taken for granted and often
gets incorporated in other technical systems, in our expectations and human behaviors,
and sometimes even in our laws and regulations.
P~ocess innovation when the industry matures

The success of a dominant design has a crucial impact on both the technological develop-
ment and the competition in an industry. Before a dominant design has been established,
there is often a large number of competing companies on the market. Competition often
takes place between different alternative technical solutions, and the products' rate of
change is fast (this is the stage of radical innovation when the technology is only being
used by technology enthusiasts and early adopters). However, as a dominant design
becomes established, there is a shift in the industry, from the early phase of high product

CHAPTER 4 • TECHNOLOGY-DR IVEN DEVELOPMENT
Prod uct innovation and process innovation
Product innovation: means an improved version of an already existing product or service, or the
creation of a new product or service.
Process innovation: means that a product or service can be produced and/or delivered using less
resources.
innovation, to a more mature phase which is predominantly characterized by process

innovation, that is, development of efficient production, distribution, and sales processes.
In this phase, the companies of course continue to develop new products, but the
product development changes: the product's rate of change begins to slow down and
the product development begins to focus more on optimizing and improving existing
functions and on creating new versions of the same basic product. The dominant design
enables standardization and mass production, which means that production costs per
unit drop. At the same time, it becomes increasingly more difficult to improve the
product technology, which results in higher development costs for the company. In
this phase, the technology has reached the majority of the customers in the market
(i.e., the users who belong to the early and late majority in Figure 4.2). These customers
are price sensitive, which means that low cost per product becomes a crucial factor to
even stand a chance of competing in the market.
Over time, the level of process innovation in the industry also drops. Thus, the
success of a dominant design usually means that the product development processes
are radically rationalized, but after the early gains of increased efficiency it usually
becomes more and more difficult and expensive for the companies to develop new
product features, but also new processes that can provide them competitive advantage
over the competitors in the industry. It is in these late stages that you start to refer to an
industry and a technology as "mature". The later the stage of development, the harder
it usually is for new entrants to establish themselves.
There is, however, no clear-cut strategy for a company in a new and growing industry
(with a high degree of product innovation). The first mover advantage of leading the
technological development is that you have the opportunity to define the rules which
the competitors have to follow. However, history has shown that it is not always an
advantage to be the first mover. Sometimes it can, on the contrary, be a good idea to wait
and learn from the mistakes made by the pioneers. Moreover, it is usually impossible to
predict which of the competitors in an emerging industry will become market-leading
once the dominant design has been established. However, it is often difficult, or at
least very expensive, for a company to enter a technology-intensive industry after the
breakthrough of a dominant design.
THE AUTHO RS AND STUDE N TLI T TE RAT U R 83

4.5 Technology shifts

It is important to remember that just because the development in one technological
field begins to slow down, it does not mean that customers experience a standstill in
product development. Instead, sometimes a technology shift emerges, which means that
one well-established technology is outrivaled by an alternative technology that meets
the same, or similar, needs of the customers. In comparison with the old technology,
the knowledge base for the new alternative technology is usually cheaper, better, or
more accessible. Moreover, technology shifts often result in entire fields of knowledge
becoming obsolete and large well-established companies going out of business. There
is a shift in the S-curves (see Figure 4.4), which means that the competitive conditions
in the industry change drastically.
The most famous Swedish example of the effect of a technology shift is the fall of the
company Facit at the start of the 1970s. This well-managed and well-reputed company
in the small town of Atvidaberg in southeastern Sweden was in the mid-20th century
a leading company in the global market of high-quality mechanical calculators, which
they sold at high prices to business customers around the world. Despite having strong
expertise in electronics and software development, the company could not manage the
technology shift to cheaper, mass-produced electronic calculators. Within a couple
of years in the early 1970s, Facit went from being a world-leading company, to a deep
financial crisis and came close to bankruptcy. The company was sold in 1973 and dis-
appeared from the market.
There are many similar cases. One example is how digital technology at the start of
the 21st century basically knocked out the demand for mechanical cameras. This shift
led to a crisis for, among others, Kodak, which went from being the largest producer
Performance
-- - -
I
" -- Technology B
I
I
Technology A
-- ,_ -
,, .- /
,- I
I _,
I
I
I
FIGURE 4.4
Typical technology shift:
shift between the S-curves. - - -- -- --
' - - - - - - - - - - - - - - - - - - - - - - - + Time
84 C> THE A U TH O RS A ND STU D EN TL I TTER A TUR

of negative camera film in the world during the 20th century, to suddenly witnessing
their market for camera film disappearing, and going out of business in 2012 (the Kodak
brand was later converted into a smaller company). Other examples of technology
shifts are how the success of steamboat traffic at the end of the 19th century drove
sailing ships out of the market; how the jet engine outrivaled the propeller engine for
passenger planes during the 1950s; how e-mails radically changed the conditions of
written communication and postal services; and how online music streaming services,
for example Spotify, changed the rules of the entire music industry.
Another dramatic example is the Finnish telecommunication company Nokia, which
during a little more than a decade, from the mid-199os onwards, was a world-leading
mobile phone manufacturer and had an unprecedented ability to develop new mobile
phones and new product features in accordance with customer demand. When Nokia
was at its peak, the company stood for more than 20 percent of the export in Finland
and roughly 4 percent of the GDP in the country. In 2009, Nokia was ranked as the
fifth most powerful brand in the Western world and the most powerful non-U.S. brand,
with a value of almost SEK 240 billion. Two years earlier in 2007, however, the computer
manufacturer Apple had introduced the iPhone, which rapidly came to revolutionize
the entire mobile phone market. Nokia had problems switching to the smartphone tech-
nology, which resulted in great financial difficulties. In 2013, only four years after the
top ranking, Nokia sold their entire mobile phone division to the American software
company Microsoft and in 2016, Microsoft closed the division for good.
The paradox of technology shifts is that the greater the expertise a company has in
the established technology, the more difficult it seems to be to adapt to a technology
shift. The well-established companies often have good insights into the demands of
the existing market and tend to invest their development resources in the areas where
they have had previous success and where they know what the most important cus-
tomer groups are looking for (who in turn buy products based on existing technology
Productivity
FIGURE 4 .5
/2
Distributed PC
1992-2001 The technology devel-
computer
opment and shifts of
r 76-1992 compu ter technology
/ Mainframe (based on Malcolm Frank,
1960-1976 Cognizant Executive Vice
President).
' - - - - - - - - - - - - - - - - - - - - - - + Time

PART I • INDUSTRIA L MA NAGEMENT
defined by a dominant design). This way, production plants, product development,

market organization, and recruitment of personnel, etc., are gradually formed by the
existing technology, which means that it can be difficult for the company to adopt a
new technology in the event of a technology shift. There are many examples of how suc-
cessful and well-established companies have been well-informed about the emerging
technology for a long time prior to a technology shift but where they have dismissed
it as uninteresting, partly because an emerging technology, in its early stages, usually
is both of a lesser quality and more expensive than the existing technology, and partly
because the new technology is not (as yet) requested by the most important customers
of the company. Figure 4.5 illustrates a number of technology shifts in the computer
industry since the 1960s.
4.6 Service innovations and new business models

So far, we have looked at technologies, technologically intensive products, and com-
panies which usually have developed as traditional industrial, technology-based com-
panies. The phenomena which have been discussed can, however, be found in several
other types of industries as well. The success of companies like Dell, Ryanair, Ikea,
McDonald's, Google, Uber, and fin tech companies like the Swedish company Klarna, is
to a large extent based on product and process development, where they have managed
to develop new types of services, new ways of delivering and providing these services,
and/or new ways of generating revenue from their services.
One example is the American company Dell, which emerged as one of the most
innovative computer companies at the end of the 20th century. However, the success of
the company was not based on advanced product technology; on the contrary, it used
standard components to build IBM-PC-compatible computers on demand. By only
operating sales via the Internet (which was unusual at the time), only manufacturing
on demand, only using standard components, and developing an advanced logistic
organization for fast deliveries, Dell became a very attractive low-cost alternative for
private customers, for example students who wanted to buy a personal computer. Dell
introduced a number of process innovations, but practically no product innovation
at all. However, today when Dell is one of the largest computer manufacturers in the
world·, it has changed strategy and offers a wide selection of products for different types
of customers (today, Dell computers can also be purchased in-store).
A Swedish example is the furniture company Ikea, which has reformed the entire
furniture industry with its concept of providing low-cost furniture. The flat-pack idea
allows for radically more efficient logistics, with the final assembly in the product
chain being performed by the customer. Ikea was one of the first companies to market
furniture by showing entire interiors of, for example, kitchens and living rooms in large
stores, but also in the Ikea catalogue, which is one of the most widespread catalogues
86 © T H E AU T H O RS AND STUDENTLI TTER ATUR

in the world. The layout of the stores means that the customers are exposed to almost
the entire selection of furniture offered by Ikea, at the same time as they are exposed
to a number of additional products and special offers (e.g., hangers, plants, napkins,
candles, baskets, batteries, food, and sweets). Everything is large-scale production:
through very large volumes, and a corporate culture in which they pride themselves
for being extremely economical, Ikea manage to keep costs low.
A similar example from the airline industry is the Irish company Ryanair, which
has radically changed competition by placing their operations at secondary airports,
only using online booking, applying so-called dynamic pricing where the ticket price
increases as the number of available seats decreases, providing minimum service, and
only offering direct flights between two cities (i.e., never taking responsibility for any
connection flights). Through Ryanair (which actually copied the business model of
the U.S. company Southwest Airlines), the idea of low-cost airlines got established
in Europe. The only product innovation introduced by Ryanair was to rid the flight
experience of all form of glamor and "extra service": flying became as fancy as riding
the bus. Apart from this, the success was about process innovation.
Other examples of service innovation are companies like the Swedish Middagsfrid
and Linas Matkasse, which deliver groceries and recipes directly to the door, or Airbnb
and Uber which offer hospitality services and taxi services online. Service innovation
does not, however, need to come from newly established companies. For example, a
highly popular service innovation in Sweden is the mobile application Swish, which was
launched by the major Swedish bank corporations in 2012 and enables easy payments
and transactions via the user's mobile phone. Service innovations are, thus, just as
important as technical product innovations. However, in practice they are often closely
linked: new technology enables the success of new types of services, at the same time
as new services may inspire companies to innovative technological development.
4.7The challenge: balancing short-term efficiency and

long-term innovation
A technology-based company is, thus, faced with the strategic challenge of balancing
the need to continuously streamline operations in order to keep up with competition
under the current circumstances, and constant product development and business
innovations in order to keep up with future development. Thus, a company should be
competitive here and now, while at the same time it needs to experiment and develop
new skills in order to keep up with technological evolution and be prepared for any
future technology shifts. In this way, all operations that are exposed to competition
must relate to an ever-changing environment.
The ability to efficiently manage today's operations and to be prepared to adapt to
tomorrow's changing demands simultaneously, is sometimes referred to as the need
C THE AUTHORS AND STUDENTLITTER A TUR 87

PA RT I • IN DUSTR IAL MANAGEMENT
for companies to be ambidextrous. This means to be able to exploit both existing skills
(exploitation) and at the same time develop new skills for future needs (exploration). If
the company is not efficient in the short term and does not create a surplus value, it risks
being questioned and may go out of business. If the company has high performance
but does not allow for learning and innovation, it risks grinding to a halt, becoming
out of date and may, after a while, no longer be in demand.
A technology-based company also needs to take into consideration that while the
resources and expertise of the company usually take a long time to build, the market is
often considerably more loose and changeable. Once the resources of the company have
been established, they are often difficult to change. What was once the core competence
of the company and made it successful, thus, can easily develop into its largest obstacle
when it comes to making necessary changes. The paradox is that the more successful a
company is, the more difficult it is to adapt when conditions change.
This challenge can be compared to the need for an innovative company to resemble
a palace which is being built at the same time as it is being torn down (Figure 4.6). The
palace entrance (existing operations) has to be tended to and kept in a nice condition
for the guests (customers). At the same time, the palace is constantly being extended
in one end, where new operations, new products, and new business deals are being
developed, while the other end of the palace is being torn down as obsolete operations
are phased out and shut down in line with the technological evolution and changes in
the market. Thus, for a company to survive in the long term it has to constantly develop
and review both its technology and its business strategies, something which is difficult,
uncertain, and sometimes even painful.
It is, however, important to remember that it is difficult to predict the future. Expec-
tations of what new technology can accomplish easily run high and are not possible
to meet in the short term. The history of technology is filled with disappointments
FIGURE 4.6
The company as a palace
which is constantly being
extended and torn down
simultaneously.
88 © T H E AUTHORS A N D ST U DE N TL I TTERATUR
and failures. At the same time, a large part of the technological evolution takes place
in small steps, in mature industries, and without any apparent radical development
or technological shifts. In all discussions on technological development and effects of
new technologies it is therefore important to keep the following wise words in mind,
uttered by the American futurist Roy Amara (1925-2007):
We tend to overestimate the effect of a techno logy in the short run and unde resti-
mate the effect in the long run .
AMAR A' S LAW
Summary
This chapter has discussed technology-driven innovation and development. Innovation
can be defined as new forms of products, raw materials, processes, or production meth-
ods. The technological evolution, for example in product performance, often follows an
S-curve. Usually, the technological development is slow; so-called incremental inno-
vation. However, in certain situations there can come a period of rapid development;
so-called radical innovation. After a period of time, the technology typically matures
and the development goes back to being incremental. The same pattern applies when
a new technology is introduced on the market. Initially, it only reaches a small niche
of the market, consisting of technologically keen pioneers or innovators, and in a later
stage it may reach the user group early adopters. If the market keeps developing, the
technology can enter into the mass market. Once the technology is established on the
mass market, the growth rate slows down and in the final stage there are only laggards
who have not yet adopted the technology. It is common for new technologies to attract
attention long before they are mature enough to be introduced on the market, which
often leads to inflated expectations. When the technology finally is introduced, it is
therefore common that the confidence in the product drops. There is, in other words,
a tendency to overestimate the qualities of a new technology in the short run, at the
same time as we tend to underestimate the effects of the technology in the long run.
When a product (or technology) matures, it often gives rise to what is commonly
referred to as a dominant design, that is, a de facto standard which functions as a role
model for what a certain technology or product should look like. After this stage, tech-
nological development primarily concerns different processes rather than the actual
product technology. However, as different products and technological fields mature,
there may emerge alternative, cheaper technologies that offer the same functionality.
This could give rise to a technology shift and the beginning of a new development with
a new S-curve, often resulting in dramatic consequences for the established companies.
In recent times, service innovation and new business models have attracted a lot of
interest. Operations have been redefined and new ways to make money have emerged
C> THE AUTHORS AND STUDE NTLITTER A TUR 89

PART I a INDUSTRIAL MANAGEMENT
within traditional industries. Two examples are Ryanair and Spotify, which have rap-
idly acquired large market shares in traditionally mature industries since the start of
the 21st century.
Thus, companies have to change and renew their product portfolio and review their
business models on a regular basis. It is a constant challenge to balance short-term
efficiency and long-term innovation.
References
Berggren, U. & Bergkvist, T. (2006). Industriforetagens serviceinnovationer, Nutek 2006:6.
Christensen, C. (2013). The Innovator's Dilemma: When New Technologies Cause Great Firms
to Fail. Harvard Business Review Press.
Christensen, C. M. & Bower,). L. (1996). Customer power, strategic investment, and the
failure ofleading firms. Strategic Management Journal, 197-218.
Cohen, W. M. & Levinthal, D. A. (1990). Absorptive capacity: A new perspective on learning
and innovation. Administrative Science Quarterly, 128- 152.
Dosi, G. (1982). Technological paradigms and technological trajectories: a suggested
interpretation of the determinants and directions of technical change. Research Policy,
11(3), 147-162.
Gartner (2016). Hype Cycle for Emerging Technologies. www.gartner.com
Kristensson, P., Gustafsson, A. & Witell, L. (2014). Tjiinsteinnovation. Studentlitteratur.
March, ). G. (1991). Exploration and exploitation in organizational learning. Organization
Science, 2(1), 71- 87.
Moore, G. A. (1999). Crossing the Chasm: Marketing and Selling High-Tech Products to
Mainstream Markets (rev. ed.). Harper Business.
Rogers, E. M. (2010). Diffusion of Innovations. Simon and Schuster.
Sandstrom, C. G. (2010). A Revised Perspective on Disruptive Innovation: Exploring Value,
Networks and Business Models. Chalmers University of Technology.
Schilling, M.A. (2005). Strategic Management of Technological Innovation. McGraw-Hill.
Tushman, M. & Moore, W. (Eds.) (1988). Readings in the Management of Innovation. Pitman
Publishing.
Tushman, M. L. & O'Reilly, C. A. (1996). The ambidextrous organizations: Managing evolu-
tionary and revolutionary change. California Management Review, 38(4), 8-30.
Utterback, ). (1994). Mastering the Dynamics of Innovation. Harvard Business School Press.
90 0 T H E AUTHOR S AND STUDENTLITT ERA TUR

...........................................................................~
············ ····· -.,
MARK ETING
Marketing includes all the measures and actions which encourage the customers
to buy the company's goods and services. Just like all value creation processes,
marketing can be analyzed at several levels and with different time horizons. In
this chapter, we look at the strategic level, which involves the company's market
position in relation to competitors, the product portfolio, the company's brands,
and the segmentation of the market into different customer groups. We also
discuss the tactical level, which involves pricing, distribution channels, and how
the customers can be influenced so that there is a demand for the products.
Finally, the chapter describes the operational level with focus on communication,
advertising, and sales.
s.1 Marketing on different markets

Private companies thrive by selling the products they develop and produce. It is not
until the products are sold that the business generates revenue, but the marketing of
a product includes much more than what takes place at the actual moment of sale.
Marketing
Marketing includes all the activities that contribute to the sales of the company's goods and
services.
The marketing process includes all employees who influence the company's relation-
ships with the outside world and the company's sales. Some examples of how employees
can contribute to the marketing of the company are as follows:
OTHE AUTHORS AND STUDENTLITTERATUR 93

PART 11 • THE VALUE CREATION SYSTEM
• An engineer at a company delivering drilling equipment who keeps close contact

with the most demanding customers and discusses new technical solutions.
• A customer service officer of a mobile phone operator that cuts the time the
customers have to wait in line before someone takes their calls.
• A production technician at a company manufacturing windscreens who demon-
strates to a truck producer how the screens can be efficiently mounted to cut
production costs.
• Consultants at an engineering consulting firm who work with several different
CAD systems to save the customers from having to convert design plans between
different systems.
A private company offers its goods and services on an (output) market with buyers and
sellers. If there is a large number of buyers and sellers of the same kind of product, and
all actors are independent and have access to the same information, there is a so-called
perfect competition. In this "perfect" market, there are so many involved that no single
actor can influence the price. A few examples of markets that resemble this perfect
competition are the stock exchange, some commodity markets, international currency
trading, and, not least, farmers' markets and local town markets (see the box "Supply
and demand in economic theory"). However, in reality there are very few markets with
perfect competition. Supply and demand can be based on a number of factors besides
the price and quantity of the product, for example access to information on the market,
bargaining power of the parties, different regulations and trade restrictions, or the price
of various substitute products.
When a market only has a limited number of sellers, it is called an oligopoly, and
when there is a limited number of buyers, it is called oligopsony. In an oligopoly, a
seller needs to consider in advance how the other sellers in the market will react to,
for example, a price change. Two examples of Swedish oligopoly markets are retail
banking and the oil industry. If an oil company changes its pricing, other companies
usually follow. Thus, actors in oligopoly markets have a tendency to play "Simon says"
and it is usually the largest company that controls the behavior of the other companies.
When a market only has one seller, it is called a monopoly. Sometimes, a monopoly is
the result of a company growing so successful and powerful that all other companies have
been pushed out of the market. However, a monopoly situation can also arise when exist-
ing·infrastructure prevents, or obstructs, new companies from emerging and competing,
like in the Internet access market for private individuals and companies. Furthermore,
regulations can sometimes also be used to deliberately create a monopoly. One example
is the Swedish government-owned enterprise Systembolaget; the only retailer in Sweden
allowed to sell alcoholic beverages (over a certain level of alcohol content).
Thus, the type of market where the company acts, and its position on that market, is
crucial for the company's business strategy (see Chapter 14) and marketing activities.
94 © THE AUTHORS A ND STUDENTLITTERA T UR

CHAPTER 5 • MARKETING
Supply and demand in economic theory
Supply and demand are two important concepts in economic theory. They describe the relation-
ship between the price of a product and the quantity of the product on a market (i.e., the quantity
that buyers and sellers are willing to trade). According to the theory, demand is determined by the
total quantity that buyers are willing to purchase at every given price. Supply, on the other hand,
is based on the total quantity of a product that all sellers in a market offer at each price level.
This is usually illustrated in a diagram that shows how supply and demand affect price and
quantity. What you get is a demand curve and a supply curve for a certain market (see Figure 5.1).
For many products (probably the majority), demand goes down if there is a rise in price, and up if
the price drops. This will result in a descending demand curve: the lower the price, the greater the
demand. At the same time, producers want to increase supply the higher the price. This will result
in an ascending supply curve: the higher the price, the greater quantity the producers want to sell.
The price at which customer demand is equal to the producers' supplied quantity in the market is
called equilibrium price.
Price
' - - - - - - - - - - - - - - - - - - - 1 Quantity
FIGURE s.1 The way supply and demand in a market affect price and quantity, according to
economic theory.
The number of sellers and buyers on the market, whether the products are the same
or differ, and whether the company has large or small market shares, affect what is
possible for the company to do. It is easier for large companies with a strong market
position to set the agenda for other companies, while companies with smaller market
shares usually have to adapt to the actions of the large companies. Companies are, thus,
rarely free to independently choose their marketing activities.
Moreover, the markets for business products ("business-to-business", B2B) often
THE AUTH O RS A N D STU D EN T L ITT ERA TU R 95

work differently from the markets for consumer products ("business-to-consumer",

B2C). In a typical business market, the customers are relatively few and large. The
customers' purchasing procedures are complicated and sometimes very formalized,
at the same time as the relationships between customers and suppliers often are long-
term. The companies often do business directly with each other as equal parties. In
a typical consumer market, however, there are many customers, many and shallow
customer relationships, and the purchasing process is relatively simple; sales usually
include different middlemen (e.g., wholesalers and retailers) and the supplier often has a
stronger position than the consumer. While the business market is relatively rationally
governed, many consumer markets are governed by more emotional factors (see Table
5.1). However, these differences should not be exaggerated. The smaller the company
and the simpler the operations of the customer in a business market, the more the pur-
chasing situation of the company resembles the processes of the consumer market. In
each individual case, it is the character of the value proposition and the complexity and
price level of the purchase which are crucial; rather than the traditional categorization
between business market and consumer market.
TABLE s.1 Traditional differences between business and consumer markets (based on Kowalkowski and
Parment, 2012).
Business market Consumer market
Customer relationships Few and deep Many and shallow
Number and size of customers Few and large Many and small
Purchasing process Complex with many decisions Simple (spontaneous buys) or

involving many parties longer, depending on the situation
Level of formalization High : purchase policies, Low

environmental considerations,
sustainability requirements
Marketing channel Often direct Long, often several middlemen
Bargaining power of the Symmetric relationship: Asymmetric relationship:

parties supplier and customer are the supplier has more power than
equal parties the consumer
s.2 Strategic marketing

At a strategic level, marketing involves, for example issues defining the goods and
services offered by the company, identifying the target groups, and how the value
proposition offered to the customers can be enforced by a strong brand.
96 © THE A U THORS A N D STUDENTLITTER A TUR

Market segmentation and product portfolio

The first step in marketing is to define the company's target groups. This is called
customer or market segmentation and means that the company structures its market
into different customer categories (segments) with the aim of clarifying which of these
categories the company is targeting as well as how to reach them. Different companies
use different methods to segment their markets. Segmentation can, for example, be
based on customer type (middle-aged men tend to have different preferences compared
to teenage girls), geographic region (customers in Italy may have other preferences
than customers in Sweden or Finland), size (large companies often have other needs
compared to small companies), or quality awareness (professional customers often have
other user requirements than private consumers). A well-executed market segmentation
ensures that the company develops different value propositions for customers with
different demands, and that customers with similar demands are treated in a similar
way. It is therefore important to identify the specific features of the value proposition
that influence various types of customers to choose the company's goods and services.
For consumer products, market segmentation is often based on the customers' life-
style, for example age, family situation, education, or private interests. It is common to
develop a so-called "persona" for each customer group, that is, a simplified customer
stereotype, that should represent the needs, interests and behavior of the identified
customer group.
Segmentation is, however, equally important for companies on the business-to-
business market. Companies' demand for specific goods or services may differ greatly
based on, for example, size, industry, business operations, and expertise. As an example,
mall companies often manage with significantly more basic IT and accounting systems
than large companies. Another example is when a large established taxi company is
going to buy new cars and the cars have to fit in with the existing fleet. This may impose
other demands on the supplier than when it sells taxi cars to a start-up company. In
other words, the key for a company is to identify in what way its products - the com-
pany's value proposition - contribute to its customers' value creation.
Market segmentation is intimately connected with the company's product portfolio,
that is, the combinations of goods and services offered to different customers. A famous
example is Ford Motor Company, which through the mass-production of the Ford
Model T opened the door for the large-scale introduction of the private car as a con-
umer product for the middle class. Ford was an incredibly successful company, due in
large part to a heavily standardized product and a highly efficient production system
that enabled low production costs. However, at the end of the 1920s, Ford was faced
with a problem: it was no longer enough to only offer one type of standard car to the
market. Instead, the competitor General Motors (GM) had a huge success by imple-
menting annual design changes to their products (different model years) at the same
CTHE AUTHORS AND STUDENTLITTERATUR 97

PART 11 • THE VALUE CREATION SYS TEM
time as they created different types of cars for different income segments and types of
use. By launching cars under the names Chevrolet, Pontiac, Oldsmobile, Buick, and
Cadillac, GM created a product portfolio where different brands marked different price
ranges and where different products were not competing with each other. Moreover,
the customers could remain within the "GM family" even if their purchasing power
and preferences changed over time.
Today, many companies apply the same strategy as GM. For example, the German
Volkswagen Group offers cars under a number of different brands - Skoda, Seat, VW,
Audi, Lamborghini, Bugatti, and Porsche, among others. The same applies to the Italian
automobile manufacturer Fiat, which besides the Fiat brand also produces Alfa Romeo,
Chrysler, Jeep, and Lancia. In the same way, white goods manufacturers, mobile phone
manufacturers, fashion companies, tools manufacturers, and software companies
launch products under different names and with different designs and features. The same
applies to several types of services. On an airplane or a train, the customer can choose
between different types of services, commonly known as "first class", "second class",
"business class", etc. In the same way, when you enter into a mobile phone contract, you
can choose between different levels of coverage, customer service, support, etc.
It is therefore key to have a strategic idea about what type of goods and services the
company will offer to different types of customers and how these goods and services
should be designed to complement each other in a good way. In addition, customer
expectations change over time, which means that technology-based companies
constantly have to develop new products which meet market demand. For products
aimed at the business market, this often entails a gradual improvement of functional-
ity and adaption to customer demand. The dynamics of the consumer market, how-
ever, tend to be slightly different, often characterized by strong short-term trends in
design and fashion.
Brands
The market segmentation and product portfolio are closely connected with the brand
of the company. Sometimes, "brand" is misinterpreted as being equal to a symbol or a
logotype. But a brand is so much more. The brand is said to be the company's promise
to its customers, that is, the expectations of functionality, quality, price, service, etc.,
that customers and users associate with a symbol or a name. Thus, the brand is about
the associations created by a specific symbol or name, that is: the values that the brand
is "loaded" with. For example, buying clothes at Hugo Boss or Armani stores usually
means that the customer has other expectations than ifhe or she goes shopping at low
price retailers like Primark (British), Dressmann (Norwegian), or H&M (Swedish).
While Hugo Boss and Armani represent exclusivity and high prices, brands like Pri-
mark and H&M represent an expectation of decent quality at low prices. Whether or
98 © THE AUTHORS AND STUDENTL I TTERATUR

CHAPTER 5 • MAR KETI NG
not the customer is satisfied with his or her purchase is, thus, a matter of how well the
brands meet the expectations.
The relationship between a brand and a product (regardless of whether it is a physical
product or a service) is illustrated in Figure 5.2. While we on an intellectual level often
can identify the functions of a product and which price we ought to pay for it, it is
more difficult to assess whether the product is "worth the price". We have all probably
experienced at some point that, even if a product was cheap, we still might have had
doubts whether it actually was worth the money. In other situations, the price difference
between an expensive and a cheap version of the same product can seem unjustified,
and some expensive products might not fulfill the expectations that come with the
price. On the other hand, some expensive products, for example luxury watches or
jewelry, may also have an emotional value for the customer that goes far beyond the
purely technical qualities of the product.
Thus, the relationship between price and value can be complicated. While the price
is an objective measure, the value is based on a subjective, qualitative assessment. More-
over, the experienced value of a product is also based on the customer's confidence in
the salesperson and the producing company. Buying a product often includes creating a
long-term relationship with the salesperson, the product, and the producing company.
Sometimes it is difficult to assess the qualities of an individual product, which is why
the customer's previous experiences with the company become crucial. Likewise, an
assessment of the future access to complementary products, maintenance and service,
technical expertise, and spare parts might be of crucial importance. Thus, creating a
well-known and respected brand is something which every serious company tries to
attain. It is the combination of product and brand which makes up the value proposition
for the company's customers.
Apple, Google, Coca-Cola, Microsoft, Samsung, Ikea, and IBM are some of the most
well-known and most valuable brands in the world. However, a brand does not have
to be synonymous with the company name. A company may have several hundred
Brand- emotional
Value proposition
Product- intellectual FIGURE 5.2

The relationship between
product. brand, and value
proposition.

PART II • THE VALUE CREATION SYSTEM
brands among its products. One example is the British-Dutch company Unilever, which
produces and sells beauty products, food, detergents, and other types of consumer
goods under more than 400 brands, yet Unilever itself is relatively unknown. Another
example is Coca-Cola, which controls more than 500 brands, even though the company
name (and the beverage carrying the same name) is the most important brand. There
are probably few people who are aware that the fruit beverage Minute Maid is produced
and sold by Coca-Cola. Another example is the U.S. company 3M, which gained its
success by manufacturing sandpaper and masking tape for the automotive industry,
but which today is best known for brands like Scotch Tape, Scotch-Brite (the sponge),
Post-it, and Thinsulate (thermal insulation for clothing).
Moreover, a brand can be more famous than the actual products. The most well-
known examples are probably the fabric membrane Gore-Tex and the microprocessors
from Intel. The concept "Gore-Tex jacket" is for many customers more important than
the clothing manufacturer. In the same way, a number of different computer manufac-
turers promote their personal computers using the label "Intel Inside". Thus, one of the
strongest arguments to buy their specific products is that they are using microproces-
sors from the sub-supplier Intel. Another similar example, though not as well known,
is how the Swedish steel company SSAB use their brand Hardox to sell high-strength
steel products with the logo "Hardox in My Body" (Figure 5.3).
A brand can, thus, be related to a company as well as a product. It can also be asso-
ciated with a person. Performers, artists, designers, architects, and athletes sometimes
become brands that are bigger than themselves . Football players like Lionel Messi
and Zlatan Ibrahimovic, rock stars like David Bowie and Madonna, or artists like
Andy Warhol and Picasso, are all brands which we associate with different expressions
and qualities. The names promise great art or spectacular entertainment and create
associations and expectations.
FIGURE 5.3
"Intel Inside" and "Hardox
in My Body". Source: Intel
and SSAB.
100 © THE A UTH OR S AN D STUDENTLITTERATUR

5 .3 Ta ctical marketing
At the tactical level, marketing includes the principles the company uses to price its
products, the distribution channels it uses, and the means it uses to influence prospec-
tive customers to buy the company's goods and services.
Pricing and price models

There are many different methods when it comes to pricing. Usually there are con-
ventions on pricing in an industry or regarding a certain type of product or service.
Pricing is important and an area where many companies try to be innovative and
create new solutions.
One of the most common pricing methods is that the supplier calculates the pro-
duction cost of the product or service, the full cost of the product, and then adds a
percentage charge, a profit margin, which is supposed to cover the supplier's admin-
istration, development, and business risks. This is an easy way to set the price and
many companies apply this method when selling standardized goods and services.
Large companies often have lists with formulas for standardized profit charges for
different products.
However, companies can rarely set the price of a product without considering their
competitors. Thus. a different technique is to base the pricing of a product on the
competitors' prices for the same product. In these types of cases, applying the technique
of full costing with a profit margin can be said to define what the lowest price of the
product ought to be. If the competitors' prices are higher and the customers accept this,
there is of course no reason to go below this market price. If, however, the market price
i below the company's own costing calculations, it will have to refrain from adding the
profit charge, review its cost structure, or perhaps step away from the deal altogether.
The more unique a product or service is in relation to what the competitors offer,
the more a company can usually charge. If it has a strong position in the market and a
truly unique product or service, the price can be set based on the value that the product
provides for the customer, so-called value-based pricing. With this type of pricing it is
not the supplier's costs which primarily set the price, but what the customer is willing to
pay (see Figure 5-4). Today, many companies, particularly when it comes to professional
ervices, favor this type of pricing. One example is that the cost of an energy consultant
could be based on how much energy you will save if you follow his or her advice. In
practice, however, this type of pricing is still relatively uncommon.
Sometimes it can be justified for a company to accept a price which is below the
full cost of the product. As an example, ski resort hotels often rent out rooms at lower
prices during the summer, compared to the winter when it is high season. The same
thing applies to business hotels that offer special deals on weekends. Instead of having
O THE AUTHORS AND STUDENTLITTER A TUR 101

Higher price level
Unique product
"Vale-based pricing"
qualities
Competitors' prices Market price
Requested profit
Full cost+ profit margin
Full cost
Specific costs+ contribution margin

Specific costs
FIGURE S.4
Different starting points for
pricing .
empty rooms, i.e., unutilized capacity, it is better to temporarily lower the price and
at least gain some revenue. The essential thing is that the price of the room covers the
specific costs, for example extra cleaning, that this particular deal includes. Provided
that the price of this type of deal is higher than the specific costs, the deal will still in
the short term contribute to the total, common costs of the company: the deal should,
thus, generate a positive contribution margin. This is, however, a short-term pricing
strategy which is typically used in a situation where the company temporarily has free
(unutilized) capacity. In the long term, a company has to charge for all its costs. This
is discussed in detail in Chapter 8 on costing.
However, decisions regarding pricing involve more than just the price level. It is
equally important to consider the revenue sources and sales channels of the company,
that is, which revenue model to apply (see Chapter 3). Many companies demonstrate
great creativity in the way they price different components in their value proposition.
Distribution channels ("place")

There are several different channels to distribute a company's products to the customers
on the market. Companies which produce consumer goods rarely sell directly to the
consumers. Instead, the products are usually sold to wholesalers, who in turn sell them
to retailers, where the products are offered to different customers. The wholesaler works
as a middleman between the manufacturers and the retailers and plays an important
role by reducing the retailers' need to establish their own direct contact with a large
102 0 TH E AUTHORS AND ST UD EN TL ITTERATUR

CHAPTER 5 a MARKETING
' '"' IIHIII FIGURE 5.5

The role of the wholesaler
as a middleman in the
distribution chain.
number of suppliers. In addition, the wholesaler often helps the retailers with the design
of their product range (see Figure 5.5 and 5.6). Typically, the wholesaler buys products
from different manufacturers, repackages them, and sells the products to retailers
(stores) in a specific region.
When it comes to business-to-business goods, however, there is usually no retailer
involved. Instead, the companies deal directly with each other. Large manufacturing
companies often have subsidiaries or own sales offices in different parts of the world. If a
company is unable to have its own representation, it can instead give another company
the right to be its agent, i.e., to sell its products in a defined region, a so-called agency.
The agent does not buy the products from the manufacturer but receives revenue when
a product is sold, often based on percentage of the selling price.
When a company enters a foreign market, the establishment is usually done in
many small steps. Often, you start by using an agent. Then you can establish a joint
venture, that is, a co-owned company together with a local actor, and then finally set
up a subsidiary in the country. Setting up your own subsidiary can be expensive. On
the other hand, it offers the opportunity of greater operational control and, in the long
term, hopefully greater profit margins.
The more actors involved in the distribution chain, the less revenue will go to the
individual company. For this reason, many companies strive to integrate forward,
that is, to cut the number of middlemen and come closer to their final customers. As
-- -----
-----
Producer Agent
c, THE AUTHORS AND ST U DE N TLITTER AT UR

Wholesaler -----
Retailer Customer
FIGURE 5.6
Different lengths of the
product distribution
channels.
103
described in Chapter 3, many industrial companies want to expand their value prop-
ositions in order to move closer to the final customers. A strategic dilemma for many
companies in these situations, however, is that they easily start to compete with their
existing customers, which may have disastrous effects on other parts of the business.
Alongside these traditional distribution channels, the growth of e-commerce means
that the logic of the traditional, physical supply chains is changing. E-commerce creates
direct contact between producers and potential customers and the physical location of
the sale is no longer important. Today, companies like the American Amazon, Chinese
Ali Baba, and Swedish Tradera are significant competitors to traditional retail in stores.
In the same way, increased e-commerce can reduce the need for some companies to
have their own representation across the globe. Through the Internet, customers and
producers can create closer relationships with each other. The customers can reduce the
number of middlemen when purchasing a product, at the same time as the suppliers can
learn more about customer behavior and product usage. This is even more accentuated
in the recent development of online services and the increasing number of products of
the installed base, which are continuously connected over the Internet (the evolution
towards "Internet of Things").
Promotion
Promotion is about using the best possible measures to encourage potential customers
in selected segments to buy the company's products. In this respect, advertising is the
most concrete promotional tool, but promotion includes much more (see Figure 5.7).
Advertising in all its different forms is used for all kinds of products. It is, however,
particularly common when it comes to consumer products. As a rule of thumb, con-
sumer products which do not differ much between different models and manufacturers
receives the biggest advertisement budgets. In these situations, it is the brand that
matters. ICA, Unilever, and Coop are the largest buyers of advertising in Sweden today
(2015). Advertising allows companies to reach large groups of potential customers.
At the same time, it is a fairly blunt tool since it is difficult to know the actual effect
of advertising.
For business-to-business products, which involve professional purchasing execu-
tives, promotion is less about advertising and more about building long-term relation-
ships. This is referred to as relationship marketing and is of particularly importance
in professional services. The idea is that a company should carry out high-quality
deliveries and pay attention to the customer's needs, thereby acquiring the customer's
confidence in the company's offering and, not least, in the company itself. This will
increase the likelihood that the customer keeps coming back. As a customer, you want
reliable suppliers that can offer, for example, services and spare parts when needed,
even in the future. Thus, the confidence in the company behind the product is often

The companies' promotional tools

(percent)
100 ...,--------------------,
Relationships
Advertisment
Sales promotion/Publicity FIGURE 5.7

0
Methods to promote
Consumer Business-to-business consumer and business-to-
products products business products.
just as important as the qualities of the product itself. This applies especially to service
deliveries, where it is often difficult to fully assess the quality of the product in advance.
Alongside advertising and relationship marketing, many companies also engage in
different types of concrete sales promotions, that is, meeting with customers, supply-
ing product information, participating in fairs and exhibitions, and hosting product
demonstrations. The company's marketing also includes the corporate communication
and information officers. Receiving positive media publicity, for example by being a
good member of society, is very much a part of building confidence in the company
and its products.
Different products - different sales procedures

Business-to-consumer and business-to-business products differ from one another,
which consequently means that different sales procedures apply. A common charac-
teristic of consumer products is that they rarely are customized. For a salesperson of
these products it means that the product is defined, and the challenge is to make the
cu tomer perceive a need for exactly this product: the company is not selling anything
else. Diapers and sodas are examples of this; standardized products with hardly any
customizations. Of course, a seller of these products can create offers which are adapted
for a certain customer, but the delivered product will be standardized.
For a seller of business-to-business products, it may instead be about adapting the
products according to the specific needs of the customer. It may also include adapt-
ing, for example, the production equipment or internal routines of the supplier. In
comparison with consumer products, industrial sales often involve a large number of
employees from the selling company and the processes may, thus, take a long time.
A spectacular example of this type of sale is when the Swedish-Swiss corporation ABB
sells an entire power plant to a customer in China. Less spectacular sales would be

PART II a THE VALUE CREATION SYSTEM
those of components and semi-finished products, for example, engines or dashboards

for cars, or antennas for mobile phones.
Sales of power plants, machinery and equipment, buildings, and other capital
products are sometimes referred to as system sales. The customer is not only buying
a product, but an installation, a service commitment, and sometimes even certain
operational support. The selling company delivers a system, not just a single product.
Consequently, after sales services are important in this type of business. After sales
refers to the service that follows a previous sale, for example upgrading software in a
large computer installation, or changing the rollers in a steelworks. In many industries,
this type of sale is at least as profitable as the sale of the original delivery.
In conclusion, advertising often is a key element in sales of consumer goods. In sales
of business-to-business products, however, it is often the technical discussions between
the buyer and seller that are crucial. Here lies part of the explanation why engineers
often are the ones who work with the sales of these types of products.
Typically, there are also differences between sales of products that are produced
as one of a kind, mass-produced in large batches, or, produced in continuous man-
ufacturing processes (see Chapter 6). Products that are mass-produced can rarely be
customized in the same way as products that are produced one by one. Products that
are manufactured in continuous production processes, characteristic of the process
industries such as pulp and paper, are often even harder to customize, provided that
the customer does not buy very large quantities.
Sales of goods and sales of services also differ in certain respects. Since services
rarely are as tangible as physical goods, it is more difficult for a seller to demonstrate the
usefulness of a service. In order to sell, for example, consultancy services to Ericsson or
subcontracting to Electrolux, you therefore often need to present reference projects. It is
about making the customer understand that the selling company has unique expertise,
for example, in advanced technical calculations. Unlike goods, services cannot be
stored and since they usually are tied to the performance of individual persons, they
are rarely as standardized as products.
Therefore, the actual "packaging" is often crucial when it comes to service sales. For
a person selling technical consultancy services (often the consultant him-/herself), it
can thus be about promoting a specific method or technique. For someone offering
office premises for rent it could be an idea to also offer janitorial services along with
the new facilities. It is no coincidence that sales of services often are compared to idea
sales, that is, sales with focus on perceptions, values, and needs, rather than a tangible
product. There is a clear trend to market business-to-business products in this way, with
increasing service content, for example in the form of service and support agreements.
However, the differences between different types of sales should not be exaggerated.
All sales are about two parties coming together: a supplier and a customer. There are
no easy sales, but the challenges differ somewhat.
106 © THE AUTHORS AN D STUDENTLITTERATUR

Competitive tools in marketing

At the strategic and tactical levels, marketing is thus about positioning the company
and its products, that is, deciding in what way the company should compete. This is
sometimes summarized as choosing the marketing components of the company regard-
ing product, price, place, and promotion, today often abbreviated as the "4 Ps" (see the
box "The marketing mix: 4 Ps").
The Marketi ng Mix: 4 Ps
The Marketing Mix of the company is the mix of marketing tools that a company uses and
describes the strategic position of a product on a market. The point of departure is usually the
most well-known marketing model in the world, the 4 Ps, created by Jerome McCarthy (1964).
The concept was originally used by an American company with fast moving consumer goods.
The 4 Ps model was picked up by the American marketing professor Philip Kotler and was
launched as an easy marketing model in his classic textbook Marketing Management (the first
edition was published in 1967).
The4Ps:
Product- product range and product features.
Price - pricing and other sales terms and conditions.
Place - distribution of the product, e.g., warehousing, logistics, and sales channels.
Promotion - advertising, relationships, direct marketing .
s.4 Operational marketing and sales

Marketing starts by developing market strategies, identifying customer segments,
building brands, and planning the company's product portfolio. However, in oper-
ational marketing, most of the methods are based on the company having finished
products and/or services to offer the market. It is commonly said that customer needs
can be created with the help of well-executed marketing.
Different marketing approaches

When the development of a new product is soon to be finished, the initiative is usually
moved from product development to the sales department. The department for product
development is, however, still involved. One example is that pharmaceutical companies
often organize public scientific symposia where their scientists present new drugs and
their effects and results to other scientists and medical doctors.
New products are also introduced at different types offairs. This applies to consumer
products, for example computers and cars, but even more to business-to-business prod-
THE AUTHORS AND STUDENTL ITTERATUR 107

ucts. There are special fairs for almost all types of business-to-business products and
they are important arenas for sellers and buyers to meet.
Customer visits is another common way to introduce new products, that is, when a
salesperson visits potential customers to promote the products or services of his or her
company. A company can also, as in the example with the pharmaceutical companies,
visit the actors that primarily influence the sales; in this context, the medical doctors
writing prescriptions.
Another way is to allow certain advanced customers to try the new products, for
example by releasing beta versions of a new software. In this way, you can get help
finding errors and making small adjustments to the products at the same time as these
customers can contribute to the promotion.
Market research, analyses, and plans

Companies use market research in order to gather information about customer
demand and get ideas about the attitudes towards their various goods and services
on the market. Market research is primarily about analyzing the size of a potential
market, something which can be done through searches in public records and statistical
databases. It can be about identifying in which sectors the customers can be found but
also about identifying potential end-users. In Sweden, there are several public records
with statistics about the population, households, employment, income, real estate,
education, vehicles, professions, and companies, which simplify the identification of
a product's target groups.
Market research also includes turning directly to potential customers and asking
them what they think about different products and carrying out tests where the custom-
ers get to try the products. It should, however, be kept in mind that market research often
is based on already existing needs and products. As such, it is mainly relevant for incre-
mental innovations. There are many examples of radical inventions for which there was
no explicit market demand prior to their breakthrough, but which became huge success
stories once they were introduced. This is one reason why market research, regardless of
how well it is being executed, should be analyzed critically and with great care.
It is also common to carry out so-called competitor analyses. As an example, compa-
nies often buy new products launched by their competitors, analyze them, and compare
them to their own products. Making comparisons between companies, both of their
products and processes, has become so common that it has its own term: benchmarking.
These types of comparisons can provide important knowledge about the company's
competitive situation as well as useful impulses to make changes in the company.
Based on these types of data, a company often produces a marketing plan, that is, a
plan of how to promote its products on the market. A marketing plan often includes
information about the company's current position and what should be achieved, for
108 0 T H E A UTH O RS A N D ST UD E N TLITTER ATUR

example that 30 percent of a specific customer group should have been contacted within
a certain time period. It also often includes descriptions of how the marketing activities
should be conducted and detailed information about different direct marketing efforts
and how the marketing activities should be followed up.
The sales process

An effective sales process is often described using the acronym AIDA (Attention,
Interest, Desire, Action). The customer gradually becomes interested, from common
knowledge, attention, to intentional action by making a purchase, via the intermediate
steps interest and desire. A skilled salesperson will understand what stage the customer
is in and adapt his or her sales efforts and the offer accordingly. He or she understands
how the customer might be reasoning, the problems the customer has, and how the
company could solve them. Based on the situation, an experienced salesperson also
understands when it is time to be concrete and, for example, discuss prices and delivery
times, and when it is appropriate to discuss the customer's problems in more general
terms, or simply passively wait for the customer's decision. The salesperson is aware
that it is a process which needs to run its course and thus understands when and why
there might be a deal.
The AIDA Model
AIDA stands for Attention, Interest, Desire, and Action. It is one of the oldest marketing models
and is usually attributed to the American E. St. Elmo Lewis (1872-1948).
The model is commonly used in consumer marketing and advertising and describes the steps/
stages that a consumer moves through, from when he or she becomes aware of a product,
becomes interested, feels a desire, and, finally, takes action and purchases the product.
The four steps of the model:
Attention - The consumer becomes aware of a product or brand (usually through advertising).
Interest- The consumer becomes interested by learning about how the product/brand fits with
his or her needs and lifestyle.
Desire- The consumer develops a favorable disposition towards the product/brand.
Action - The consumer forms a purchase intention, shops around, and makes a purchase.
Even though there are different modified versions of the model, it is still the most dominant
model for how, for example, an advertisment should be graphically designed in order to be effec-
tive: {A) an eye-catching image or headline, then (I) an opening text that creates interest, then
(D) explanations that describe the benefits of the products, and finally, (A) practical information
about where the product can be purchased.

From inquiry to agreement

A successful result of the marketing efforts may be that the customer becomes inter-
ested in the products offered and asks the sales representative for a tender; i.e., an offer
from the company to the buyer. Tenders are fairly uncommon in the consumer market,
even though they do of course exist, but for sales between companies it is common
practice. The sales representative provides the customer with a tender, which, among
other things, specifies what the company can deliver, when it can be delivered, and at
what price. For large projects, for example when selling a large computer system or
tendering for large roadworks, there may be extensive work involved in producing the
tenders. Companies who deliver these types of products therefore often have specially
appointed tender engineers who are in charge of this.
Once the customer has received the tender, there is usually a negotiation between
the two parties. This could involve changes in quantities, that the price is considered
too high, or that the delivery time needs to be adjusted. There are different types of
negotiations; it can be informal and an agreement can be reached after a couple of
meetings, or it can be a long process that goes on for months. Finally, the parties will
hopefully agree on the terms and sign an agreement.
In the public sector, there is usually a more formal sales process, so-called public
procurement. Public procurement procedures are regulated by law and function as a
role model also for many private industries. Public procurement means that an inter-
ested buyer, for example the Swedish Transport Administration or the Swedish Public
Employment Service, publicly announces a request for tenders. Interested suppliers can,
then, based on this request, submit a tender. The buyer compares the tenders, which
usually have to be structured in a specified way, and selects the bid who best meets the
requirements. Construction and capital equipment companies, like Skanska, NCC and
ABB, have extensive experience of this type of tender procedures.
The marketing organization

The segmentation of the market often forms the basis for how the internal marketing
organization is structured. Sales departments are often divided by region (northern and
southern part of the country), product (technical expertise), customer type (large cus-
tomer, small customer, etc.), or personal contacts between individual salespersons and
customers. In practice, there is often a mix between the different categories. Sometimes,
one of the categories will be combined with internally appointed product managers,
that is, persons who are responsible for the coordination of sales and development of
a specific product or product family.
Departments dealing with business-to-business customers often have specific sales
representatives, so-called key account managers, who are responsible for the strategi-

cally most important customers of the company. The role of the key account manager
is to maintain good relationships with a given customer, to function as a resource for
the customer's contacts, and to connect the right persons within the company with the
right persons at the customer's company.
The marketing organization, thus, often reflects the structure of the company's
customers, rather than the structure of the company's own operations. An important
task for the marketing organization is to translate the customers' needs into activities
that need to be performed internally. The marketing organization differs therefore
from, for example, a product development department, which is usually structured
based on technical expertise, or a production department, which is usually structured
based on different manufacturing processes.
The orga nization of the buyer

When a private consumer buys a product, it is often the same individual who makes
the decision, makes the payment, and uses the product. This, however, is rarely the
case in large companies. Instead, the decision maker, the purchasing executive, and the
product user may be three different people, with significantly separate interests. Very
la rge purchases are often decided by the company's board of directors, irrespective of
who in the company will use the product, system or facility.
In practice, however, it usually is the product users who prepare the purchase and,
thus, have significant influence on the choice of product, even though they are not the
ones making the formal decision. In large companies there may, however, be conflicts
of interest between the purchasing department, which aims for standardized purchases
at low prices, and the users, who want to have high-quality equipment and systems
that are easy to use.
For larger purchases, procurements, experienced companies usually put together
designated project teams with the purchasing officers, project managers, and engineers
that will handle the entire purchasing process. It could involve developing technical
speci fications, preparing a call for tenders, evaluating tenders and holding negotiations,
and then monitoring the client's interests during the execution of the contract.
5.5 Rules and regulations for doing business

When a deal is made, it means that the seller and the buyer have met an agreement. The
sellercommits to delivering a product in exchange for financial compensation from the
buyer. A basic principle is that an agreement must be honored (pacta sunt servanda, in
Latin), that is: the parties who meet the agreement are bound by it. An agreement is,
thus, binding for both parties, which means that the parties in principle have the right
to compensation if one of them should breach it.
TH£ AUTHORS AND STUDENTLITTERATUR 11 1

The agreement process

According to the Swedish Contract Act, an agreement means that a party submits
an offer (in business language often called a tender) with a specific content. When
the receiver has granted acceptance (a positive response) which corresponds with the
tender, an agreement has been met. An agreement can be oral or written, but it can also
be completely tacit and only be clear through the parties' way of acting, for example,
when a passenger gets on the bus and shows a valid travel pass to the driver. Written
contracts are only necessary in specific cases, for example sales of real estates, in order
for the deal to be legally binding for the parties.
The procedures regarding business agreements differ significantly between different
types of deals and also between different countries. There is, for example, a major dif-
ference between the purchase of a standard product in a store and procuring suppliers
for construction of a power plant, which may take years to complete. Since both parties
are obliged to fulfill the agreement, contracts that cover several years may include large
business risks for both the seller (contractor) and the buyer (client). The contractor
needs to have the skills and resources to be able to carry out what has been specified in
the contract, at the same time as the contractor needs to be sure that the client is able
to pay. As the contract binds the buyer and the seller to each other, it is often difficult
(and expensive) to break an agreement. Consequently, for these types of business deals,
the content of the agreement, but also the formal procedures around the signing of the
agreement, are very important.
Standard agreements
Originally, agreements were considered to come about when two parties voluntarily
agreed on terms which were specific for the situation in question. Today, however,
agreements are often of a different kind. Many trade associations (especially those of
the sellers) have drawn up so-called standard terms and conditions which form the
basis for the agreements entered into by the members of the association. This type of
standard agreement often has an important function in business, since the parties do
not have to negotiate all the details but can concentrate on the most important issues
of the deal (e.g., functionality, price, and delivery deadlines).
Standardized agreements are very common in relationships regulated by consumer
laws, that is, between a company and a consumer. It could be a written form which
gets filled in, for example a guarantee certificate when buying a product in a store, or
that the seller has a catalogue which includes terms and conditions for sale, which is
common among insurance companies and travel operators. Standard agreements are
also common between companies. In the construction industry, for example, there
are many standard agreements for different types of contracts and work assignments.

The risk of the product

An important question is about when the risk of the product passes from the seller to the
buyer, that is, at what point the buyer takes over the risk of the product being damaged or
getting lost. There are many variants, depending on the types of actors, type of product,
or type of sales contract that the deal concerns. In principle, the risk passes over from the
seller once the buyer has received the product, for example when a consumer picks up a
standard product in a store (so-called cash and carry). In legal terms, the consumer has
come into possession of the product. However, when it comes to a purchase including a
delivery service, that is, when the good is delivered to the customer's premises, the situ-
ation is different. In these situations, it can sometimes be enough to place the package at
the door of the buyer's house or that the product has been received by a representative of
the buyer, for example a hauler or shipping agent. For larger business deals, for example
when a company buys new equipment including installation and commissioning, the
agreement terms for the customer's takeover of the machinery can be comprehensive
and include clauses about different types of tests, trial operations, and inspections.
Breach of agreement
If one of the parties does not comply with what has been agreed, there is a breach of
agreement. If, for example, a product is delivered late, the seller will be responsible
for a delay. In this situation, the buyer has the right to insist that the seller meets the
agreement, withhold payments, revoke the purchase (if the delay is significant), or
claim damages. In large projects, delays are not uncommon, which is why the parties
often have agreed on the consequences beforehand. A common consequence is that
the supplier has to pay a penalty fee, penalty interest, to the buyer for each overdue day.
If the product or service differs from what has been agreed, a fault has occurred. When
there is a fault, the buyer has, in principle, the right to take similar measures as when
there is a delay. He or she can, for example, withhold the payment, demand to get the fault
repaired, demand to have the product exchanged for a new one, get a discount, receive
compensation for repairs, revoke the purchase, or claim damages. A buyer has the right
to get the product repaired or exchanged within a reasonable time frame and without
charge. He or she should not, in principle, have to accept more than two repair attempts.
In Sweden, there are many separate regulations if the buyer is a private person.
The legislators' aim has been to protect private persons, in different ways, from being
exploited by, for example, door-to-door salespeople or companies that use far-reaching
and complicated contracts and guarantee agreements. When it comes to business deals
between two companies, however, the Swedish legislation is not as comprehensive.
However, the fundamental principle of the Contract Act still applies: that no agreement
hould allow for one party to exploit the other.
THE AUTHORS ANO STUDENTLITTERATUR 113

Summary
Marketing includes all the activities within a company that contribute to increasing the
sales of the company's goods and services. Markets are theoretically described as either
perfect competition (a large number of sellers and buyers), an oligopoly (few sellers),
or a monopoly (one seller). In a market with perfect competition, no individual seller
or buyer can influence the price or the supply.
In reality, however, companies invest large resources to influence customers and
increase sales through different marketing efforts. In a business-to-business market,
the customer relationships are often few and deep, the customers are usually large, the
customers' purchasing processes are often formal, sales often take place directly with
the customers, and the bargaining power between buyer and seller is often symmetrical,
that is, they have equal strength. In the business-to-consumer market, the opposite
often applies.
The company's strategic marketing is based on the market segment(s) that the com-
pany targets and its product portfolio. Companies often build different brands, a type
of promise to the customers which appeals to emotional values, rather than intellectual
considerations.
At a tactical level, marketing is about pricing, price models, distribution channels,
and how to influence the customers to be favorable to the company's value propositions.
For standard products, there is usually an established market price which is difficult for
the company to affect, while other more unique goods and services might be possible
to price according to the value that they generate for the customer.
Operative marketing is often based on, for example, market research and competitor
analyses. Based on this, companies create marketing plans which then are turned into
concrete sales activities. Operative marketing is often about attracting the customer's
interest in the specific product of the company, making the customer develop a favora-
ble conception of the product and, finally, buy it. In business-to-business markets, the
rules and regulations for doing business are different than in consumer markets. In
business-to-business markets it is often about a customer sending an inquiry for bids
to a number of suppliers (sellers), who then reply with a tender. The customer can then
reject, renegotiate, or accept the tender. However, in all business, agreements must be
honored and kept.
114 © THE A UTHORS AND STUDENTLITTERATUR

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Uggla, H. (2015). Organisation av varumiirken: for kapitalisering och affiirsutveckling. Liber.

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•••••••
.......... ............................................................................0
PR ODUCTION
Production involves creating value by efficiently transforming input resources

into various goods and services using equipment and staff. The term industrial
production traditionally refers to manufacturing, i.e., the physical transformation
of raw materials and semi-finished products into physical goods. However, the
term has been given a wider meaning in line with industrial evolution where an
increasingly larger share of the company offerings consists of various types of
services. In this chapter, industrial production is discussed on three levels. The
production strategy level involves designing the production system so that it
meets market demand efficiently. The production tactics level focuses on the
design of the production processes themselves, while the operational level
involves production planning and scheduling, logistics, and inventory manage-
ment, as well as various tools and techniques for efficiency improvement.
6.1 Production under different conditions

The word production comes from the Latin word produco, which literally means "bring
forward", "put into motion", "generate", or "create". These are the meanings when
the word is used in expressions such as "to produce goods", "to produce energy", "to
produce a film", or "to create a theatre production".
As discussed in Chapter 3, a company's production system often extends beyond
the company's legal limits and can include a number of external actors, for example
sub-suppliers, contract manufacturers, and consultants. The term operations man-
agement is often used to indicate this diversification, to include all the parts of the
company's operations that are engaged to deliver a good, or perform a service, on behalf
of a customer. Production management (operations management) may also be used as

a way of understanding business operations. Many of the management concepts and

models originally developed for industrial production also work well for understanding
and enhancing efficiency of other types of operations. In this book, we use this wider
meaning of the term production.
Production
Production comprises all activities that contribute to producing and delivering the company's
goods and services to the company's customers.
Conflicting demands between marketing and production

A production system must, of course, be designed for the products that are to be pro-
duced, the markets on which they are to be sold, and the dynamics of the market
demand. An efficient production system must be able to deliver the right products in
the right quality and be flexible so that it can be quickly adjusted when demand changes
or new products are to be launched.
The problem is that several of these requirements are difficult to combine with
cost-efficient production. This is a dilemma for most companies. While the market
is fluid and dynamic, and customers can quickly switch to other suppliers, it usually
takes a long time to build an efficient production system. A company has often made
considerable investments in facilities, equipment, and competences of its staff, which
makes it difficult to change the production apparatus without the risk of disruption.
There are several inherent conflicts between marketing and production on which
most companies need to compromise. While cost-efficient production requires a
standardized range of products with a small number of special versions and customer
adaptations; marketing officers usually like to be able to offer customers a wide range
of products with many different variants and customer adaptations. In the same way,
many companies strive to achieve high-capacity utilization of production equipment
and staff, although customers do not want to have to wait because equipment or staff is
involved in production for another customer. Furthermore, a production department
_is usually a cost center (it has a cost budget) and has no responsibility for product
design or pricing, while a marketing department is usually a revenue center (it has a
sales budget based on revenue) and has no responsibility for costs that arise when the
products sold are produced.
It is important to remember, however, that the aim of production is always to serve
the customers on a market. The design of a production system is, consequently, a
compromise between a number of different factors. Several examples of conflicting
demands between production and marketing are provided in table 6.1.
118 <O THE AUTHORS AND STUDENTLITTERATUR

CHAPTER 6 • PRODUCTION
TABLE 6.1 Examples of production and marketing perspectives on various key issues.
Production Marketing
Product Few product variants for increased Many product variants to be able to
portfolio production volume. This simplifies meet the demands of many different
management and reduces production customers. Few variants reduce the
costs number of customer segments
Product High standardization: few changes Low standardization: important to be

standardization reduces uncertainty, enables economies able to adapt the products to individual
of scale, and reduces production costs customers' requirements
Performance Cost center: opposes orders that Revenue center: opposes production
measurement increase production costs rationalization measures that reduce
fiexibility in relation to customers
Capacity Strives for full utilization of equipment It must be possible to supply products
utilization and staff, which tends to create queues and services with short lead times in
and long lead times for delivery delivery and without unnecessary delays
Location Where production is cheap and practical Near customers
Different types of demand

When a production system is designed, it is important to consider what drives the
demand for the products. There is a distinction between independent and dependent
demand. Independent demand means that demand is market-driven, direct and, in
principle, random, i.e., even if it may be possible to influence the demand by means of
pricing and marketing, it is impossible to control it completely. A company must instead
rely on sales forecasts. For example, it is difficult to know in advance exactly how the
demand will vary over time at a car repair shop, a service center, a restaurant, or an
emergency room at a hospital. Such operations often strike a balance between having
urplus staff and equipment capacity (which is expensive), and letting customers wait
until capacity is free (which increases the risk of customers turning to a competitor).
In their planning, these operations need to rely on uncertain assessments and adapt
quickly if actual demand differs from what was anticipated.
However, if the demand for one product or service is driven by demand for another
product, this is called dependent demand. A sub-supplier with a long-term contract to
produce standard components for the electronics industry can, for example, forecast
demand with relatively high certainty based on the production plans of the customers.
Thi also allows the subcontractor to plan its production long in advance and, thus,
achieve high levels of production efficiency.
Another aspect is that some products, for example crude oil, milk, hinges, compo-

nents for refrigerators, or spare parts for motorcycles, have to be standardized to be

possible to sell at all. For such products, a highly automated production process often
makes it easier to maintain uniform product quality, which in turn often requires
high production volumes. Similar logic applies to standardized services, for example
cleaning, surveillance, and knee or hip surgery. Even if a hip surgery may be a diffi-
cult treatment for an individual patient, such surgeries represent standardized mass
production in the health care sector. Thus, by scheduling similar surgeries to the same
period in time you can achieve efficient operations, with one team of doctors serving
a large number of patients during one day.
However, for other goods and services, the essential feature is a unique design and
a perfect customer adaptation, which makes it difficult to plan the production process
in detail in advance. For example, a tailor rarely starts sewing a dress or suit without
having discussed the color, cut, fit, and quality with a customer. To be able to produce,
the tailor needs to have an inventory of different fabrics at hand in his or her workshop,
as well as machines that can sew different materials. Much of this equipment will
probably not be used very frequently, but they must be available when they are needed.
The same applies to a car repair shop or a fire department. In these operations, it
must be possible to adapt both staff and equipment to each specific order or customer.
Consequently, they need broader skills, more multi-purpose equipment, and usually
considerably less specialization, than at a supplier of standard products.
6.2 Production strategy

A company's production strategy can be defined as a number of decisions concerning
investments in processes and infrastructure which are expected, in the long term, to
enhance the competitive factors which are crucial for a company to win orders from its
customers. Such strategic decisions often concern the company's position in the value
chain, the process design of the production system, capacity dimensioning, location,
supply-chain strategy, as well as competence development and recruitment.
The requirements made on different production systems can be described in terms
of different production strategic competitive factors, i.e., different factors that may affect
the value proposition and thus customers' decisions to buy a good or a service. In
practice, competitive factors are usually translated into various internal objectives
and performance measures for production. The following four competitive factors are
usually considered to be of the most important:
1 Price - a company's ability to produce and deliver at a low cost to the customer.
This can be achieved by means of an even and high resource utilization in
production and low levels of capital tied up, i.e., by having small inventories and
short throughput times.

2 Dependability - a company's ability to deliver fast and reliably.

This can be achieved by holding large inventories of finished products, short
throughput times in production, and swift deliveries with high delivery
precision.
3 Quality - a company's ability to meet customer needs and expectations.
This can be achieved by good control of production processes, standardization
of products and processes, and systematic knowledge generation about customer
needs.
4 Flexibility - a company's ability to quickly and efficiently make necessary
adaptions of its production due to changes in the business environment.
This can be achieved by a production system design which enables swift
conversion and change.
However, the challenge is that these competitive factors are conflicting. A good ability
to deliver by holding a large inventory of finished goods can be combined with high
and uniform resource utilization, but this usually means an extensive level of capital
tied up (which increases costs and consequently makes it more difficult to sell at a low
price). Short delivery times can be combined with low levels of capital tied up, but this
usually requires surplus capacity, which also increases production costs. Low levels of
capital tied up usually means a low and uneven resource utilization and it also risks
the ability for swift deliveries since components and finished products may not be
available when a customer order is received. Consequently, some of the factors can often
be achieved, but not all at the same time. Therefore, the final compromise has to be
made with respect to the company's value proposition and corporate business strategy.
Qualifiers and order winners

In successful companies, the production strategy supports the company's value prop-
osition. While the marketing strategy describes how the company's products are to
compete on the market, the production strategy describes how production should be
de igned and managed to ensure that the company achieves its goals. Consequently,
from a production perspective, it is often said that there is a need to specify the market-
ing trategy in terms of qualifiers and order winners. While qualifiers are factors that
make it possible for the company to compete on the market at all, order winners are the
factors in the value proposition that ultimately determine what customers choose. For
most mass-production manufacturers, for example, low production costs are essential
if they are to compete. However, a product's price is often only one of several factors
that determine whether a product is successful or not on the market.
Qualifiers and order winners therefore create a link between the company's overall
goals and the way in which it strategically manages and controls its production (see

Match
Marketing-Production
Overall Marketing Order winners

goals strategy Order qualifiers Infrastructure
Growth Market segment Price Process design Planning

Survival Brand Quality Inventory levels Control
FIGURE 6.1 Profit Value proposition Ability to deliver Capacity Quality assurance
Ord er winners and Flexibility dimensioning
Profitability etc. Organization
qua lifiers: the links between Service Supply strategy Reward system
etc.
marketin g strategy and Spare parts Location
etc.
production strategy (based
etc. etc.
on Hill, 2000).
Figure 6.1). The challenges are about positioning the company's production in the value
chains to which it belongs, as well as designing the processes involved so that together
they match the company's value proposition as efficiently as possible.
To design a production strategy, it is consequently important to understand the
overall logic of the production system itself, as well as the logics of the various subsys-
tems and sub-processes of the system. In the following, we will therefore discuss some
of the most important concepts in this context.
Impact of production volume

An important factor with many different effects on the production system is the required
production volume, i.e., how many products or services of a certain type need to be
produced and delivered during a particular time period. A high production volume
enables low costs per product as a result of economies of scale, i.e., the costs of resources
in the form of staff, equipment, and facilities can be distributed over a large volume of
products, which permits the cost per unit to be low. High production volumes create
opportunities to specialize tasks and acquire specialized equipment. The reverse also
applies: to be able to compete with high volumes and low costs, it is often necessary to
make extensive investments in specialized facilities.
However, it is normally difficult to achieve a high production volume without reduc-
ing the variety in the product range. A high volume therefore requires standardization
of the products and/or the components, which, in turn, permits standardization and
enhancement of the efficiency of the production process. This also usually means that
the process becomes less flexible. It can only supply standardized products and services
within a limited range and it is expensive and difficult to change.
122 © THE AUTHOR S AND STUD EN TLITTERATUR

Product variety
High
Flexibility
Matching customer
expectations
Complex process
High unit costs
High repeatability
High standardization
FIGURE 6.2
High specialization
Capital intensive The classic compromise
Low unit costs between production
volume and product
Low Low prices
variety (based on Hayes &
' - - - - - - - - - - - - - - - - - - + Production volume
Wheelwright, 1984).
Low High
To maintain high variety in the value proposition, however, it is necessary to have a

production system with high flexibility that is able to cope with a high level of unpre -
dictability. This means considerably lower economies of scale and less specialization
in the production processes. The consequence is higher unit costs for each product or
service produced. In other words, there is a classic conflict between high production
volume, which requires a high level of repeatability, specialization and standardization,
and high product variety, which requires high flexibility and the ability to handle a
more complex production process. This compromise between production volume and
product variety is illustrated in Figure 6.2.
When a company designs its production process, it is therefore important to pay
attention to the link between production volume and product variety. Typically, five
different, partially overlapping, types of production process can be identified (see
Figure 6.3):
• Projects are used for the production of unique products and services. The imple-
mentation of a unique project is entirely geared to the given task (see Chapter
17). This means in principle that there is little chance of achieving economies of
scale and low production costs. The ability to quickly and flexibly adapt the work
procedures and equipment to each task is essential.
• Jobbing (one-of-a-kind production) means efficiently developing and producing
products tailored to each individual customer order. The product is typically
marketed and sold before it has been fully developed. Following receipt of the
customer's order, the product is developed and then produced. In many cases, it is
installed and commissioned at the customer's premises. Examples of such one-of-

a-kind production processes are construction, capital equipment contracts,

production of precision-tool products, but also tailor's workshops, IT consulting,
car repair shops, and ala carte restaurants.
• In batch production of small and medium-sized batches, a certain number of
units of a product is produced during a particular period of time, before the
plant switches to producing another product, etc. Batch production is the most
common process type in production of both goods and services as it makes
it possible to combine economies of scale and high utilization of production
equipment and staff, with flexibility in the product range. Many companies in the
manufacturing industry use this type of production, but it is also, for example,
employed in many fast food restaurants. The size of batches may vary extensively
between different production systems. The problem is that a certain setup time is
usually needed to switch from producing one product to producing another. By
focusing on reducing these setup times, companies with this type of production
system try to create the conditions in which they can produce different types of
product as efficient as possible.
• In mass production, large batches of the same product are produced. In mass
production it is consequently crucial to have a streamlined and efficient
production apparatus. The logic of this type of business operation is usually that
the products are first developed, then produced and placed in an inventory of
finished goods, and in a final step sold to the customers. However, it is common
that mass production companies customize their products to some extent as
well. In the automotive industry, the iconic example of mass production, most
components and subsystems of the vehicles are standardized and made in
advance, but final assembly is often done on demand, i.e., when a customer orders
a vehicle.
• In continuous production, very large volumes of a single product are produced
in a continuous flow. This process type is typical for the processing industry,
for example paper mills, steelworks, breweries, and power stations. This process
usually requires large investments in production facilities, which, in addition,
are often designed to run at a specified production volume. Consequently, a
large proportion of the production costs are fixed costs: they do not vary with
the production volume (see Chapter 8). Consequently, capacity utilization of the
facilities is crucial. In turn, this means that control of the production processes
and maintenance is very important. Continuous production often lacks direct
manual production work. Instead, the staff control and monitor the production
process and manage the maintenance of the facilities.
124 © T H E AU T H ORS A N D STUDE N TL ITTE RATUR

Product variety
High
11111
Batch production
-,1.1m1 FIGURE 6.3

Different process types
in the production of
Low
goods (based on Hayes &
L - - - - - - - - - - - - - - - - - - - + Production volume Wheelwright, 1984).
Low High
Production volume and product variety are important not only in the production of
goods. The terms can also be used to understand how different types of service pro-
duction are organized and executed. Some services are entirely customized and vary
according to customers' specific situations. Many such services demand a high level of
expertise in the staff who performed them. Such professional services are provided by
engineering consultants, lawyers, accountants, and other specialists of different kinds.
A they have small volumes of each assignment, this type of service is usually relatively
expensive per unit performed (see Figure 6-4).
Other service companies produce standardized services in large volumes. These
include banks, canteens, security companies, staffing agencies, and telecommunica-
tions companies. Economies of scale allow these services to be standardized, resulting
in a low production cost per unit.
Between these two extremes there is a wide range of service companies with lower
variety and higher volume than the professional services, but higher variety and lower
volume than the standardized services. These can be compared to service shops, for
example car repair shops, IT service centers, primary care clinics, and clothing stores,
which are able to produce a number of different services within a specific range of
value propositions.
OTHE AUTHORS AND STUDENTLITTE RA TUR 125

Lawyers
Product variety Architects
Accountants
High Engineering consultants
etc.
Hospitals
Car repair shops
Professional
IT service centers
services
etc.
Retail banks
Service
Supermarkets
shops
Accounting companies
Lunch canteens
Standard etc.
FIGURE 6.4
services
Production volu me -
product variety in service
Low
operations (from Silvestro,
1999) ~ - - - - - - - - - - - - - - - - + Production volume
Low High
The logic of the production flow

The logic in (or the "profile" of) the production flow is usually linked to the product's
technical design and components. In simple terms, we can distinguish between four
flow logics: convergentflow (A profile), divergent flow (V profile), hourglass-shaped flow
(X profile), and T-shaped flow (T profile).
In a convergent production flow (A profile), a large quantity of input is converted into
an output of a few products. The production process for such products is often complex
as it involves planning and coordination of a number of different activities and a large
number of components, which also need to be designed so they fit together and match
each other. Convergent flows occur in jobbing, batch production, and mass production.
A typical example is the production of the Boeing Dreamliner, which involves the
assembly of more than five million components per aircraft. Another example is the
development of a complex IT system, which requires coordination of a vast number of
specialists with different technical and commercial competences.
In a divergent production flow (V profile), the situation is reversed. A few inputs
are converted into a large number of different end-products. These operations are
typically based entirely on continuous production processes, high volume, and high
level of specialization in order to achieve economies of scale. One typical example
is a steelworks, which can produce many hundreds of different steel grades from, in
principle, just iron ore, carbon, and a few alloying materials. Another typical example
of divergent production flows is oil refineries, which can convert crude oil into a large
number of products, from gas to asphalt.
Other production flows are hourglass-shaped (X profile). This type of flow is a
126 © THE AUT H ORS A NO ST UD ENTLITTERATUR

combination of convergent and divergent flows. One example is companies in which

the products are modularized, which means that the company uses a large volume of
components to produce standardized modules (high volume, produced for inventory),
which can be combined in many different ways, thus offering customers a wide range of
products (high variety, production to customer order). One well-known example is the
Swedish truck producing company Scania (today owned by Volkswagen). Over several
decades, the company has systematically developed a number of different variants
(modules) of cabs, gearboxes, engines, and frame components which can be combined
in a large number of different ways to meet customer requirements (see Figure 6.5).
Many suppliers ofIT systems employ similar strategies. By offering different modules
of a software system, which can be combined in different ways, an ERP (enterprise
resource planning) software system supplier, such as the German company SAP, is
able to standardize its development processes for each module, while customers get
exactly the systems they want.
Finally, there are also T-shaped operational flows (T profile) in which variety is
generated in the value proposition by giving each product a specific design in the very
last stage of production, before delivery to the customer. One example is the manufac-
turing of aluminum cans in the brewing industry. A packaging company essentially
produces only one type of can, but at the end of the production flow, the cans are printed
FIGURE 6.5
Scania's module system
has an hourglass-shaped
production profile.
THE AUTHORS AND STUDENTLITTERATUR

127
in different ways, creating a large number of variants. Equivalent logic exists in many
other sectors. For example, it is common for clothing companies to first produce a new
collection of T-shirts or sports tops, and then, as the last step in the process, dye the
garments in different colors according to current trends. This is an attempt to combine
high production volumes with flexibility, in order to be able to quickly adapt to any
changes in demand on the market.
As indicated by the two last flow logics, a production system may have a certain profile,
while at the same time consisting of a combination of different subsystems and produc-
tion steps that have other types of production flow profiles. It is important to understand
where the waist of the profile is located, i.e., the point in the flow that comprises the least
number of components. This narrow point is usually the central point in production
planning. The production steps carried out before the waist of the system are usually
forecast-driven; while the production steps after the waist are often, but not always, driven
by customer orders. Consequently, many companies strive for hourglass-shaped and
T-shaped flow profiles in order to combine the mass production of large volumes of
components and subsystems, with the ability to offer a wide range of customized variants
of end-products, which are produced and assembled in small batches.
Capacity of the production system

The system's capacity determines the ability of a production system to meet the demand
for products. Capacity is therefore a strategic concept of central importance, which
often defines the limits for other activities. Capacity means the maximum production
level over a period of time when the activities in the system are carried out under
normal conditions. Capacity is normally expressed in terms of possible production
volume per unit of time. When the capacity does not match demand, various forms of
inventories are created, for example raw material inventory, finished product inventory,
or queues of customers.
Capacity can be defined at various levels, for the entire production system and for
various subsystems, facilities, machines, or sub-processes. However, regardless of the
level of analysis, it is important to note that the total capacity is defined by the pro-
duction step where the capacity is the lowest. This step is the bottleneck of the system.
The bottleneck may be constituted by a machine or a tool with limited capacity, but it
could also be a technical specialist, a manager or another employee who is occupied.
An example is provided in Figure 6.6. This production process consists of four steps
that have different capacities. The assembly step has the lowest capacity and functions
therefore as the bottleneck. This means that, whatever the capacity of the other steps,
the capacity of the assembly will always determine the total capacity of this produc-
tion process. Any attempt to utilize the capacity of each step to the maximum will
consequently result in building an intermediate stock between the step of component
128 © THE AUTHORS AND STUDENTL ITTERATUR

Component manufacturing Distribution

850 units/week 820 units/ week
Inventory
700 units/ week
Assembly
350 units/ week
component manufacturing Distribution

850 units/ week
Inventory 820 units/ week Surplus
700 units/week ~ (unutilized)
Assembly
I ~ V-- capacity
.
350 units/ week 1
FIGURE 6.6
Maximum Maximum The bottleneck determines

capacity capacity the capacity for the entire
~-~~--,---' process.
manufacturing and the step of assembly, while the later steps of finished product inven-
tory and distribution will have surplus capacity.
When a production system is designed, it is therefore important to level the capac-
ities of the production steps so the type of the imbalances illustrated in Figure 6.6
are minimized. This kind of production balancing can be achieved by expanding the
bottleneck or by reducing capacity in the other steps (unutilized capacity in the form of
idling machinery and staff is usually expensive). However, in most cases it is inevitable
that there will be some form of bottleneck in a process. In such cases, it is important
for the bottleneck to be utilized to the maximum and that it does not become subject
to unnecessary disruptions that can lead to stoppages.
Another aspect of strategic capacity planning is how the company should adapt
capacity to changes in demand. If a company does not want to end up in a situation with
too little capacity, it can develop production capacity in advance to match forecasts .
This can, however, involve major costs, particularly if the forecasts are incorrect and the
company is left with an oversized production apparatus. The reverse, adapting capacity
to demand, is safer but also involves the risk of not being able to meet the demand and
therefore losing customers.
Positioning and supply strategy

Another important issues in production strategy relates to the positioning of the com-
pany's production system in the business ecosystems of subcontractors, customers, and
customers' customers of which the company forms a part (cf. Section 3.4):
CTHE AUTHORS AND STUDE N TLITTERATUR 129

1 How vertically integrated along the various links of the supply chain should the
company be, i.e., how many production steps should be internal and what should
be purchased from subcontractors?
2 How complete should a company's value proposition be in relation to a
customer's needs, i.e., should a company supply full customer solutions or supply
components that other operators integrate?
3 How many parallel supply channels (internal and external) should a company
have for each production step, i.e., should it work closely with just one or a few
selected suppliers or should it use a large number of parallel suppliers?
Few companies cover the entire chain from raw material to end product. This means
that all companies have suppliers of different types. For companies in mining and
forestry, capital equipment suppliers are the most important, while, for companies
downstream the supply chain, it may be mines, steelworks, and pulp and paper mills
that constitute the upstream links in the chain. Figure 6.7 describes, in simple terms, a
supply chain in which a company's production is related to its suppliers and customers.
Materials, components, information, ideas, and sometimes people, flow through the
supply chain's network of customer-supplier relations. Thus, a company's management
of its purchasing and suppliers is often called supply chain management.
On the supply side in the supply chain, a focal company typically has a number of
suppliers of raw materials, components, products, and services. In some cases, specific
manufacturing operations are performed by contract manufacturers that produce com-
ponents based on the focal company's drawings and specifications. This is common in the
fashion and furniture industries, but the phenomenon exists in many other industries as
well, including electronics and pharmaceuticals. In other cases, relatively advanced parts
of the product may be both produced and developed outside the focal company, sometimes
by large global sub-suppliers with their own brands and product development. Two such
examples are the Swedish ball-bearing manufacturer SKF and the German automotive
parts manufacturer Bosch. However, even if a specific sub-supplier may be a very large
Second tier First tier The focal First tier Second tier
suppliers suppliers company customers customers
FIGURE 6.7
The company in the supply
chain. ---+ Material flow + ------- Information flow
130 © THE A UTHOR S AND STU D ENTLITTERATUR

CHAPTER 6 a PRODUCTION
company that supplies many customers, most sub-suppliers account for only a relatively
small proportion of their customer companies' total value propositions.
Many sub-suppliers also have their own suppliers for their operations, which means
that there may be long supply chains with first tier suppliers, second tier suppliers, etc.
The same situation exists on the focal company's demand side, where customers often
have their own customers who, in turn, have their own customers, etc. The more
integrated these supply chains are, the more efficient they usually are. At the same
time, the links between the various companies also mean that production problems
caused at one sub-supplier easily spread to downstream actors in the chain since they
might not receive their deliveries. In the same way, changes in demand and purchasing
behavior at customers' customers may spread upstream in the supply chain and affect
the conditions for the subcontractors' production.
Deciding which steps in the production system should be performed in-house, and
which should be purchased from suppliers and consultants, is a strategic issue often
referred to as sourcing. This decision is based on a number of different factors, not least
the company's own expertise and production capacity, access to external competences
on the market, the actions of competitors, and how significant each production step
is for the company's value proposition. The rule of thumb is that, the more important
a resource, a competence, or a production step is to the value proposition, the more
important it is to gain control by making it in-house. However, the long-term global
trend has been increased specialization, with the result that supply chains are becoming
increasingly fragmented between various actors. Consequently, the purchasing depart-
ments have successively gained increased importance and status in many companies.
Corporate purchasing departments usually develop specific strategies for different
categories of items or suppliers, so-called category management. Figure 6.8 describes
High
• Exploitation of full • Development of long-term
purchasing power relationships
• Target pricing strategies/ , Collaboration and innovation
negotiations • Natural scarcity
• Abundant supply
Leverage items Strategic items
• Production standardization • Low control of suppliers

• Process efficiency , Innovation and product
(automated purchasing e.g., substitution and replacement
catalogues, e-tendering) • Production-based scarcity
• Abundant supply
FIGURE 6.8
Non-critical items Bottleneck items
Kraljic's matrix for strategic
Low High purchasing (based on
Supply risk
Supply chain complexity Kraljic, 1983).
THE AUTHORS AND STUDE N TL ITTER A TUR 131

Kraljic's matrix, which is a portfolio analysis of a company's purchased items based on

how much the item affects the company's value proposition and profitability, and the
consequences of any supply problems. Consequently, the purchasing items are divided
into four categories which, according to the model, should be managed differently.
1Strategic items (high effect on profitability, high supply risk):

These supplies require the most attention from the purchasing department.
Strategies include developing long-term, in-depth relations with suppliers,
being prepared for disruption, and, if possible, starting to produce these items
in-house.
2 Leverage items (high effect on profitability, low supply risk):
The recommended strategy is that, based on its negotiating strength as a

purchaser, the company should exploit competition between the suppliers in the
market as much as possible.
3 Bottleneck items (low effect on profitability, high supply risk):
There are few alternative suppliers for these items and they result in major costs
if the deliveries fail. Recommended measures are to order more than is needed
at present when the items are available, to seek alternative suppliers, or to seek
alternative items by changing the product design.
4 Non-critical items (low effect on profitability, low supply risk):
The typical strategy is to use standard products, to try to minimize purchasing
costs, and to optimize order volumes and inventory levels.
Kraljic's matrix was originally developed to manage different categories of purchase

items. However, the model can also be employed to classify suppliers in order to identify
where in the supply chain a company is most vulnerable.
The strategic decisions: position, capacity, location, and

production equipment
Consequently, designing a production strategy involves a number of decisions that
set the long-term limits of a company's production process. In practice, it is necessary
t? balance between a number of options. There are rarely any clear right or wrong
options. They all have both advantages and disadvantages. However, in principle, the
more investments in physical facilities, premises, and equipment a production strategy
requires, the more difficult it will be to change the strategy in future. Capacity is one
strategic question: how many products, customers, or patients, should the system and
its subsystems be designed to handle? What is a reasonable balance between delivery
readiness, throughput time, flexibility, and costs? At which stages in the supply chain
should the company be positioned? Which components and subsystems should be
132 ~ THE AUTHORS AND STUDENTLITTERATUR

manufactured in-house, and which should be purchased from suppliers? How many
alternative suppliers should the company have?
In addition to these questions, there is the question of the physical location for
roduction. This may seem to be a trivial issue, but it often sets the limits for the struc-
~ure, management, and efficiency of the operations. One important issue is whether
the production should be located near customers, near important suppliers, or near
supplies of raw materials. Or perhaps production should be located where there is
good access to competent employees? Finally, there is the strategic question of the
design of the production processes and the choice of process equipment. The choice
here is between investing in general, flexible equipment that can rapidly be adjusted
as demand changes, and investing in specialized equipment to achieve high efficiency
and thus low production costs.
6.3 Tactical production management

Production management, at what we here refer to as the tactical level, addresses the
process design of the system and the system's various sub-systems. Tactical production
issues concern designing production flows and layouts, creating robust production
processes, and how to balance flexibility and efficiency in the processes.
Production flows and layouts

Production processes are often depicted by flow charts that illustrate how inputs are
transformed into outputs via different production stages. In the production of goods,
the processed materials are moved physically between different manufacturing oper-
ations in a specific sequence. Sometimes the material is stored between the different
processing stages in various kinds of inventories (see Figure 6.9). Correspondingly,
the activities of a consultancy assignment may also be described as a flow. Even the
movement of patients, passengers, and restaurant guests may be described as flows,
except that in such service systems, the inventories are usually called waiting rooms,
lines, or queues.
/ o- e "-..
Input-• ---+ 8 - G _. T - 0 - T -output
Material"-..
inventory 0 _. F
/ Inter-
mediate
inventory
Finished
product
inventory
FIGURE 6.9
A styl ized flow chart.

Dependencies of various types occur in a production system. In the production of

goods, these are often linked to the physical layout of the production system, i.e., how
the premises are arranged, where different machines are placed, etc.
In projects and certain types of jobbing, the production often takes place at a spe-
cifzc location (fixed-position layout). An infrastructure project, building of a ship, or
implementation of an IT project, often involves the use of staff with different skills,
and equipment with different functions, at the physical place where the project work
is carried out. This is also often the case in the end-stage of capital equipment and
system deliveries, when the new equipment needs to be installed and commissioned
on site at the customer's premises. Small but complex products in small batches may
also be manufactured at a specific location in a workshop. Instead of transporting the
product between different workstations, materials and staff are moved to the prod-
uct. The opportunities for automation are few as the work tasks have a low degree of
standardization.
For small batch production (and also some jobbing) of products with high product
variety, production usually takes place in facilities with a functional layout, i.e., where
equipment with similar function is grouped together in different workshops (some-
times called job shops) and production takes place by the products being moved around
between the workshops (see Figure 6.10). In this way, the production apparatus can be
structured in, for instance, a welding workshop, a milling workshop, and an assembly
workshop so that a large number of different products can be produced by using the
same equipment. The functional layout allows great production flexibility without the
capacity utilization of the machines and staff being too low. A functional layout also
permits the development of deep specialized skills at the various workshops. However,
the layout often means long throughput times and low dependability, as it is common
for queues to emerge in the material flow, with the result that batches of components
and semi-finished products must be stored between different production steps. The
planning and control of the production is resource-intensive and there is extensive
transportation of the material, which easily lead to a high level of capital tied up.
A traditional general hospital is an example of service operations with a functional
layout. A large number of patients with different illnesses and physical problems move
between the various clinics and departments in the hospital, all of which have different
medical specializations and different types of equipment. Before each stage of treat-
ment, the patients have to wait in each clinic's waiting room. An unplanned visit to
the emergency room at a hospital for a minor wrist injury can therefore take several
hours, even though the actual treatment (X-ray, examination, and splint) only takes
a few minutes.

Metal sheet processing Welding
Product A
Product B - - - - - - - - - , •
Milling Painting
FIGURE 6.10
Product C ----------w Production flows in a
production facility with
Lathing (turning) Final assembly a functional layout.
Mass production of standard products usually takes place in a flow layout, some-
times also called line-based layout or product-oriented layout (see Figure 6.n). In a
flow-oriented production facility, the machines are grouped in a line so that a product
is produced from start to finish in a comprehensive flow. This reduces the throughput
times and capital tied up but also reduces the flexibility of the production system. The
most extreme flow layout is the continuous production flow in the process industry,
for example in a steelworks or a paper mill. In these types of operations, an entire
production facility may correspond to a single production flow and a single product.
Production is highly automated and very specialized. The volumes are high and the
product variation is very low. The equivalent in the manufacturing industry is dedicated
product workshops (sometimes called focused factories) in which mass production takes
place using highly specialized machines that are placed following the sequence in
which the manufacturing operations are to be performed. The assembly line, which is
common in the manufacturing industry and has come to symbolize mass production,
i another example of an extended flow layout.
Metal sheet processing Milling Lathing (turning) Welding Painting Final assembly
Product A
Metal sheet processing Milling Painting Final assembly

Product B
• • • • • FIGURE 6 .11
Production flows in a
Lathing (turning) Milling Welding Painting Final assembly production facility with
Product(
• • • • • • a pure flow layout .
HE AUTHORS AND STUOENTLITTER A TUR

135
FIGURE 6.12
Critical
Product ion flow in a flow machine
sho p (produc ti on cell) w ith
a com pon ent inventory
(bu ffer) befo re and afte r. Input buffer Output buffer
A compromise between a functional layout and a flow layout is the flow shop (see Figure
6.12). In this production layout, certain machines are grouped following the flow so that
products that undergo the same processing sequence are produced at the same place
in the workshop. Simple but efficient transport devices move the products between
the machines so that each flow shop becomes an autonomous production cell. The
principle is that one of the machines, usually the most expensive, controls the capacity
of the flow shop. Thus, the capacity of this critical machine should be maximized and
be the bottleneck so that the whole production cell, in principle, can be planned as if it
consisted of one single machine. In a workshop with flow shops, there is less flexibility
to switch between different types of products than with a functional layout. However,
the complexity is reduced, the throughput times are shorter, and the capital tied up in
products in progress is thus lower. At the same time, a layout with flow shops is less
specialized than a pure flow layout.
In practice, it is common that different types oflayouts are combined. If a general
hospital is a typical example of service operations with a functional layout, then a
maternity clinic, for example, can be compared to a flow shop: all resources for child-
birth are concentrated in one place.
Several factors must be weighed up against each other when designing the produc-
tion layout. One of the most important criteria is the impact of the layout alternatives
on the production costs. In simple terms, it can be said that this impact for the various
alternatives follows the profiles illustrated in Figure 6.13. For products produced at
a fixed position, the fixed costs are usually low, while the production costs increase
dramatically for each new unit produced. The opposite is usually the case for products
produced in a flow layout. To be able to produce the first product at all, you are forced to
invest in expensive, specialist process equipment, but once the production equipment is
in place, the cost increase for each new product that is produced is small. A flow layout
is consequently most economical with large volumes. From a financial perspective, a
functional layout and flow shops lie between these two extremes.
136 © T HE A UTH O RS A N D STUDE N TLITTERATUR

Production cost per unit

Fixed position (specific location)
High
Functional layout
Flow shop (production cell)

Flow layout
FIGURE 6.13
Production costs' principal
Low volume dependence for
c _ _ _ - - - - - - - -- - - - - - - + Production volume various layout options.
Low High
Robu stness of the production processes

The aim of production planning and control is to create a robust production process,
i.e., as far as possible avoid disruptions and achieve an even workload and pace of work.
Robustness in production is often essential to the ability to maintain a specified and
high quality. Achieving an even production flow is also essential to the ability to gain
efficiency and maintain low production costs.
In principle, there are three reasons why a production system becomes unstable. The
fir t is variation in demand, which makes it difficult to know what will be in demand
and when this demand occurs (variation in output). The second is variation in the
upply of, for example, raw materials and components. Deliveries may be delayed,
uppliers may be overbooked, or necessary skills may not be available when they are
needed (variation in input). The third is that the tasks in the production process may
have inherent ambiguities, making them impossible to fully define in advance. Conse-
quently, different types of "shock absorbers" are used in different production systems
to manage such variations and potential disruptions caused by external factors.
Variation in demand (output) is usually managed in one or more of the following
way:
1 By creating a backlog, which means that customers have to wait for their
deliveries, or their turn. This is risky since the customers might not accept the
waiting time and decide to use a competitor instead, or they might not come
back with new orders as they are dissatisfied with the long delivery times.
THE AUTHORS AND STUDENTLITTER A TUR 137

2 By having surplus capacity, i.e., extra staff and equipment to be deployed

if required. This is expensive, since the extra production capacity will be
unutilized for long periods of time.
3 By building.flexibility into the production process, for example designing for the
possibility to change the sequence of activities, or by having staff and equipment
that can be used in multiple ways, according to demand. However, this generally
leads to higher production costs per unit.
4 By building up an inventory of finished products, which might also be expensive
as a finished products inventory ties up capital that could be used elsewhere.
In a similar manner, variation in supply (input) is usually managed in one or more of

the following ways:
1 By not making the company dependent on a single source, i.e., by utilizing

everal alternative suppliers for the same functionality or component. This is
called multi-sourcing. However, this requires additional work on purchasing and
coordination and it sometimes also creates a barrier to achieve economies of
scale.
2 By using standard components, which makes it easy to find new suppliers
if there is a delivery problem. However, this may mean that the company's
value proposition becomes less unique to the customers, in comparison with
competing products.
3 By maintaining an inventory of raw materials and components. However,
this is expensive as it ties up capital in the same way as for a finished products
inventory.
4 By building.flexibility into the production process, for example designing for the
possibility to change the sequence of activities, or by having staff and equipment
that can be used in multiple ways, depending on the available input. However,
this generally leads to higher production costs per unit.
Consequently, these built-in "shock absorbers" are about protecting the production
process from the external environment in various ways, using various types of buffers,
for example an inventory of finished products or raw materials, or extra capacity, at
both the front-end and back-end of the production process. This is the basic reason why
there are often various forms of inventories and queues. The raw materials inventory for
a paper mill and the waiting room at a health center both have this buffering function.
Both are designed to maintain stability in the production processes in focus. In the
same way, the fast food restaurants of McDonald's manage variation in demand by
having an intermediate inventory of finished burgers between the sales counter (front
office) and production in the kitchen (back office).

In many production systems, there are mechanisms with the purpose of actively
. ng both demand and supply to maintain this stability. Many companies try to
in fl uenc 1 . . . .
d the variation in demand by means of different pncmg, vanous extra offers and
re uce
different types of standardization of their value propositions. Furthermore, many com-
. work with different types of forecasts. Ikea, for example, has relied on weather
pames
forecasts for many years to be able to summon extra staff at weekends if the weather
i bad, as Ikea knows from experience that bad weather brings a surge in customers.
The production process itself contains another source of instability. There may be
uncertainty in one or more stages, for example concerning which activities to carry out
and in which sequence. There are various ways of managing this internal uncertainty,
including standardizing the products and the processes as far as is possible. If this is
not enough, some of the common ways of managing internal uncertainty are as follows:
1 By creating output buffers, for example finished product inventories, or by

having extra-long delivery times that can be employed if there are delays in the
process.
2 By creating input buffers, for example of raw materials, extra staff or equipment,
that can be deployed in the event of problems.
3 By taking various process measures, like creating surplus capacity in normal
operations, having staff with a wide range of skills, having multi-purpose
equipment and, if necessary, adding capacity to the process by using subcon-
tractors, personnel from staffing agencies, or consultants.
Con equently, internal process uncertainty is primarily managed by creating flexibility

in the production processes, which, by definition, means that it entails higher produc-
tion costs per unit than in processes without uncertainty.
The customer order decoupling point

The delivery time which is accepted by the customers in relation to the throughput
time required by the production determines whether it is possible to start production
only when a customer order is received, or if it is necessary to produce in advance
and then sell finished products. If the market requires immediate deliveries, make to
stock is the natural choice. This is the situation that we encounter as consumers for
mo t everyday products. If the delivery time is be shorter than the throughput time
of production, some production activities must always take place in advance. If the
agreed delivery time is longer than the production throughput time, make to order
can be applied instead. This means that production only starts when the company has
received a customer order, for example for a bespoke suit, a consultancy project, or a
hairdresser's appointment.

PAR T II a THE VALUE CREATION SYSTEM
Here, the position of the customer order decoupling point, i.e., the position in the
sequence of production steps at which a specific customer order is linked to a specific
product, is a crucial factor. Before the customer order decoupling point, make to stock
is the most common ordering logic. This means that the products produced are placed
in a finished products inventory from which deliveries are made. Consequently, the
rate of production depends on the rate at which the finished products are drawn from
the inventory. This logic of production is bound to be based on forecasts, which means
that it always contains a degree of uncertainty as it is impossible to be perfectly sure that
everything produced, will also be sold. However, after the customer order decoupling
point you will have a defined customer for each product, which means that the company
knows exactly what, and how much, has been ordered.
Figure 6.14 illustrates five different typical cases of where the customer order decoup-
ling point, CODP, is positioned in a production process (in practice, several hybrids
occur):
1Make to stock is the case when short delivery times are required. These products
are standard products that are usually produced in large batches (mass
production and continuous production) with no form of customization. For
example, there is no identified customer when a tube of toothpaste, an adjustable
wrench, or an Ikea couch is manufactured.
2 Assembly to order means that various components and subsystems are produced
based on demand forecasts but not assembled until a customer order has been
received. This creates flexibility and the possibility of customizing products. For
example, a car is usually not assembled until it has been sold, but its components
are mass-produced to inventory. Similarly, computers are usually packaged and
configured to customer specifications only after they have been sold, although
the components are produced way in advance.
3 With make to order, raw materials and components are in inventories and
production starts when a customer places an order. This type of production
usually takes place for jobbing (one-of-a-kind production) or small batch
products and depends on variation in demand and the supplier's production
planning. Designer furniture is one example, where it may take several months
for a couch or dinner table to be delivered. Car repair shops are an example of
service operations with this logic.
4 With purchasing to order, raw materials and components are not purchased for
production before a customer has placed an order. This means that the product
is available in several versions with a high degree of customization. Product
variety is high, but production volume is low, often one-piece production.
Small construction projects are often executed according to this logic, as well as
contracts of capital equipment and system deliveries.
140 0 TH E A UT H ORS A ND STUDE N TL ITT ERATUR

5 With design to order, the product is developed in partnership with the customer.
Consequently, the customer gets a unique product that is tailor-made to specific
requirements. This is common for large construction and engineering projects
and also, for example, when the Swedish defense contractor Saab develops a
new weapons system for the Swedish Armed Forces, or when Ericsson and
Huawei sell, design, and install telecommunications systems for various telecom
operators worldwide. Design to order is also the typical logic at a traditional
tailor.
Consequently, the position of the customer order decoupling point is closely linked to
the opportunity for product variety. Production with a late customer order decoupling
point (make to inventory) is therefore primarily applied for production systems with
high volume and low product variety, and where the demand is difficult to forecast.
Early customer order decoupling point (make to order), on the other hand, occurs with
low production volumes and high product variety, as well as in situations where the
demand can be forecasted with certainty.
In addition, the position of the customer order decoupling point also explains why
many industrial companies want to locate production as close to their markets as
possible. A Volvo car produced in China can be assembled to customer order and
delivered to a Chinese customer within a few weeks. However, a Volvo car with final
a sembly to customer order in Sweden, with identical, mass-produced components,
would need to be transported by ship for several weeks before the Chinese customer
would receive his or her purchase.
Product
development Purchasing Manufacturing Assembly Delivery
To stock Customer order

Make to stock •---- ------------ -- --- --- --- ----- ---- ----- ------ ----- ---- ---• 4 •
CODP
Assembly to order •------------------ ------------ ------------•
CODP
Make to order •-----------------------•
CODP
To stock FIGURE 6.14
Customer order
Resource to order •---------------• Position of the customer
CODP
order decoupling point
Customer order
Engineer to order (CODP) in tive typical cases
CODP of production .
HE AUTHORS AND STUDENTLITTER ATUR 141

'
Lean Production
The concept Lean Production was coined in 1990 in the book The Machine that Changed the
World as a description of the best practices of the production system at the Japanese Toyota
Motor Company. The ideas, principles, and techniques of Lean Production have today become
firmly established and are applied in a number of operations far beyond the manufacturing
industry, for example in health care operations and public administration.
The fundamental idea behind Lean Production is to identify and eliminate everything in a
production process that does not create value for the end customer. Consequently, it involves
mapping the value creation processes and attempting to eliminate all waste. Instead of maxi-
mizing resource utilization in each production step, the aim is to maximize flow. The concept
of Just in Time is a core pillar of Lean Production. Just in Time means that information, compo-
nents, and materials should be at the right place at precisely the right time, i.e., there should be
no buffers or inventories. Some other important concepts related to Lean Production are value
stream mapping, kaizen (continuous improvements), kanban (an ordering principle, see Section
6.4), zero-defect philosophy, and muda (waste).
Toyota identified seven types of waste (muda) which frequently occur in most production
systems, whether for goods or services. Taken together, these seven sources of muda are often
described as the core of Lean Production:
Transports - every time a product is moved, it risks being damaged, lost, or delayed. In itself,
transports create no value that a customer wants to pay for.
Inventories - raw materials, products in progress, and finished product inventories tie up capital
and produce no value for the customer.
Movements - movements of staff and equipment add no value to the products.
Waiting - components and materials that are idle or waiting for the next processing step to be
carried out add no value.
Additional work - to produce a quality that is higher than that required by customers, or
unnecessary tasks on account of poor product or process design, add no value.
Overproduction - production of more units than those required by customers at a specific time.
Defects - repairs, adjustments, and reworking due to mistakes, faults, and quality shortfalls
which add no value for the customer.
6.4 Operational production management

At the operational level, the production management issues are mainly about produc-
tion planning and control, logistics, inventories, capital tied up, and various techniques
for efficiency improvements.
142 © T HE AU T HO RS A ND STUDENTLITT ERATUR

Production planning and control

. ·s a way of trying to anticipate and deal with the future, i.e., of trying to identify the
Pfannmg1
. . s that might occur and decide how they should be managed. However, planning is
~00 ..
also a way of trying to influence and create a (shared) future, for example by coordmatmg
the actions of a team in a desirable manner. When planning, the current actions become
influenced by conceivable future situations in order to avoid problems and be prepared
for action. Control is closely linked to planning. As no plan is perfect, measures to control
di ruption and uncertainties are constantly required in order to keep production running
to Ian. In addition, plans usually require adjustment during production according to the
ouf comes. The difference between production planning and production control is therefore
linked to the time horizon. Planning is more long-term and control is more short-term. In
simple terms, the poorer the planning, the more time and energy are required for various
adjustments and controlling measures. A planning procedure follows six steps:
1 What is to be achieved?
This is the objective of production, which is linked to the production strategy and
the overall conditions.
2 What is to be carried out?
This is determined by the products to be supplied and defines the activities which
consequently have to be performed.
3 In which order?
This involves sequencing the various activities.
4 When?
This involves scheduling, i.e., deciding when various activities are to start and to
finish.
5 How much, by whom, and with which equipment?
Thi is about the load for staff, departments, and machines.
6 How should it be monitored and controlled?
Thi mainly involves managing disruption and, where possible, reducing uncer-
tainties in the production process.
In practice, of course, much of this planning is a continuous undertaking. In addi-

tion, everal of the planning parameters are often more or less defined, depending on
the trategic decisions made earlier about the design of the production system. For
m tance, flexibility is high in projects and jobbing (one-of-a-kind production): it may
be necessary to go through all six stages following a customer order, i.e., everything
from identifying activities to deciding which resources should be engaged. However,
production systems with flow layouts have less flexibility as the sequence of both the
activities and the resources is predetermined and built into the production layout.
The primary concern in these systems is therefore to monitor the production process.
HE AUTHORS AND STUDENTLITTERATUR 143

Ordering principles
Production control also involves deciding and signaling when different production
processes should start, that is, ordering. In the production of goods, a distinction is
traditionally made between two different ways of ordering a production activity. These
ordering principles are called push control and pull control (see Figure 6.15).
Push control system means that production is initiated from the first stage of the
production process and when this stage is executed, the next stage begins. In this way,
the product is "pushed" through the production process. In practice, this means that
each production step receives a signal to start when a production order arrives to the
workstation where the step is to be carried out, together with materials, components,
and semi-finished products from the previous production steps. Since a product under
production is pushed forwards in the process each time a step has been finished, interme-
diate inventories tend to emerge in which semi-finished products wait to be processed in
the next step. For a long time, this was the dominant method of planning and controlling
the production of goods. The principle is also familiar from visits to the emergency room
of a hospital. Treatment is initiated by the patient arriving in the emergency room. They
have to wait in the waiting room, after which they meet a doctor, who assesses what care
they need and may send them on to the X-ray department, for example, where they will
wait in another waiting room before returning to the emergency doctor, etc.
Pull control system, on the other hand, means that production is started "from the
back", i.e., a downstream production step orders production from an earlier, upstream
stage of production. Thus, each operation step functions as a customer ordering from an
earlier operation. This produces no intermediate inventories in the production process,
which means that the throughput time is short. However, as the last production step
in this way controls the process, the previous steps may have surplus capacity, or even
be idle while waiting for new production orders.
"Kanban" is a common pull control system. The term kanban is Japanese and means
"card" or "sign". The way it usually works is that there are standardized containers (crates,
pallets, or similar) in which the materials and components are handled. When all compo-
nents of a container have been assembled in operation 6 in the right-hand part of Figure
Forecast Order
Master plan Kanban
FIGURE 6 .15
The "push" and
•· '! ,. '!Gt ·· ·'!S t ·..
'
' ''
"pull" ordering "Push" "Pull"
pri nciples. By order from the production plan By order from downstream steps
144 © T H E A U T H ORS A N D ST U DE NTL ITTERATUR

6_15 , the empty container is sent to the upstream stage of production, operation 5. The
empty container functions as a signal to start production. When operation 5 is carried out,
materials are picked from other containers which, when they are empty, are sent to opera-
tion 4, etc. As components and semi-finished products are completed at the various oper-
ations, they are placed in the empty containers and sent on to the downstream operation.
Logistics and inventories

Logistics is basically about planning and controlling the transportation of materials
in the production process. This means ensuring that the right material is at the right
place at the right time. Logistics concerns material flows both within factories (internal
logistics) and between suppliers, manufacturers, and customers (external logistics).
Logistics costs include the costs of freight, storage, loading, reloading and unloading,
safety inventories, receiving inspections, purchasing management, damage and wast-
age, obsolescence, and insurances.
If materials are transported in the production process, it means that they are
moved between different production stages. This, in turn, means that transportation
has impact on production control and throughput times. Today, many production
processes consisting of several different companies are connected almost as if they
were taking place in one single factory. For the manufacture of cars, for instance, it is
common for components to be delivered by external suppliers in small batches directly
to the final assembly line. Thus, material logistics between different production plants
ha increasingly come to resemble production control within the production plants.
One difference is that the material flows between production plants involve different
type of transportation, for instance by rail, road, air, or sea. These material flows tradi-
tionally consisted of many intermediate stations, relatively low delivery times, and low
delivery service. Today's strong emphasis on throughput times has, however, resulted in
delivery times decreasing and delivery service increasing. Modern transport planning
contains few intermediate stations and often only one central inventory center, with
regular scheduled deliveries, supplemented by direct deliveries. Such logistics solutions
often require extensive investments and it is important for large central inventories and
logistics centers to be located in places that are easy to access with different types of
tran portation, while also being as close to customers and/or manufacturers as possible.
There are different types of inventories in all production systems. Inventories func-
tion as buffers (shock absorbers) to manage disruption, uncertainties, and variations. To
achieve disruption-free production of goods, it is usually necessary to have inventories
of raw materials and semi-finished products. In order to be able to meet demand with
sufficient speed, it is necessary to have inventories of finished products. Consequently, it
15 often necessary to maintain various types of inventories; they increase the capability
to deliver and enhance flexibility. Furthermore, it is often cheaper to purchase materials
THE AUTHORS AND STUDENTLITTE RA T U R 145

Inventory level
High
Maximum inventory
Average inventory
Safety inventory (buffer inventory)

Low
'---------+-----:,--------+ Time
:~ Delivery time
FIGURE 6.16
Typical inventory with order
point system. Order point
and components in a few large batches, than in many small ones. At the same time,
inventory ties up capital, requires inventory management, and occupies physical space.
In other words, unnecessary costs are incurred if inventories are too large, while, if they
are too small, the result may be production stoppages or missed sales opportunities.
The reasons for an inventory may vary, but the root cause is always an imbalance
between input and output in terms of rate or quantity (see Figure 6.16). There is often a
desire to maintain a minimum level of items in inventory as a buffer or safety inventory
to prevent shortages from occurring. When the number of an item falls to a certain
defined inventory level, the order point, an order is placed. A certain lead time is then
usually required until new items are delivered and the inventory is replenished.
Inventory levels and replenishment volumes are linked. Large replenishment vol-
umes each time (from suppliers or own production) means higher average inventory
levels, than if the inventory is replenished more frequently but in smaller quantities
(see Figure 6.17). At the same time, each purchase usually involves purchasing work
and various types of additional costs, for example for transportation and materials
handling. Consequently, there is a trade-off between costs resulting from capital tied
up, and costs for transportations and materials handling.
Inventory level
~
~~,n~
Inventory level
~
FIGURE 6.17
Relation between inventory
level and replenishment
volume. , Time
146 © THE AUTHORS AND STUDENTLITTERATUA

Capital tied up
Inventories occur not only at the start and finish of a production process. They also
often occur between different stages of production. From a financial perspective, the
products that are unfinished but in the process of being produced in the company's
production facilities also constitute a form of inventory. In accounting, these are called
products in progress or work in progress. As most companies have to incur expenses
for purchasing materials, consultants, and salaries long before they earn revenue from
the sale of the products they produce, a considerable amount of capital may be tied up
in ongoing operations. In a company that produces goods, this capital tied up consists
of the physical items in the raw materials inventories, the component inventories, the
products in progress at the production workstations, the various intermediate inven-
tories between the production stages, the finished products inventory, and, sometimes,
also the transports to various customers. In financial terms, this capital tied up is called
working capital (see also Chapter 12).
The working capital tied up in goods in manufacturing usually has the profile illus-
trated in Figure 6.18. When the material is purchased, it is valued at the price of pur-
chase. As materials are processed, their value increases, which means that the finished
products inventory has a considerably higher value than the raw materials inventory. In
addition, there is a causal link between the throughput time, the production volume,
and the quantity of capital tied up in the production process. For example, the working
capital tied up in products in progress is a function of the production volume multiplied
by the production time (lead time/throughput time). Consequently, if the production
volume for a workshop is 1,000 units per day and the lead time is 5 days, a value equiv-
alent to 5,000 units is tied up in production. If the lead time is reduced to 2 days, only
a value equivalent to 2,000 units is tied up in production (see Chapter 12).
SEK
Finished
product
Products in inventory
progress
Intermediate
Products in inventory
FIGURE 6.18
' - - - - - - - - - - - - - - - + Time
Working capital tied up in a
Total throughput time goods manufacturing.
l AUTHORS AND STUDENTLITTERATUR 147

Since extensive capital in this way can be tied up in ongoing operations, most com-
panies emyhasize both reduction of the levels in their various inventories and reduction
of the throughput times (lead times) in production. One of the great advantages of
a flow-oriented layout is precisely that it produces short throughput times. This is
considerably more difficult with mixed production in a facility with a functional layout
(see Section 6.3).
Reduction of batch sizes, i.e., the quantity of a specific product that is produced
before switching over to the next product, is one measure for reducing the throughput
time. Smaller batches mean shorter throughput times, but at the expense oflonger setup
times (the time it takes to adjust the equipment to produce the next batch of a different
product) as the equipment needs to be adjusted more frequently. However, the biggest
advantage of reducing the batch size and the setup times is that greater flexibility is
achieved without compromising on the efficiency of the flow. Reduced batch sizes also
mean reducing the working capital that is tied up in inventories, products in progress,
and finished products inventories.
The example "Link between batch size, throughput time, and setup time" illustrates
this: to achieve a reduction in batch size and thus throughput time while maintaining
the production volume, the setup times must be reduced accordingly.
Example: Links between batch size, throughput time, and setup time
Definitions:
Operation time= The time required to perform a production operation
Processing time/batch= (The time it takes to process an item)* batch size
Setup time= The time it takes to adjust a production process from one batch of components to a
different batch of components
Throughput time/batch= Processing time/batch+ Setup time
A machine produces three different components: A, B, and C. They are produced in batches of
ten units, and when the production of component C is finished, the production of a new batch of
component A starts again (see figure). The machine that will process component A will therefore
receive deliveries of 10 A that are part of the company's products in progress. After having been
processed in the machine in question, all batches of components are moved to other workstations
for further processing.
l0A
I I 10 B
II 10(
II lOA =
D Batch being processed in a group of machines in the workstation for 10 hours .. Time
D Machine group in workstation being set up for 2 hours.

Case 1: Each part is produced in batches of 70 units.

When the production of component A has been finished, it takes 26 hours before component A is
produced again (three setups of 2 hours and production of B for 10 hours and C for 10 hours).
A decision is then made to reduce the batch size by 50 %, i.e., to produce five items of each
component before switching over to the next.
SA SB SC SA SB
Batch being processed in a group of machines in the workstation for 5 hours. Time
O Machine group in workstation being set up for 2 hours.

case 2: Each component is produced in batches of 5 items.
In this situation, it takes 16 hours from when the production of component A is finished, until it
is produced again (three setups of 2 hours and production of B for 5 hours and Cfor 5 hours). The
machine that will process component A further will now receive deliveries of 5 A, i.e., reducing the
batch size by 50 % means reducing the products in progress by 50 %.
If we now compare how much of the available time is used for processing in two cases, we see
that in case 1the machine utilization is:
Cycle time/batch l0 hours 83 % of the time

Total time 10 hours+ 2 hours
In case 2, the machine utilization is:
Cycle time/batch= 5 hours = 71 % of the time

Total time 5 hours+ 2 hours
Thus, a reduction in the batch size means that the capital tied up in products in progress is
reduced, as well as the throughput time. However, the proportion of time used for processing is
reduced as the number of setups increases.
To be able to reduce the batch size and thus the throughput time and still produce the same
volume, it is necessary to reduce the setup times with the same percentages as the batches, i.e., if
the batches are halved, the setup times must be halved. In case 2, this means that the setup times
need to be reduced to 1 hour in order to utilized the machine to the same extent as before.
~le time/batch 5 hours 83 o/c f h .

Total time 5 hours+ 1 hours o o t e time
E AUTHORS AND STUDENTLITTERATUR

149
Consequently, setup time reduction is one of the most important methods for improving
efficiency in mixed production. By reducing the time it takes to prepare for the pro-
duction of a new batch, for example to adjust machinery and equipment, it is possible
to achieve greater flexibility and reduce the production throughput times. There are a
number of different techniques for setup time reductions. One example is SMED (Single
digit Minute Exchange of Die), a technique developed in Japan that essentially involves
distinguishing between internal and external setup work. Internal setup work com-
prises work procedures that can only be carried out while the machine is idle, whereas
external setup work comprises work procedures that can be prepared in parallel, while
the machine is completing a previous batch of parts. By systematically trying to convert
internal setup work into external setup work, setup times can be reduced, for instance
by designing the tool's fixtures in such a manner that the tool can only be installed
in one way, without any necessary adjustments or fine-tuning. Another example is to
prepare a batch of products in line, waiting to be processed in a machine, by placing
them in a special loading unit, which then is plugged into the machine.
Just in Time
Just in Time (!IT) is a planning philosophy aiming to produce and deliver products
in exactly the quantity, and at exactly the time, they are demanded. The basic idea is
to have no inventories at all, which means that a minimum capital is tied up in the
production process. Since there are no inventories (in theory), each delayed delivery,
incorrect operation, or incidence of external disruptions, is directly visible because
they result in stoppages of various lengths in the production process. Thus, when the
identified problem is resolved, the efficiency of the entire process is improved.
JIT is one of the fundamental components of Lean Production (see Section 6.3)
and is an ideal towards which many manufacturing companies and other operations
strive. However, running a production process according to the JIT philosophy makes
production very sensitive to disruptions. Therefore, JIT is subject to a number of nec-
essary conditions, such as geographical concentration, very short setup times, short
throughput times, high quality so scrappage in the production processes is negligible,
reliable transports, and high availability of the machinery and production facilities.
Consequently, working towards JIT means high discipline, efficiency, and constant
adjustments and fine-tuning of the production processes.
Production engineering
Production engineering includes process planning and job design (sometimes also
called work studies) and is a key function in order to achieve efficient production.
Process planning can be understood as the link between product development and
150 © THE AUTHORS AND STUDENTLITTERATUA

roduction and revolves around defining in which sequence of operations a component

~r roduct is to be produced. In manufacturing operations, process planning usually
inJudes a number of activities, for instance:
• Assessing designs of new products from a manufacturing point of view.

• Determining accurate manufacturing techniques, i.e., defining in detail how the
production should take place .
• Engineering the production equipment, as well as the sequence, in which
processing and assembly should take place .
• Ordering necessary specialized production equipment and machine tools .
• Calculating the processing time for each stage of production.
Job design includes performing work studies, i.e., identifying the various movements
and elements that make up a production operation. Such analyses allow the work pro-
cedures to be improved (methods studies) and the work time for various movements to
be determined (work measurement). Methods studies are often carried out on ongoing
production in order to enhance efficiency. There are several different ways of carrying
out methods studies, but most are based on the principle of dividing the work up into
mall, simple elements that are analyzed separately.
Work measurement involves calculating the time required for various manual tasks
in order to provide data for scheduling, costing, and sometimes also determining
salaries (this was common in the manufacturing industry up to the 1980s, when most
production personnel were paid on piece rate basis). One method is to measure work
in progress with a stopwatch or handheld computer. Another method is to apply a
predetermined motion time system, based on every manual task being divided up into
mall, simple work elements which have been analyzed precisely in advance (Methods-
Time-Measurement, MTM, is the most well-known time and motion system). The times
required to perform such work elements can then be retrieved from tables and added
together to find the time for an entire work task. For example, an assembly task may
con i t of the following work elements:
• extending the hand (to a component)

• gripping (the component)
• moving (the component to the workbench)
• extending the hand (to another component)
• moving (the component to the workbench)
• fitting together (the components)
• moving (the component to a box).
Although today it is unlikely to see a production engineer with a stopwatch in his/her

band in Swedish production facilities, it does not mean that time and motion studies
THE ~UTHORS AND STUDENTL ITTERATUR

151
55 is a method developed by Toyota in order to create order in the workplace. It is today often
conceptualized as part of Lean Production. The five Ss can be rendered as follows in English:
Sort (seiri) tools and materials that are used in the workplace. Separate what is required from
tools and materials that are not required.
Set in order (seiton) the tools and materials that are required so that they are easily accessible.
Create specified locations that are clearly labelled. Remove everything else that is not required.
Shine (seiso): clean regularly. Minor cleaning every day. Major cleaning every week. Work is
documented to create procedures. Photographs define the new level of ambition.
Standardize (seiketsu) the daily procedures. Use to-do lists for daily maintenance of machines
and premises.
Sustain (shitsuke): ensure that order is maintained. Improve the to-do lists step by step.
are not performed. To make an assembly line efficient, it needs to be balanced, i.e., all
the workstations must be designed with the same length of cycle times. Detailed time
and motion studies are still performed to achieve this. Similarly, the time it takes to
assemble a hamburger at the major fast food chains has also been determined using
traditional time and motion study methods.
Quality management
Quality management is a generic term for the principles, methods, and tools used
to achieve a (sufficiently) high level of quality in a company's products and pro-
cesses. While product quality concerns the degree to which products meet customer
requirements and needs (effectiveness), process quality concerns the degree to which
production functions well, with little reworking, repair, scrappage, and disruptions.
The costs for quality deficiencies may be extensive, particularly if the deficiencies are
discovered at late stages in the production process, or if they result in complaints and
dissatisfaction from customers.
Quality management is partly about monitoring and discovering faults. However,
modern quality management usually emphasizes preventive work, i.e., preventing qual-
ity problems from occurring at all. The aim is to do things in the right way from start.
Inspired by role models, such as the Toyota production system, many manufacturing
companies apply a zero-defect philosophy, i.e., an ambition to always get things right
from the start.
There are a number of international standards for quality management that a com-
pany can be certified to follow. The most well-known is the ISO system, where the ISO
152 <O THE A UTHORS AND STUDENTLITTERATUR

9000 standard is about quality management, although some industries apply their own
s ISO 9 000 comprises a number of requirements, for example that a company
stan dard ·
should have established and well-defined procedures and that its organization should
archive and communicate information efficiently. Regular quality audits conducted by
an independent certifying body, supplemented by the company's own internal audits,
ensure that the company's quality management system functions over time.
There are a number of quality management techniques, which range from statistical
methods for process and quality control, to qualitative methods to enhance continuous
improvement (kaizen), as well as techniques for the identification of the root causes of
faults that occur. These are some of the best-known examples:
• Six Sigma - a methodology for enhancing the efficiency of operations and
development projects (see the "Six Sigma" box) .
• Fishbone diagram (Ishikawa diagram) - a technique for identifying causal
connections between factors .
• "5 Why?" - ask the question "why" five times to identify the root cause of an
identified quality problem .
• PDCA (Plan, Do, Check, Act) - a systematic procedure for quality improvements .
• DMAIC (Define, Measure, Analyze, Improve, Control) - a methodology used in
Six Sigma.
s,x Sigma
Six Sigma is a methodology for enhancing the efficiency of operations and development projects.
Efficiency enhancement, and thus cost reduction, is achieved by reducing the root causes behind
defects and variations in the production process. Six Sigma is used by several large companies
In the automotive industry and other manufacturing industries. It had its major breakthrough in
the second half of the 1980s as a result of organizational development within the U.S. electronics
company Motorola. Motorola's engineers had been asked to develop a method for more exact
quality management in production and were inspired by both statistical methods and the quality
management philosophy developed in the Japanese industry during the decades following the
Second World War.
The name Six Sigma comes from mathematics, where the Greek letter o (sigma) is used as a
symbol for standard deviation, the measure of variation. All industrial processes have variations in
their outcomes, and these outcomes must fall within a specific tolerance range to be approved.
The Six Sigma methodology has been developed to be more generic than the name indicates.
In practice today, Six Sigma is constituted by a blend of statistical and quality management tech-
niques of various kinds. There are also associated methods for managing improvement work. The
following are some of the features of Six Sigma:

Structured improvements based on the sequence "Define, Measure, Analyze, Improve, Control"
(DMAIC).
Focus on measuring, managing and reducing variation, partly by applying statistical tools.
Emphasis on leadership and results.
Compared with Lean Production, Six Sigma focuses less on logistics and flows but more on
variation. Large parts of Six Sigma are a repackaging of advances in quality management made by
the U.S. engineers, researchers, and management consultants Joseph Juran and Edwards Deming
in the 1940s-1960s.
Summary
A company's production operations comprise all the activities that contribute to pro-
duction and deliveries of the company's products, whether they are goods or services.
Different parts of the business raise different demands on production. The interests of
the marketing function and the production function are often contradictory, for exam-
ple in terms of product portfolio, product standardization, performance measurement,
capacity utilization, and location. The market demand is fundamental to the design
of the production system. If it is difficult or impossible to influence demand, surplus
capacity is often required to avoid queues. If demand is easier to predict, production
can be dimensioned more precisely.
Production strategy concerns issues such as production costs, supply capabilities,
quality, and flexibility. The challenge lies in achieving a balance between these dimen-
sions. The trade-off between the production volume and the variety in the value prop-
osition is a fundamental issue. There are different basic types of production. Project
deliveries are typically unique, with the result that planning and production need to be
extremely flexible. Jobbing (one-of-a-kind production) involves efficiently producing
products adapted to the needs of each customer by reusing previous solutions and
components as much as possible. Batch production of small or medium-sized volumes
is a common production type for both goods and services as it combines economies of
scale and high resource utilization with flexibility in the product range. Mass produc-
tion involves the production oflarge volumes of the same product, where components
and subsystems usually are produced in advance and assembled to customer order.
Continuous production, which is typical for the process industry, is capital-intensive,
which means that it is important to have high capacity utilization to achieve efficiency
and profitability.
The logic of the production flow also affects the design of the system. There is a
distinction between convergent, divergent, hourglass-shaped, and T-shaped flows.
Another important factor is where in the supply chain the company is positioned. Is
154 C THE AUTH O RS AND STUDENTLITTERATUR

the company upstream or downstream? Does the company have few or many suppliers,
nd few or many customers?
a The tactical level of production management concerns issues such as flows and
la outs. In project deliveries and jobbing, the layout is often determined by the specific
lo~ation where production takes place. With small batch production, it is common to
have a functional layout, and sometimes flow shops. Mass production usually takes
place in linear process layouts (e.g., assembly lines). The same applies to continuous
production process, where the technical content of the process completely deter-
mines the layout.
Different forms of intermediate inventories exist in virtually all production. These
inventories tie up capital but also function as shock absorbers during production.
Where and how intermediate inventories are built up affects the position of the cus-
tomer order point in the production flow, i.e., the point at which a specific order is
linked to a specific product. If products are produced for a finished products inventory,
the customer order point is late in the production flow. If final assembly takes place
to customer order, the major inventory is positioned more upstream and, if produc-
tion takes place entirely to customer order, most inventory is kept in a raw materials
inventory. If also design and product development are initiated on customer order, no
intermediate inventory is needed. Today, many companies apply the principles and
techniques of Lean Production in order to systematically increase flow efficiency and
reduce inventories and resource consumption at all stages of production.
Operational production management primarily concerns planning and control.
Logistics and inventory planning are also important issues. The optimum inventory
level in each case depends on many factors, including the throughput time, which also
affect the capital tied up in the production system. Many companies try to reduce
their tied-up capital in various ways, for example by reducing setup times and using
Ju tin Time deliveries.
Process planning is applied to define how a product should be produced. Job design
(work studies) analyzes the tasks involved and how they can be engineered to become as
efficient as possible. By applying systematic quality management techniques, companies
also try to minimize the number of defects and reworked products in production.

PART 11 a THE VALUE CREATION SYSTEM
References
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Technology: Pursuing the Competitive Edge. John Wiley & Sons.
Hill, T. (2000). Operations Management: Strategic Context and Management Analysis.
MacMillan Business.
Johnston, R. & Clark, G. (2008). Service Operations Management: Improving Service Delivery.
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Kraljic, P. (1983) . Purchasing must become supply management. Harvard Business Review,
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Lysons, K. & Farrington, B. (2012) . Purchasing and Supply Chain Management (8' h ed.).
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Stockholm School of Economics, Institute for Research.
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utveckling av industriell produktion. Studentlitteratur.
Silvestro, R. (1999). Positioning services along the volume-variety diagonal. Internationa l
Journal of Operations and Production Management, 19(4), 399-421.
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and Schuster.
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156
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.................................................................................•
PRODUCT DEVELOPMENT
Technological development, actions by competitors, and change in market

demand mean that companies constantly have to improve and develop their
value propositions. Just like the discussions on marketing and production, this
chapter will discuss the development process of the company using three levels
of analysis with different time horizons. We will start with the innovation strategy,
which takes a long-term perspective on the company's product portfolio, core
technologies, and development of technical competence. Secondly, we will look
atthe tactical level, which includes how the research and development (R&D) pro-
cess is organized and managed, and how the portfolio of ongoing and planned
R&D projects is handled. Finally, there is the operational level, which includes dif-
ferent tools and techniques for how to run successful and efficient R&D projects.
1.1 Product development in different types of businesses

Ju t like
the other two value-creation processes, marketing and production, product
development is an aspect of the company's operations. All staff, regardless of their
formal organizational position, contribute in one way or another to the development
and improvements of the company's value proposition in terms of different products
and services.
development includes all activities that contribute to the development and improve-
ofthe company's value propositions.
E AUTHORS ANO STUDENTLITTERATUR 157

Companies often have a special department for "product development", "design and
engineering", "product innovation", or "R&D" (Research and Development). The name
differs between different industries. Usually, the product development process also
includes a number of other functions in the company, for example, marketing, pro-
duction, and customer services.
Product development has different logics in different types of business operations.
Small batch and unit production companies, for example, are based on efficient devel-
opment and deliveries of customized products and systems in accordance with the
specific needs of each individual customer. During product development, these compa-
nies usually work closely with a customer based on an agreed requirement specification
which describes the product's functionalities, design, and price. Moreover, production
often starts before the product development is fully complete, which means that devel-
opment and production may take place concurrently.
In mass production companies, the product development process rarely involves an
external client. When, for example, companies like Volvo or Electrolux are going to
develop a new product, the technical specification is instead produced by the company
itself, often with an appointed product manager functioning as an "internal customer".
In this type of product development, it is often a challenge to efficiently coordinate
all the in-house experts and other resources needed in the process. In addition, pro-
duction efficiency usually has a higher priority than in small batch and unit produc-
tion. Especially for mass production companies in mature industries, it is important
that the products, already in the development process, are designed to be easy and
cheap to produce.
Companies in the process industry, for example, in the sectors of steel, petroleum,
and paper, usually have a small development department. In many cases, the devel-
opment departments in these companies are more like research laboratories than the
large development departments of mass production companies. Instead, a large part
of the product development in a process company is incorporated in the equipment
and systems used in the production. Process industry companies rarely develop their
own production technology but buy equipment from different suppliers. This means
that many of the engineers in a process company work with the specification and
procurement of new technology, which is developed by other, often small-batch and
· unit producing, companies. Since the process companies are more capital-intensive
than labor-intensive, the coordination between experts is not as complex as in a mass
production company. Instead, the main focus is on the automated production pro-
cesses, i.e., the production flow.
Service companies, for example, in trading or consulting, usually have no formal-
ized, technical product development in the same way as the traditional industrial
companies. Except for IT and telecommunication services, where the value creation
mainly follows a goods-dominant logic (cf. Section 3.2), product development in most
158 lc> T HE A UT H ORS A ND STUD ENTL ITTERATU~

CHAPTER 7 • PRODUCT DEVELOPMENT
service companies are found under labels like "business development". Since these
companies often are labor intensive, with a relatively small number of machines and
production equipment, their product development is mostly about establishing new
service concepts, developing work routines and techniques, training staff, and facil-
itating knowledge transfer and learning between different customer projects. Large
service companies also aim to clarify and standardize their services in different ways by
productifyingtheir service offerings and developing structural capital such as routines,
procedures, and tools which will enable the company to be more efficient and offer
higher quality than its competitors.
In the following we will, however, mainly discuss the product development in
companies whose business models are based on developing and producing goods,
that is, companies which in an international context often are referred to as Original
Equipment Manufacturers (OEM).
7.2 The innovation strategy of the company

Companies that produce their own products have to constantly improve and maintain
their value propositions. This includes making technical updates, handling complaints
and warranty claims, offering maintenance and service, and being prepared to inves-
tigate any reports about errors and technical problems. This type of regular product
maintenance plays an important role in enabling the company to maintain its status
a a competent and reliable supplier.
Alongside product maintenance, the company also has to develop new products
to be launched on the market at regular intervals. Sometimes, this type of product
development includes a technological leap to achieve radical innovation, sometimes
it i about launching a new product family, and sometimes it involves approaching
new customer categories and market segments based on already known technology.
However, the majority of the product development activities are about incremental
innovation, where the company develops new applications, models, and improvements
of already existing products for well-known customers.
The product lifecycle and the need for innovation

Over time, the life of most products on the market follows a lifecycle that can be
described in four stages: introduction, growth, maturity, and decline. During these
stages, the sales volume of a product usually follows the typical pattern illustrated in
Figure 7.1. The introduction stage is when the product is launched and since it is new it
will take some time before sales start to increase, which means that the market share
small. During the growth stage, sales increase, only to level off in the maturity stage,
where the product no longer gains more market shares. Finally, the product reaches a
l AUTHORS AND STUDENTLITTERATUR 159

Sales volume
FIGURE 7.1
The prod uct lifecycle. L.,o-=c.~ - -- - ~ - - - - - - - - -~ - - ---+ Time
Introduction : Growth : Maturity Decline
stagnation stage where sales begin to decline; other products have been launched on
the market which the customers perceive as more modern, better, and/or cheaper, and
it is time for the product to be phased out.
The length of the different stages and the size of the market share vary between
different products. However, in order for a company to maintain its competitiveness
over time, it has to have products in different stages of the lifecycle so that the revenue
from the older, mature products can finance the development of new, future products.
This, in turn, means that companies have to run several product development pro-
jects simultaneously, where some projects might be close to a product launch, while
others are in the midst of the development process, and some are just getting started
(see Figure 7.2).
The product lifecycles vary between different types of products and the level of matu-
rity in an industry or technical field. When there is rapid development in a technical
field, the lifecycle is generally short, while the lifecycle of products in mature industries
tends to be longer. Companies in mature industries may, thus, intentionally aim to
Sales volume
Product D
FIGURE 7.2
The need for the company
to constantly develop and
launch new products.
160 Cl THE A UTH ORS A NO STUDE NTLITTERATUR

shorten the lifecycles by constantly introducing new models and cosmetic changes to
their products (so-called "planned obsolescence"). This is particularly evident when it
comes to consumer products, where fashion, design, and short-term trends may have
a crucial impact on sales. However, for business-to-business products, the market does
not usually change as fast, since it is technical and financial factors, like the functional-
it of the product, access to maintenance, service and spare parts, and operational costs,
t:at are crucial. When purchasing more expensive products, for example machines
and production equipment, the technical features of the product are often assessed
against the buyer's total costs during the life of the product, often referred to as the
total cost of ownership.
All product development does, however, include a compromise between many
different types of requirements. A product with high technical performance may be
difficult to manufacture and maintain, functional technical requirements are not
always compatible with modern and attractive designs, customer requirements from
the market are often contrary to the most efficient alternative from a manufacturing
perspective, and ergonomic requirements in the manufacturing process are often con-
trary to requirements oflow product costs.
Innovation-strategic positioning
The amount of resources that a company chooses to invest in product development
depends, to a great extent, on the company's innovation strategy, which affects not only
the product development but the marketing and production processes of the company.
Many companies have an official strategy about being a "leading technology company"
and a "pioneer", which usually is much easier said than done. Moreover, being the first
to introduce a new technology is not always the best strategy: there are many examples
of how pioneering companies that established themselves early in a new technical field,
over time, got pushed aside and sometimes were driven out of the market by companies
that entered later.
There are four typical innovation strategies among technologically intensive com-
panies:
• Technological pioneer (offensive):

The basic idea is to create a situation of technological monopoly by launching new,
technically advanced products that put the company ahead of competition. This
type of strategy requires significant investments in research and development,
usually in combination with large investments in marketing to efficiently launch
the new products. One example is how U.S. company Apple at the start of the
2 1st century launched a number of innovations, among them iTunes, iPhone, and
1Pad, which radically changed the rules on the market.
E AUTHORS AND STUDENTLITTERATUR 161

• Fast follower (defensive):

This strategy requires great technical expertise so that the company quickly
can adopt a new technology and launch its own improved versions (cheaper,
different design, extra features) of the competitor's original product. The Korean
company Samsung has, for example, never claimed to be leading within mobile
phone and tablet technology in the same way as Apple, yet it has managed to
achieve and maintain a competitive and profitable position. The two strategies
"technological pioneer" and "fast follower" are often applied simultaneously by a
company, especially if the company has tough competition from one or two rivals.
Sometimes, a company may be the first to introduce a product on the market, only
to be the second, or third, to launch the next version of the product.
• Cost minimization (imitative):
This strategy means intentionally following the technological pioneers with
the aim, as a low-cost producer, oflaunching cheaper versions of the pioneers'
products. The success lies in the company's capacity to cut production costs
through large-scale production. The technology behind the product is rarely
developed by these companies themselves, rather it is often licensed from other
companies. Companies with this innovation strategy can be very successful,
and sometimes even become market-leading. History has shown that many
companies which have applied the cost minimization strategy and competed with
low production costs, over time, have been able to build and develop their own
technical expertise and eventually compete using products based on their own
design and engineering.
• Traditionalist (conservative):
This niche strategy is about meeting the exact needs of certain selected market
segments. The products should not be altered too much or too quickly, rather the
opposite. Mass production is not a necessity. Rather than innovation and change,
the appeal of the products is that they refer to traditional values, reliability,
authenticity, and high quality. Rolls Royce cars is a typical example of this
strategy. The strategy is also common in the food industry, for instance when it
comes to cheese, whiskey, and wine.
Depending on which innovation strategy a company chooses, it will have consequence

for the company's technology and product development process. Different strategies
require different types of competencies and capabilities. A pioneer strategy usually
means that more resources are invested in the company's own R&D, while a follower
strategy usually means more emphasis on design and production. The choice of strategy
also depends, to a great extent, on the company's technological position and expertise
in relation to its competitors.
162 © THE AUTHOR S AND STUDENTLITTERATUA

Techn ology strategy

There are several reasons for a company to conduct its own technological research and
development (R&D). One reason is, of course, to have the capability to launch its own
products. Another, just as important reason, is to be able to keep up with the develop-
ment of the competitors and being able to procure suppliers or establish collaborations
with companies with valuable expertise. Usually there is also a need for a technical
competence base to maintain the quality of the company's products and to support the
production and marketing functions in different ways.
The products of a company should, thus, not be seen as singular, independent units,
but as outcomes of a comprehensive and long-term technical competence development
of the company as a whole. The most significant competitive advantages of successful,
technologically intensive companies are not really made up of the separate products,
but of the core competencies behind the products.
The core competencies of a company are the unique set of competencies in the
value creation process that gives the products great customer value. This way, the core
competencies are directly connected to the fields of technology which the company
i investing in, but it also stretches across the operations of the entire company, from
product development, to production, sales, delivery, and customer service. A company's
core competencies are characterized by the following three qualities:
• It provides potential access to a wide variety of markets .

• It makes a significant contribution to the perceived customer benefits of the
products.
• It is difficult to imitate by competitors.
For a ca mera company like the Japanese corporation Canon, for example, the core
competencies have long been about precision mechanics, optics, and microelectronics.
This has enabled Canon to successfully produce high-quality cameras, but the same
competencies have also been used to develop other types of products, for example,
copying machines, printers, and scanners. In the same way, Siemens has its core com-
petencies in electric power and electrical engineering, which have resulted in a great
variety of products, ranging from refrigerators to power plants. A core competence does
not, however, need to be tied to different product technologies. The core competencies
oflkea in logistics, design, and supply chain management have, for example, proven
to be very difficult for competitors in the furniture industry to copy.
What a company defines as its core competencies is, thus, connected to the tech-
oological fields which the company chooses to focus on, that is, the areas of expertise
which wi II constitute the technological base of the company. From an R&D perspective,
this ba e can be described as consisting of four parts:
E AUTHORS AND STUDENTLITTERATUR 163

1The core technologies of the company, which are essential to most, or all,
products of the company, and within which the company, thus, has to conduct
its own R&D.
2 Complementary technologies, that is, technologies which are important in
product development but not unique to the company's products. However, the
company has to have enough expertise to be able to specify and use the right
complementary technologies.
3 Peripheral technologies, that is, technologies which are important to the use
of the product but which do not need to be integrated in the product itself.
Peripheral technologies may be absolutely crucial to the company's business
model, despite that they are often beyond the control of the company (computer
software programs are a common example of this type of technology).
4 Emerging technologies, that is, new technological fields which are yet to reach
commercial use, but which in the long term may come to affect the products and
competence base of the company.
A crucial problem is that all forms of technology and product development involve
uncertainty. Companies that invest resources in technological development always run
the risk that it will not pay off. Even if the investments are successful, there is a risk that
competitors, without having to make large investments, quickly can imitate the new
products, which means that the company will lose its technological lead. Moreover,
there is always a risk of making the wrong investment. When it comes to technological
fields and markets where the speed of evolution is rapid and there is a high level of
uncertainty, it is especially difficult to predict exactly which investments to make in
order for the company to have competitive value propositions in the future.
Strategic product planning

The company's core competencies, together with the competencies that the company
can acquire from suppliers and partners, set the framework for what the company can
achieve though its R&D. But the competencies alone are not enough, they also have to
be manifested in concrete products.
Strategic product planning is closely related to the company's market segmentation
and portfolio of value propositions, as described in Chapter 5. More specifically, prod-
uct planning is about which new technologies and products to develop, in which order
the products should be developed, and when the products should be launched on the
market. There are several different alternatives. The connection between marketing
and product development is illustrated in Figure 7.3, where the X-axis describes the
degree of change in product technology and the Y-axis describes other changes in the
marketing mix (see Section 5.3). The total degree of change goes from none whatsoever
164 <O THE AUTHORS AND STUDENTLITTERATUA

Product
No change Modification Technology change
Facelift Inconspicuous techno-

Appearance logical substitution
Technology
Materials
Manufacturing
Re-merchandising Relaunch Conspicuous technological

Name Costs substitution
Promotion Promotion Technology
Price Price Materials
Distribution Distribution Name
Packaging Appearance
Promotion
Price
Distribution
Intangible repositioning Tangible repositioning Neo-innovation

Name Name Technology
Promotion Appearance Materials
Price Costs Manufacturing FIGURE 7.3
Distribution Promotion Promotion
Market segment Price Price The connection between
Competition Distribution Distribution marketing and product
Target market Target market development (based on
Competition Competition
Saunders & Jobber, 1994).
m the upper left corner, to a fundamentally new product on a new market in the lower
right corner. In between, there are several varieties of development measures, which
lead to what the customers may perceive as "new" products, for example, a makeover,
relaunch, repackaging, or repositioning. In addition to this, there is often technology
development taking place which is not visible to the customers but which facilitates
and improves the engineering and manufacturing of the product.
Platforms and derivatives

From a technology perspective, the company's product portfolio and product planning
are about which technologies and which products to invest in. One way to manage
thi is to create a standardized set of basic technologies, which then can be used for
era) different products and models. The automotive industry is probably the most
well-known example using this type of technological platforms, but it is used in most
lndu tries. A typical platform includes a set of technologies which are not directlyvisi-
to the customers. Based on these technologies, different end-products are developed
(sometimes called derivatives) for the market, with different technical functionalities,
ures, and designs.
E AUTHORS AND STUDENTLITT ERA TUR 165

FIGURE 7.4 Platform development - Audi A3, VW Golf, SEAT Le6n, and $koda Octavia are built on the
same platform.
Platform development is, in principle, always used to develop product families. One
of the principles behind a product family is that the same basic product is offered in
different varieties and models. Technical platforms can also be applied across prod-
uct families and, sometimes, even across different brands. This is how automotive
corporations, like Volkswagen, use the same platforms to develop derivatives, which
are launched on the market as car models under different brands, for different target
groups, and in different price ranges (see Figure 7,4).
From a technology point of view, structuring R&D in platforms and derivatives ha
a number of advantages. Platform development enables reduced production costs by
allowing for mass production of common components, it enables shorter lead times in
the development of end-products, it reduces the complexity of the product system, it
facilitates learning between different development projects, and it improves the com-
pany's capacity to update their products.
There are, however, also certain risks with platform development. Firstly, the deriv-
atives can "cannibalize" each other, that is, compete over the same customers. When
the basic technology and many of the components are the same, there is a risk that
the end-products become too similar, which risks undermining the credibility of the
more expensive derivatives. Why should you, for example, pay more for an Audi car, if
a Skoda contains the same technology? Secondly, a technology platform may impede
166 © THE A UT H O RS A N D ST UDE NTLITTERATUA

technological development. Since the development of a technology platform requires

large investments, it may_be a_difficult and ~xpe_nsive d~cisi_o n to move from well-es-
tablished platforms in a situation where radical mnovat10n 1s needed.
There are, thus, a number of strategic factors regarding innovation, technology, and
roduct planning which define the framework for the company's product development,
:ot least for individual product development projects. The major challenge lies in the
fact that technological R&D, by nature, is an uncertain, future-oriented activity. There
i no "quick fix" when it comes to innovation and technology strategy. Technical core
competencies usually develop gradually over time; they cannot simply be bought from
uh-supplier, but are tightly coupled to the company's current and previous R&D pro-
jects and, not least, the industry and technological field of the company.
7•3 The tactical level of product development

Traditionally, the organization ofR&D has, in the majority oflarge technology com-
panies, been seen as an internal matter. The classic discussion is usually about whether
R&D should be centralized to one corporate department or decentralized to the dif-
ferent business units of the company.
However, with increasing costs for R&D and increasing specialization between
companies, more and more companies are also making use of external technical exper-
tise. It can involve cooperating with other companies in alliances and joint ventures,
contracting technological R&D from subcontractors and research institutes (i.e., mass
production companies acting as companies in the process industry), assigning engi-
neering consultants to work in projects at the R&D department, or licensing or buying
design solutions which have been developed by other companies. Today, there are also
discussions about the opportunities to use open innovation, for example, by engaging
ternal product users to test prototypes of new products (so-called beta-versions) so that
they can identify bugs, propose new functions, or even develop new technical solutions.
At the tactical level of product development, questions mainly address what manage-
ment model to use for the product development process and how the company should
coordinate its R&D portfolio. Before going deeper into this, the general character of
technological development in relation to the different phases of product development
11 bed iscussed.
The technology development process

Research and technology development is often described as a linear process with differ-
sequential stages. In its simplest form, the process starts with research, research leads
product development, product development leads to production, and production leads
sale · It is not, however, as easy as investing in research at one end of the process and
AUTHORS AND STUDENTLITTERATUR

167
•• • • • • • ••
I
Pre-development Product development Launched
FIGURE 7.5 Scoping study project products
The development funnel. - - - - - - - - - - - - - - - - - - - > Time
automatically ending up with marketable products at the other. In practice, the relation-
ship between research and technology development is much more complex than that.
At company level, however, a conceptual model, sometimes referred to as the devel-
opment funnel (see Figure 7.5), is commonly used. The idea is that the funnel is wide
in the early, front-end stages (to the left in the figure). In this stage, different types
of studies, research projects, and technical investigations are conducted to generate
knowledge and ideas. Some companies refer to these fundamental development activ-
ities as pre-development. Studies conducted in the pre-development stage are often
initiated internally in the R&D department. They are not intended to lead to new
products as such but are primarily aimed at generating knowledge which hopefully
can be used in future projects. Some of these investigations may be pre-studies (or
feasibility studies) where the viability and commercial potential of possible development
projects are studied. Even though a large number of investigations may be conducted
simultaneously in the pre-development stage, these projects are relatively small and
together they rarely make up more than 10 percent of the company's total R&D budget.
At the other end of the funnel (to the right in the figure), however, product development
projects are conducted that are aimed at launching commercially viable products on
the market. These projects are significantly more well-defined than the investigation
and pre-studies in the pre-development stage, and even if they are significantly fewer in
number, they usually take up more than 90 percent of the total budget for R&D. These
projects are usually strictly controlled, with appointed project managers, product specifi-
cations, budgets, and deadlines. Moreover, they normally have a defined customer, either
an internal product manager at the marketing department ifit is a mass production com-
pany, or an external customer if it concerns customized small batch and unit deliverie .
The exact shape of the development funnel differs between different companies and
products. Due to the uncertainty inherent in all R&D, most companies strive to keep
the opening of the funnel wide and the cone of the funnel short in order to, as long a
possible, enable the flexibility to choose between different alternatives and not have to
stick to one specific product or technical solution. In practice, however, this is often dif-
ficult since product development projects require time and resources, which means that
most companies are not able to conduct too many development projects at the same time.

The idea with the development funnel is, thus, to illustrate how the company should
include many ideas at the start of the process, and then, through successive studies and
different evaluations, select a small number of product ideas, which result in formalized
projects that are executed and result in finished products.
The product development process

Once a product development project has been formally decided, most major companies
have a formalized product development process with pre-defined stages, decisions, and
checkpoints which the projects have to follow before the product can be launched (a
typical product development process is illustrated in Figure 7.6). However, there is no
generic development process which works for every type of business. Consequently,
the exact process varies for each individual company.
The 0-stage in figure 7.6, the planning and pre-studies stage, specifies, among other
things, the functionality and performance of the product, market segments, scheduled
introduction date, and the resources required for the project. The actual project begins
in stage 1, the fundamental concept development stage, which looks at different alterna-
tive and sets the fundamental design and requirement specification of the product. In
tage 2 , system design, the basic technical design of the product is defined, followed by
stage 3 with detailed design of different components and subsystems. In stage 2 and 3,
different types of prototypes are usually developed in different steps to visualize ideas,
facilitate communication, and investigate the functionalities of different technical
alternatives. In stage 4, the final product is tested in different ways, technically and
sometimes also on future customers and users. These tests usually lead to different
modifications and adjustments. If the product is going to be mass produced, this stage
also usually involves preparing for production, for example, by ordering machines
nd equipment, deciding the production layout and starting small-scale pre-series
production. In the final stage, stage 5, production is scaled up in terms of volume and
the product is launched on the market.
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8 FIGURE 7.6
Stage 0: Stage 1: Stage 2: Stage 3: Stage 4: Stage 5: A typical product
Planning and Concept System Detailed Testing and Start of production development process (from
pre-studies development design design modifications and fine-tuning Eppinger & Ulrich, 2015)_
I AUTHORS AND STUDENTLITTERATUR 169

The most crucial decisions, for example, regarding the basic design, engineering
design, and performance of the product, are thus made in the early stages of the devel-
opment process. A well-executed job in these stages is key in order to achieve short lead
times in development. If you do things right from the start, you will avoid expensive
and time-consuming changes in the later stages of the process. The problem is, however,
that it is in the early stages of the product development that the company has the least
knowledge about the finished product.
Sequential development
Traditionally, product development was structured as a sequential process. This was a
process consisting of step-by-step stages in the product development, where the fol-
lowing stage did not start until all activities in the previous stage had been completed.
Sometimes, sequential process models are therefore called waterfall models, that is, the
development process is similar to the downward flow of a waterfall, approaching the
final destination one stage (metaphorically: one ledge) at a time. The transition between
the different stages in a sequential development process is also usually connected to a
transition of responsibility from one department in the company to another.
One advantage with the sequential method is that it is easy to control the process
since you always know how far you have progressed and who is responsible for the
different activities. Since each stage is completed before the next begins, there is also
less risk that the activities are based on the wrong data. Another advantage is that it
enables the company to build expertise in different areas.
The problem is, however, that reality is usually significantly more complicated. If
communication fails between the experts in the early stages, errors easily occur, which
typically are not detected until the later stages and by then they are usually both more
expensive and more time-consuming to correct. In addition to this, there is also a risk
that different experts become so focused on their own area of expertise that they do
not develop a necessary understanding of the needs in other areas. This may easily
create conceptual walls between different functions in the development process that
are difficult to overcome. The phenomenon is illustrated by the classic concept over the
wall engineering (see Figure 7-7).
(7\~(m~
Concept
development
Detailed
design
Production
development
Purchase Manufactunng
and
FIGURE 7.7 assembly
"Over the wall
engineering" in a
manufacturing company.
170 © TH E A UTHO RS AND STU DENTLITTERATUR

Seque ntial product development of stamping tools for a car company
The manufacturing offloors, side panels, fenders, and doors are examples of important and
expensive stages in car manufacturing. These components are manufactured in large stamping
machines by placing the metal sheet between two tool halves that are pressed together with
great force. Manufacturing a complicated car body component may require half a dozen steps,
which means that the component has to be stamped in up to six different stamping machines
with twelve tool halves before it gains its final shape. The tool halves are made of special and very
expensive alloy steel with high demands on, for example, durability, hardness, and strength. The
tolerances of the tools are very strict and the shape is complicated with many curved surfaces.
Moreover, the two halves, the "male" and the "female", have to fit perfectly when pressed
together. If not, it will ruin the metal sheet, the tool, or both. These stamping tools are, thus, both
complicated and expensive, and when the body of a new car model is being developed, a lot of
time is spent on tool development.
Traditionally, this means that a design engineer designs a specific car body component and
specifies the dimension of the drawings as precisely as possible. Once this is done, the tool
designer orders a number of steel blocks from a steel company. These are sent to the factory
where the tools are manufactured based on the drawings. Some automotive companies manage
the tool manufacturing themselves, while others engage subcontractors. The manufacturing of
these tools is a complicated process which requires expensive special machines. It can take up to
two years from when the design engineer hands over the drawings, to the start of the car body
manufacturing.
Concurrent engineering
With the aim of minimizing the time from product idea to product launch, often
referred to as time to market, many companies have replaced strictly sequential devel-
opment with concurrent engineering (sometimes also called simultaneous engineering).
Instead of waiting for one department to finish like relay runners, the participants in
concurrent engineering process gradually deliver the required information to each
other so that each and every one can prepare and perform their work. At a basic level,
however, the development process is still described according to the same linear model
before. The development process includes the same activities, but during a shorter
period of time (see Figure 7.8).
One of the advantages of concurrent engineering is that expertise from all concerned
functions in the company are involved in the project from start to finish. The idea is that
will facilitate collaboration between different experts, which reduces the risk that,
example, the engineers design something which will be too expensive to produce.
the same reason, subcontractors may also be invited to participate already in the
stages of the product development projects.
AUTHORS AND STUDENTLITTERATUR 171

Design
Lead time
Design
FIGURE 7.8
A comparison between
sequential (top) and
concurrent (bottom)
product development. Lead time
There are, thus, several advantages with concurrent engineering. It has, however, proven
to be easier said than done to change a company's product development process from
the traditional, sequential structure to a predominantly concurrent model. There is
often a technical logic behind the sequence of activities, some work tasks simply have
to be carried out before other activities can start. Moreover, concurrent engineering
requires a highly efficient dissemination of information throughout the work process.
This is facilitated by cross-functional groups where all representatives from all area
of expertise are included right from the start of the project.
In practice, concurrent engineering also means that large parts of the flexibility to
handle uncertainty, which was included as buffers in the sequential process, is removed.
By initiating later activities, e.g., tool manufacturing, machine purchases, and market-
ing preparations, long before the basic design of the product has been completed, the
development process becomes faster but also considerably more sensitive to both inter-
nal and external disruptions. When the timetable is compressed this way, it becomes
very important to get things right from the start, even if you have never developed a
similar product before.
172 0 THE A UTHOR S A ND STUDENTLITTERATUA

CHAPTER 7 a PRODUCT DEVELOPMENT
Concurrent engineering
An alternative way to develop stamping tools for car bodies is to start the design of the stamping
tool and the design of the car body at the same time. If the tool designers are informed about the
estimated size of the finished component, they can order the steel blocks. As the car body design
starts to take shape and some of the measurements can be confirmed, the manufacturing of the
stamping tools can begin. At the start, the tool manufacturer makes a rough version which can
be refined gradually, and once the design of the components are completed, the final processing
of the tool can be carried out quickly and efficiently. This way, some companies have managed to
reduce the development time for stamping tools by SO percent.
Agile product development (iterative product development)

Since the mid-00s, agile product development (also referred to as iterative product
development) has gained popularity. If concurrent engineering is a way to cut long lead
times, iterative development is a way to try to reduce the growing complexity of many
development projects. The ideas behind this logic originate from software development.
Instead of trying to develop detailed plans and specifying all technical functionalities
in advance, the logic is based on the strategy to first develop a functioning product
with simple technology, and then gradually, in short iterative loops, add new function-
alities to the product. The idea is to have a functioning product (in different versions)
during more or less the entire process. In practice, this means that all progress made is
brought together in a functioning product at regular intervals, for example, every three
weeks. After this, a new iteration starts where the existing solution is refined and new
functionalities are added. The idea is to continuously create a common understanding
of the objectives and how to proceed.
The difference between traditional product development and these agile methods is
illustrated in a simplified version in Figure 7.9. There are essentially two ways to build a
pyramid. According to the first method (traditional product development), you start by
laying the foundation. Then you gradually add layer by layer until you have a complete
pyramid (to the left in Figure 7.9). In this way, you make sure that the pyramid is stable.
At the same time, problems may arise if there is not enough time or resources, as this
would mean that the pyramid cannot be completed.
According to the other principle, agile product development, you start by building
asmall pyramid. Then you gradually add new vertical layers to the pyramid so that it
gradually grows bigger and bigger, until you consider the pyramid complete. In this
you can, in principle, end the development process at any time and still have a
complete, albeit small, functioning pyramid. However, the risk with this logic is that
first layers cannot carry the total weight of the pyramid as new layers are added,
Yresulting in a collapse.
I AUTHORS AND STUDENTLITTERATUR 173

FIGURE 7.9
Two w ays to bui ld a
pyramid. Traditional Agile
Agile product development has attracted extensive attention since the start of the 2000s.
In practice, however, this development logic has mainly been applied in software devel-
opment. By applying this approach, it is possible to break down large and complex IT
projects into smaller, accessible parts. However, for hardware development and classic,
mechanical design, this type of development logic seems to be more difficult to apply.
The stage-gate model

Regardless of whether the company's development logic is sequential, concurrent, or
agile (iterative), virtually all large companies apply a management model for their devel-
opment projects which is based on step-by-step decision-making. By implementing
decision points at the transitions between different stages of the development process,
a stage-gate model is created where each stage is initiated and concluded by a formal
decision, a gate, by a steering group, product manager, or a client (see Figure 7.10). In
this way, the entire product development process does not have to be decided in detail at
the start of a project. As knowledge increases along with the progress of the project, the
successive gate-decisions gradually become more and more detailed, at the same time
as the step-by-step decision-making creates an opportunity to terminate, or change,
the project at different phases of its execution.
Initiation of Project Decision to

feasibility study decision start execution Approval Project closure
Steering
0 0 0 0
committee
1 ],
~,
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174 C> THE A U THO RS A ND ST UD EN TLI TTERATUR

Strictly applied, the stage-gate model is a disciplined way to conduct product devel-
opment. The successive and formalized decision process disciplines the staff and pre-
vents poorly prepared project proposals from going ahead. Since the project will only
receive funding for one stage at a time, the financial risks are reduced as the project
manager has to convince the client (or the internal actor funding the project) about the
excellence of the project repeatedly throughout the development process.
Stage-gate models are often criticized for the same reason as the sequential waterfall
model. They are seen as inflexible, bureaucratic and are often accused of not fitting
with today's demands on fast and dynamic product development. It is important to
remember, however, that the stage-gate model is primarily not aimed at engineers who
are working in the development projects, but at their managers and clients. Through
the step-by-step decision-making, the company has the opportunity to control, at given
points in the development process, that approved projects are executed within their
defined scope and framework, at the same time as the project team, in between these
control points, are given the opportunity to work autonomously.
Highly radical and innovative projects, however, usually have to be kept away from
the for malized development process and stage-gate model that other projects have to
follow. Instead, these are usually controlled by being organizationally separated from
the rest of the operations. However, also these types of projects are usually granted
resources gradually as they progress.
7.4 Operational level: methods and techniques

Today, there are many methods and techniques to support the development of new
products. Some of the methods are aimed at facilitating the development process and
making it more efficient. Others are aimed at ensuring that the products are developed
in line with customer expectations. There are also methods that are used to identify
potential error sources in the product, ensure its functionality, or enable easy and
cheap production.
Most of the techniques presented below do not, however, replace the creative process
of developing new technical solutions, but facilitate collaboration and indicate tech-
nical fields and problems on which the project should focus. The techniques function
as development support; they do not guarantee that the company is heading in the
right direction.
Many of these techniques and methods are promoted by consultants and authors of
handbooks under various comprehensive management concepts. However, it is often
llllclear where to draw the line between these concepts, and sometimes the very same
method is included in several management concepts at the same time. In this section,
will look at some of the most common methods today, irrespective of which of these
rching concepts they are claimed to belong to.

Visual planning and obeya

Today, many product development teams apply visual planning where the operational
work is coordinated through daily, or weekly, stand-up meetings in front of a project
board, for example, a large whiteboard which illustrates what needs to be done, the
status of the activities, and the work situation of the group (see Figure 7.11). In some
companies, the project teams have their own obeya (Japanese for "large room" or "war
room"), that is, a special room, or place, decorated with different types of visual plans,
graphs, and diagrams, which provide a quick overview of the current work situation.
The coordination meetings in an obeya are usually intentionally held brief. They focus
on status updates, problem identification, and dissemination of information to coor-
dinate the work.
The aim of visual planning is to improve the communication in the project so that
everyone understands the common task. Moreover, the idea is to facilitate cross-func-
tional communication across different departments and areas of expertise through
FIGURE 7.11
Visua l pla nn ing .
Backlog Not started In progress Ready for test Done! Lucky dip!
Story Dev
Story Test F.e. F.e. task
Test
task
task Test
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176 e THE AUTHORS AND STUDENTLITT ERATUR

frequent and regular project meetings where the participants can interact. Thus, if
visual planning and obeyas are used correctly, they can function as administrative
techniques that also improve the group dynamic of the project.
Scrum
Scrum is one of the most popular agile methods in software development. The word
scrum is a rugby term and refers to the restart of the game when the entire team gather
together to fight for the possession of the ball. The work method has been developed
for iterative planning in short cycles, called sprints, which means that the features
(increments) of the final product is developed one at a time (see Figure 7.12).
A sprint constitutes the basic unit in the work flow. The length of the sprints is set
in advance and all sprints are equally long, usually between a week and a month. Each
sprint starts with a sprint planning meeting where the team, based on the order, defines
which activities to perform during the sprint and gathers these in a sprint backlog. As
the activities are completed, they are removed from the sprint backlog. This makes it
easy to detect any activities that are left pending when the sprint is over.
Each sprint has a set timeframe. At the same time, each sprint should result in a
functioning, albeit incomplete, increment or subsystem of the product. In this way, the
functionality of the final product is developed in small, but always controllable, steps.
The scrum method also emphasizes work in small, tight teams of experts with sim-
ilar skills. The team is led by a scrum master and is expected to autonomously plan
and solve any problems that may arise. The scrum team, therefore, holds brief daily
meetings (daily scrums) in front of a visual board (scrum board) to coordinate the work
process. In addition, the team also holds weekly scrum meetings and after each sprint
there is an evaluation (retrospect) .
Sprint backlog Sprint Functioning, albeit

incomplete, increment or FIGURE 7.12
subsystem of the product Example of a scrum process.

There is a comprehensive conceptual apparatus surrounding the scrum method.

The method has been widely used in software development and many companies have
shown interest in applying it to other types of product development as well. An impor-
tant difference with scrum compared to the traditional approach to product devel-
opment, is that it is the development time which is fixed, and the functionality of the
product which is changeable. Another difference is that the scrum method tones down
the need for cross-functional communication. In the scrum method, the cross-func-
tional coordination is handled by other actors, not the individual scrum teams.
Set-based design
Set-based design (or set-based concurrent engineering) is another work method, which
focuses on the idea that the development process should not commit to one or two solu-
tions too quickly. Instead of starting off by defining a detailed technical specification
that controls the development process, the idea is to create loosely defined objectives to
leave more room for alternative solutions. By investigating and developing knowledge
about the different alternatives, the alternatives which are not working, or seen as
non-feasible, will gradually be removed. Thus, when applying this principle, you do
not choose what seems to be the best alternative already at the start. Instead you start
with a broad approach and work with a set of alternatives. During the development
process, alternatives which are deemed to be the worst options based on the knowledge
acquired, will be successively eliminated until only one alternative remains.
In theory, the development process in set-based design should wait as long as pos-
sible before eliminating an alternative. However, since companies in practice have
limited resources, it is usually difficult to apply set-based design in the later stages of
the development process.
Prototypes and prototyping

A prototype is an early sample or test model of a product. There are many different
types of prototypes. They do not have to be according to scale or have functioning
technology. They are sometimes used for communication or visual purposes, or to test
different technical solutions, etc. The development of prototypes is one of several design
techniques that are aimed at creating an idea of the future design and use of the product.
In software development, mainly in the later stages, prototyping is often used. This i
the quick and iterative development of different levels of incomplete versions, beta ver-
sions, of a software product in order to gradually test these on customers, system owner ,
and users. Based on the test results, new, incomplete but improved versions of the
systems are developed, which will then undergo new tests. This way, iterative steps are
taken as the usability and suitability of the product are tested through different stage ·
178 () THE AUTHORS A ND STUDENTLITTERATUR

Digital models and Computer Aided Design

Most companies use CAD systems (Computer Aided Design) to create a digital model
of the component or product that is being developed. Joint inspections of a three-di-
mensional CAD drawing of the product design are usually a powerful tool for commu-
nication between different experts. By using three-dimensional, digitalized models, it
is possible to easily study complicated products from different perspectives, simulate
fitting of components, evaluate design solutions, and check that the product can be
produced and maintained in an efficient way.
A CAD model can also be used in a CAM system (Computer Aided Manufacturing)
where it is supplemented with instructions for manufacturing and assembly, which
can be transmitted directly to numerically controlled machines in the manufacturing
of the product.
Quality Function Deployment

Quality Function Deployment (QFD) is a method to convert customer demands into
technical requirements which can define the basis for the development process. The
aim is to reduce the risk that expensive and difficult changes in the requirement spec-
ification have to be made in the later stages.
The basic tool is the QFD matrix (the house of quality). Figure 7.13 shows an example
of a QFD matrix for a seat belt lock. The QFD matrix specifies a number of customer
demands, which have been identified with the help of, for example, a market survey.
In the example in question, this includes, for example, that the lock should be easy to
find, easy to lock and easy to open with one hand. The customer demands are then
tran lated into product qualities/functionalities ("how can this be achieved?"). The
hape, size, and color of the lock are examples of important product qualities. As a
next step, the correlations between the customer demands and the product qualities
are analyzed by giving them numerical values based on whether they are strong or
weak. The correlations are marked with circles and triangles in the figure. The customer
demand are graded in terms of their importance (the numbers in the column "Cus-
tomer weighting"), which makes it possible to calculate a corresponding weighting of
the product qualities (the numbers in the row "Weighting"). This way, the properties
which the development process should focus on can be identified. The house of quality
can al o be supplemented with technical target values for the product qualities (the
basement of the house), an analysis of the correlations between the product qualities
(the roof of the house), and a comparison between the company's existing products and
competitors' products. The QFD method should be used by cross-functional groups
ensure that important customer demands or product qualities are not overlooked.

0 Very strong correlation = 9 + = Positive correlation

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Design for Manufacturing and Assembly

Design for Manufacturing and Assembly (DFMA) is a method which focuses on manu-
facturing and assembly early in the product development; that is, already in the design
and specification stage when the basic ideas fo r the product are defined. The intention is
to minimize the number of components in a product and to m ake it easy and cheap to
manufacture and assemble. DFMA can also be useful when choosing assembly method.
180 © T HE AU TH ORS AND STUD ENTLITTER ATUR

CHAPTER 7 a PRODUCT DEVELOPMENT
Each component in the product is analyzed with the aim of finding out whether it
can be eliminated or combined with another component. The analysis means that a
prototype is manufactured and assembled at the same time as each step is inspected
according to a fixed schedule. When the number of components has been reduced
as much as possible, you estimate the time it will take to assemble the product. The
analysis, thus, forms the basis to determine which parts of the design can be eliminated
and which should be redesigned to facilitate the assembly process. The main purpose of
a DFMA analysis is to reduce the total manufacturing costs and therefore it is mainly
applied in companies with large production volumes.
DFMA includes three criteria that should be applied to each component in the
assembly process:
1 Does the component move relative to all other components when the product is
being used?
2 ls the component made of a different material than the other components? Only
fundamental differences, like material properties, should be considered.
3 Does the component have to be separated from the other components in order to
be assembled or dismantled?
As a next step, different alternative design proposals of the product should be compared
to each other, mainly in terms of cost and assembly.
Failure Mode and Effect Analysis

Failure Mode and Effect Analysis, FMEA, is a tool to identify potential errors already
during the development process (see Figure 7.14) . The idea is to focus the develop-
ment efforts on the specific areas where a product error would affect the customer in
a negative way.
The method is based on the product being broken down into components. Potential
sources of error are assessed for each component. For each error, an assessment is made
to determine the likelihood of it occurring, how severe it is, and the risk of it being
detected. These probabilities are rated (often following a scale from 1 to 10) and given
a ri k priority number. A high-risk priority number means that this particular error
source should be eliminated to the extent possible, for example, through a redesign.
There are special worksheets on how to perform an FMEA.
I AUTHORS ANO STUOENTLITTERATUR

181
Potential SEV
Failure Effect
What is the In what ways What is the How severe What causes How What are How Risk priority What are the
step? can the step go impact on the is the effect the step to go frequently the existing probable is number actions for
wrong? customer if the on the wrong (i.e., is the cause controls that detection of calculated reducing the
failure mode is customer? how could the likely to either prevent the failure as SEV X occurrence of
not prevented failure mode occur? the failure mode or its OCC x DET the cause or
or corrected? occur)? mode from cause? for improving
occurring or its detection?
detect it should Provide actions
it occur? on all high RPNs
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ratings of 9 or 10.
ATM Pin Authen- Unauthorized • Unauthorized 8 Lost or stolen 3 Block ATM 3 72

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withdrawal three failed
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customer
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failure customer balancerto
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disbursed customer of low cash in minimum cash
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debited but no dissatisfied failure balancerto
cash disbursed customer • Network issue distribute
workload
across network
links
Extra cash Bank loses 8 • Bills stuck to 2 Verification 3 48

dispensed money each other while loading
• Bills stacked cash in ATM
incorrectly
FIGURE 7.14 An example of Failure Mode and Effect Analysis (FMEA). Source: iSixSigma, 2018.

Product development includes all activities that contribute to the development and
im rovement of a company's value propositions. This takes place in different ways
de pending on the company's operations,, for example, if the company conducts small
ba~h and unit production, mass production, or capital-intensive process production.
Every company has to work consistently on improving and developing its value
propositions. Since most products go through a product lifecycle on the market, where
the sales of new products after a while usually mature and stagnate, companies always
have to have products in different stages of the product lifecycle. From a strategic
per pective, a company can choose to be a pioneer, that is, aim to be the first company
with a new product and have as many products as possible with strong growth; be
more defensive; or focus on imitating already existing products and running a more
co t-efficient production than the competitors. A common way to create conditions
for rational product development is to create a technical platform that enables the
development of different product variants, so-called derivatives.
Companies try to keep a portfolio with different development projects that are in
different stages of the development process. A typical development process of a physical
product starts with a planning stage, which is followed by concept development, system
design, detailed design, and prototype development, after which testing is done and
production starts. In many cases, the development follows a sequential process since
me basic parameters have to be established before the development can move to the
ne t tep. However, it is often more time-efficient to carry out the development steps
concurrently. In software development, agile methods have been introduced. Thus,
many software companies work iteratively, which means that the development process
tructured in a number of short development steps which are performed by tightly
connected development teams.
Many development teams use visual planning, where the operational work is coordi-
nated with the help of frequent meetings in front oflarge project boards in designated
project rooms. Other common tools in the development process are different types of
digital models. In order to create a relevant visualization of the project goal, custom-
centered planning is often used, and with the aim of facilitating future production,
4iff'erent techniques are used for design support and failure mode effect analyses.
183
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Saunders, J. & Jobber, D. (1994). Product replacement: Strategies for simultaneous product
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Tidd, J., Bessant, J. R. & Pavitt, K. (2013). Managing innovation: integrating technological,
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Trott, P. (2008). Innovation Management and New Product Development. Pearson Education.
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Leaps in Speed, Efficiency, and Quality. Simon and Schuster.
© THE AUTHORS AND STUDENTLiTTE~ATU•
184
........·· ·············································································· • .
PRODUCT COSTING AND
ANALYSIS
There are many reasons to analyze a company's financial situation. One of the
more common reasons is to obtain information for important decisions related
to the company's future. Should we develop a new product? Will we make money
on a particular service? How much could we lose in a given market on this prod-
uct? Should we shut down this department? Making such financial decisions
means using established and standardized methods for obtaining data and for
making calculations. However, obtaining this data often also requires making
various financial estimates. In this chapter, we present various concepts and
methods used to make such estimates and calculations.
1.1 The basic concepts of accounting and costing

Costs, revenues, and other concepts
1here are three significant pairs of concepts that are used to describe a company's
ney inflow and money outflow: revenues and costs, income and expenditures, and
ipts (cash in) and payments (cash out). These terms are defined in the box.
ues are the value received for goods or services delivered in a certain time period.
(expenses) are the value of resources consumed in a certain time period.
occurs in connection with a company's sending of an invoice.
itures occur in connection with a company's receipt of an invoice.
ts (cash in) occur when a company receives cash payments.
ts (cash out) occur when a company makes cash payments.
THORS ANO 5TUDENTLITTER A TUR

187
PART Ill • THE FINANCIA L SYSTEM
When a company buys goods or services from a supplier, the company will receive
an invoice for the delivery. By definition, the expenditure occurs when this invoice is
recorded in the company's bookkeeping system. At the same time, the income occurs
for the supplier when the supplier records the amount of the invoice. The invoice states
the payment's due date. On that date, at the latest, the purchasing company makes a
payment (cash out), and the supplier records a receipt (cash in). In short, these dualities
help us follow the sequential stages of business transactions.
Companies record these transactions - income, expenditures, receipts (cash in),
and payments (cash out) - on a continual, day-to-day basis (see Chapter 10). The two
concepts of revenues and costs, however, relate to a specified time period, usually a year
although other time frames are also used (e.g., months, quarters, etc.)
Consider the following example: A company in a certain year purchases raw mate-
rials for a manufacturing process from a supplier but does not immediately put these
materials into production. The company records the expenditure when the invoice for
the materials is received and records a payment when the invoice is paid. However,
the company has not yet incurred a cost (given the definition of costs) because the
materials - a resource - have not been consumed. Thus, the expenditure is recorded in
the current year, but the cost is allocated (deferred) to a future year when the resource
is consumed. The cost is allocated to the relevant time period. The expenditure wa
incurred and recorded, and may have even been paid, in the current year, but the cost
will not be recognized until the resource is consumed.
There is a similar situation with revenues and receipts . Receipts (cash in) may be
received before they are earned, in which case the revenue is allocated (deferred) to
a future year. These examples illustrate the concept of allocation in accounting for
companies' revenues and costs and their income and expenditures.
When did the cost occur? According to our definition, a cost is the value of resource
consumed in a certain time period; in other words, when were the raw materials in our
example consumed? As already observed, the cost did not occur when the raw material
were ordered, delivered, or paid for. In fact, these materials continue to be resources
until they eventually leave the company, often as part of a delivered product. In account-
ing terms, no costs exist until the resources are used in the company's production of a
product that has been sold and delivered to a customer. In accounting, you sometimes
use the term cost ofgoods sold, which is an accounting term for the cost of the materials
used when the company sells the product that includes these consumed materials.
Many difficulties, however, arise in estimating and calculating the cost of goods sold.
For example, what quantity of the materials was actually used for a specific product?
How many hours were spent working on a specific product? How do we determine
those amounts? Can we trust the reported data that we use for our calculations? Or is
further investigation required? These are examples of important questions that must
be asked and answered when making such estimates and calculations.
188 0 THE A UTHOR S AN D STUDENTLITTERATUR

CHAPTER 8 • PRODUCT COSTING AND ANA LYSIS
Fixed costs and variable costs

A company's profit is the difference between its revenues and its costs (expenses). A man-
ufacturer's revenues derive primarily from the sale of its manufactured products. Thus,
revenues are proportionate to sales - the more products sold, the greater the revenues.
However, a company's costs have other relationships. While some costs, like reve-
nues, vary with volume, others do not. Therefore, it is necessary to differentiate between
fixed costs and variable costs.
Variable costs relate to some activity volume - for example, to the number of products
produced, to turnover, or to some other measure of a company's output or input. As such
activities increase, so do variable costs. Fixed costs, however, are independent of the
activity volume, at least within a certain range. Variable costs increase with the increase
in activity volume. Variable costs may be linear, progressive (increasing), or regressive
(declining). Fixed costs are constant at a certain level of activity although they may jump
to adifferent (typically higher) level outside the relevant range. Such fixed costs, called step
costs, then are fixed in a new relevant range where they are again independent of activity
volume. For example, a new relevant range for fixed costs is set when business activity
mcrea es to the point that the manufacturing plant must be expanded (see Figure 8.1).
Fixed costs
Total costs Unit cost
400
200
100
0 200 400 Number 0 200 400 Number
Step costs
Total costs Unit cost
40,000 400
200
100
FIGURE 8.1
Fixed and variable costs.
0 200 400 Number 400 Number
0 200 Continues on the next page

189
PART Ill • THE FINANCIAL SYSTEM
Linear variable costs

Total variable costs Unit cost
40,000 400
20,000
100
0 200 400 Number

0 200 400 Number
Progressive variable costs

40,000 400
20,000 200
100
0 200 400 Number

0 200 400 Number
Regressive variable costs

40,000 400
20,000 200
100
FIGURE 8.1 (Continued.) 200 400 Number

0 200 400 Number 0
Fixed and variable costs.
To illustrate the relationships between total revenues and total costs (fixed and variable)
we can draw the break-even chart. Figure 8.2 illustrates a case in which the total reve-
nues are proportional to the activity volume, the total variable costs are proportional
© THE AUTHORS AND STUDENTLITTERATUR
190
CHAPTER 8 • PRODUCT COSTING AND ANALYSIS
SEK
, Total revenues
,,,'
,,
Real sales -------------------------------------, : / Total costs
,,,, '
,,
,,
,,
,,
,,
,,,'
FIGURE 8.2
Critical sales
Break-even chart. Total
revenues exactly equal total
"-- - - ' ' - - - - - - - - - - - - - - - Fixed costs costs at the critical volume
,/ Safety margin (break-even point) (based
I..''~'- - - - - - '= = == =::::__ _ _ _ _ _------, Volume on Lantz et al., 2014).
Critical Real
volume volume
to the activity volume, and the total fixed costs are independent of the activity volume.
company that has both fixed costs and variable costs is said to break even when total
revenues exactly equal total costs. In the break-even chart, total variable costs and total
revenues appear as linearly dependent on volume. This is, of course, a simplification
because, in reality, a large increase in sales volume often affects the revenue per unit,
producing a regressive revenue curve.
Few companies sell their total annual production at the same time to the same cus-
llOmer. Therefore, to set prices or to evaluate whether certain orders should be accepted
or not, a company must first calculate the cost per product unit.
,even point or Critical volume: Total revenues= Total costs
margin (volume)= Real volume - Critical volume
margin(%)= Real volume - Critical volume

Real volume
can also be categorized according to their type: for example, salaries, raw mate-
rents, and interests (see Figure 8.3).
AUTliORS AND STUDENTLITTE RA TU R 191

PART Il l • THE FINANCIAL SYSTEM
Type of cost Cost unit

(e.g., salaries, raw Direct costs (goods or services
materials, rents, the company
and interest) produces)
FIGURE 8.3
The cost allocation
L Cost centers
(often departments)
_J
pri nciples. Indirect costs
In referring to direct costs and indirect costs (overhead), we link these costs to various
cost units. By cost units, we refer to the goods and services that the company produce
(i.e., the revenue-producing items that are intended to cover the company's costs).
Consequently, products or projects are common cost units at many companies.
Direct costs are easy to trace to the different products. For example, the costs of raw
materials, various production components, and labor for production employees, etc.
can be traced directly to the manufacturing processes and to each product.
Direct costs
Costs that can be traced directly to specific cost units.
Indirect costs (overhead)
Costs from a department or function (a cost center) that are indirectly allocated to cost units.
Costs for administration, sales, and product development staff and for machinery,
buildings, and top management, etc. are more elusive. Such costs are called indirect
costs or overhead costs. They must also be allocated to products or projects (the co t
units) in some way. For indirect costs, traditionally most manufacturing companies
establish cost categories such as materials indirect costs, manufacturing indirect costs,
sales indirect costs, and administrative indirect costs. These costs are then assigned to
cost centers (i.e., the various organization units where the costs were incurred). When
this is completed, the costs of the cost centers are further distributed to the variou
cost units (i.e., the produced goods and services or projects), typically by the u e of
standardized overhead charges (see the examples below).
192 © THE AUTHOR S A N D STUD ENTLITTERATUR

Common costs and specific costs

d on how costs are incurred, they can be differentiated as either specific costs or
Base ·
n Costs (sometimes ca 11ed" re Ievant costs " an d "·ure1evant costs ") . C osts t h at
comma
are incurred as the result of specific actions are specific costs. Examples are the costs
a ociated with beginning production of a new product or with processing an order
for a particular product. Costs that are not incurred as the result of specific actions are
called common costs. Examples are machinery costs that are unaffected by the decision
to manufacture a new product or to process an order.
Thus, the situation determines whether a cost is a common cost or a specific cost.
Moreover, in some situations, a cost may be classified as a common cost while in other
situations the same cost may be classified as a specific cost.
The term specific revenue is used to refer to revenues affected by a specific action.
In product costing, this refers to a product's sales price. After all, the sales price is the
additional revenue from the sale of the product.
costs that are unaffected by the action or the decision in focus of the cost calculation.
divi ion of costs according to these different concepts has different purposes. Each
ept pair can be used to divide all costs. However, because the pairs overlap, every
may be categorized according to each of the three basic principles (see Figure 8.4).

PART Ill a THE FINANCIAL SYSTEM
Division principle Cost concept
Variable Fixed
costs costs
Direct Indirect
Costs
costs costs
FIGURE 8.4
Cost divisions by three Specific Common
costs costs
different principles.
Cost determination and product costing

A company needs to know in advance how much it will cost to produce a good or a
service. Such information is used to set prices or to calculate if a certain product will
be profitable. Furthermore, this information is useful for decisions about production
methods or in make-or-buy decisions (i.e., which components to make in-house and
which components to buy from the suppliers). These are essential decisions that com-
panies must make even before production begins. This is the background for what i
called product costing.
In this section we introduce four methods of product costing:
• Contribution costing
• Step costing
• Full costing
• Activity-based costing.
s.2 Contribution costing

In many companies it is often not necessary to allocate all costs to the cost units (i.e.,
goods or services) when calculating the cost to produce and deliver them.
A common method of calculating the product cost without allocating all costs i
contribution costing. In this method, only the specific costs are allocated to the co t
units. Thereafter, each cost unit's contribution margin (i.e., the coverage of the common
costs) can be calculated. Specific costs are those costs that the company incurs becau e
it produces a particular object (a product, an order, a project, etc.). These are costs that
would not have been incurred had the company not produced that particular object.
By comparison, common costs are the costs that the company would incur regardles
of whether or not it produced the object. Examples are office costs, administrative
salaries, and so on.
194 © THE AUTHORS AND STUDENTLITTERATU~

Co ntribution margin
Contribution margin (CM) for an object= Specific revenue for the object - Specific costs for the
objeet.
1he total contribution margin, the sum of the contribution margins from all cost units,
should cover total common costs, and, hopefully, provide a profit. Contribution costing
i used mainly for existing resources in situations where assortment, demand, and
capacity remain constant in the short term. As an example, business hotels often charge
lower rates on weekends. Most hotel costs are common costs (i.e., costs that the hotels
will incur whether their rooms are rented or not). Therefore, the revenue from renting
1room at the lower weekend rate may cover the room's specific costs (e.g., cleaning)
and will contribute towards covering the hotel's common costs.
Contribution costing is commonly used in, for example, consultancy companies
when determining if client assignments should be accepted at a certain price. The
followi ng example illustrates how contribution costing works.
:XAM PLE
The consulting firm LexCom provides systems and programing advice, among other things, to
companies that want to adapt their systems for electronic sales. The following information is
available for on e period. Note: Project 3 has a negative contribution margin (CM).
Project 1 Project 2 Project 3 Project 4 Total
peofic revenue (SEK) 800,000 1,200,000 1,500,000 500,000 4,000,000
pe fie LOS ts (S EK) -350,000 -600,000 -1,550,000 -250,000 -2,750,000
ntnbution margin (SEK) 450,000 600,000 -50,000 250,000 1,250,000
mmc• costs (SEK) -800,000
450,000
1he LexCom example shows the contribution margins for the four projects. The anal-
i important because it reveals at least two things. First, the company can see each
,ect's contribution margin. Second, the analysis reveals that common costs must
ubtracted from the total of the four projects' contribution margins to calculate
pany profit. For consulting firms, in which the basis for overhead charges is the

same for all projects (the consultants' working hours), contribution costing is often used
because it simplifies the calculation when preparing project proposals for new clients.
s.3 Step costing

Step costing tries to provide a more complete cost breakdown than the traditional
contribution margin analysis described in the previous section by gradually calculating
the surplus in steps. (Not to be confused with step costs, a type of fixed costs, which
was discussed above.) The first step, CM1, corresponds to the contribution margin in
the contribution method, whereas the last step corresponds to the difference between
total revenues and total costs. See the box for an example.
CM1 is the contribution margin per product (per liter) calculated by contribution
costing. CM2 is the total contribution margin per product - that is, CM1 multiplied by
volume. CM3 is the total contribution margin for the product groups (in this exam-
ple, CM2 from the sports drinks less their product group's specific costs plus CM 2
from the fizzy drinks less their product group's specific costs). Finally, CM4 is the
total contribution margin that the Beverage Division makes to the company (i.e., both
product groups' CM3 less the Division's specific costs). Of course, the structuring of
the contribution margins into different levels can be handled differently if it better
suits the company.
The treatment of the specific cost concept in step costing can seem confusing. The
specific costs at a particular level of the company are often common costs at a lower
level. As an example, let us look at the calculation for the two sports drinks (Blue and
Green). The corporation has revenue of SEK 15 per liter sold of Blue and revenue of SEK
19 per liter sold of Green. Specific costs are SEK 7 per liter of Blue and SEK 8 per liter
of Green. CM1 for the two drinks is as follows: Blue, SEK 8 per liter, and Green, SEK
11 per liter. Continuing with the example, CM2 is then the total contribution margin
from the two sports drinks (i.e., CM1 multiplied by volume for each drink). To obtain
CM3, we reduce CM2 by the product group's specific costs. These costs are the common
costs if we look at them from a product level, which means that the company would
have these costs even if it stopped manufacturing the sports drinks. However, from the
company's point of view, these costs are specific costs, belonging to the sports drink .
Thus, if the company ceased manufacturing sports drinks, it would incur no costs for
this product group.
Adding the CM3 of both groups - sports drinks and fizzy drinks - and subtract-
ing the Division's specific costs, gives CM4. The Beverage Division's specific costs are
common costs for the two product groups of sports drinks and fizzy drinks. Thi
means that the Beverage Division would have these costs even if a product group were
discontinued. For the company, however, these costs are specific costs; the company
can decide to close the whole Beverage Division.
196 e, THE AUTHORS AND STUDENTLITTERATUI

EXAMPLE
The Bevera ge Division is part of the global company SADIDA that mainly manufactures and sells
perfume, clothes, sunglasses, and watches. The company's Beverage Division makes and sells two
sports drinks (Blue and Green) and two fizzy drinks (Black and Yellow). Step costing (in four steps)
for the division is as follows:
Specific SEK 15 SEK 19 SEK 50 SEK 70

revenue
(/liter)
Specific SEK 7 SEK 8 SEK 25 SEK 30

costs (/liter)
CM 1 (/liter) SEK 8 SEK 11 SEK 25 SEK 40
Quantity 750,000 330,000 220,000 40,000

ter)
CM2 MSEK 6 MSEK 3.63 MSEK 9.63 MSEK 5.5 MSEK 1.6 MSEK 7.1
Product MSEK 243 MSEK 0.59

roup's
pec,fic
osts
M3 MSEK 7.2 MSEK 6.51 MSEK 13.71
vs on's MSEK8.5
pec1fic
SIS
M4 MSEK 5.21
g step costing, as illustrated here, a company can focus on the profitability of each
uct, product group, and division. In regular contribution costing, only product
fitability is calculated.
AUTHORS AND STUDENTL ITTER A TUR 197

8.4 Full costing

It is obvious that contribution costing has a big disadvantage. When using this costing
method, only the specific costs are allocated to the cost units. This means that it is
impossible to know if all costs are actually covered at a certain price for the goods and
services that are produced.
In full costing, a company calculates all costs related to a product until it is delivered
and payment is received. The company that manufactures only one product illustrates
the simplest form of full costing. This calculation is often called process costing and
means that all costs of operations are divided by the production volume. Since the
company only manufactures a single product it needs to carry the total costs. In the
Trebla AB example (see below), we can rather easily conduct an investigation and
acquire relevant data (e.g., from employee interviews) for this type of costing. The
situation becomes more complex when a company manufactures several products.
Such an analysis is not possible at a company with multiple products, in the hun-
dreds or even thousands. In that situation, some form of a systematic cost allocation
method is required.
In full costing, direct costs and indirect costs are handled differently. Direct costs
are not problematic because the company's cost accounting system traces these costs
to the cost units. The indirect costs (overhead), however, must be allocated among
the cost units.
Full costing for a product
In full costing, the cost of a product is the sum of all costs until the product is delivered and
payment is received.
EXAMPLE
The company Trebla AB manufactures only one product: a chair. The company's total costs to
manufacture 40,000 chairs in the previous year were SEK 6,000,000.
How much does it cost to manufacture and deliver a chair?
The full cost for a chair= SEK 6,000,000 SEK 150/chair

40,000 chairs
Recently the company received an order for a variation on its standard chair that costs SEK 150
to manufacture. The original chair was an easy chair, but the new order is for an office chair. The
company wants to calculate the cost to manufacture 20,000 Easy Chairs and 20,000 Office Chairs.
198 0 THE AUTHORS AND STUDENTLITTE~AT I

CHAP TER 8 • PRODUCT COSTING AND ANALYSIS
It is no simple matter to work out the costs to manufacture and deliver two different products.
Although many company resources can be used for both chair types, they are used in different
amounts. Among these resources are warehouse personnel wages; the cost of warehouse equip-
ment; managerial, sales and administrative salaries; and utilities costs. The only cost that is easily
traced to the two chair types is the cost of the direct materials.
Trebla then conducted an analysis of these costs. Employees were asked to determine how
much time they spent on the two production activities. Employees used their experience with
Easy Chairs (as far as time spent and materials used) for their calculations for Office Chairs. Their
calculation s differed widely, so Trebla averaged these amounts, as shown below.
Data from Trebla personnel. All figures are shown in SEK. (ch= chair, hr= hour)
Easy Office Total cost

Materials cost SEK 40/ch SEK 60/ch 2,000,000
Inventory cost, etc. (% of time) 40% 60% 400,000
Labor time in manufacturing 0.20 hr/ch 0.28 hr/ch 2,000,000
Machine cost, etc. (% of time) 45% 55 % 1,200,000
Sa es, etc.(% of time) 60% 40% 400,000
Based on these data, Trebla made the following calculations for the manufacture of 20,000 Easy
Chairs and 20,000 Office Chairs.
Easy Office
D rect material costs 800,000 1,200 000
nd r" t costs (overhead) for 160,000 240,000 40 % and 60 % of 400,000

matrrials handling
D rect ,abor costs for 833,000 1,167,000 0.20/0.48 and 0.28/0.48 of

manufa, turing 2,000,000
d rec• costs (overhead) for 540,000 660,000 45 % and 55 % of 1,200,000

a ufacturing
d rect costs (overhead) for 240,000 160,000 60 % and 40 % of 400,000

es
cost 2,573,000 3,427,000

cost/chair 128.65 171.35

199
PA RT Ill • TH E FINANCIAL SYSTEM
·-------------
dM Direct material
0..
0
u MO Materials overhead
c'
0
·.:;
u
::,
dl Direct labor
'O
eC. MgO Manufacturing overhead
0
t=:
t=: 0
0 u Other direct Other direct
u
'S
manufacturing costs manufacturing costs
u..
Sales and Administrative

S&A
overhead
FIGURE 8.5 Special direct

Special direct sales costs
The components of the full sales costs
costing method.
----------· - --
Absorption costing is a systematic way to allocate costs to cost units. Direct costs are
traced directly to products, but the indirect costs (overhead) are allocated at flat rates
to the cost units.
Figure 8.5 illustrates the most common way manufacturing companies calculate
the cost of producing a product using absorption costing according to the full costing
method. The calculation involves the following costs:
• Direct material costs (dM):

costs of materials used in production.
• Indirect material costs (materials overhead; MO):
costs associated with handling materials, such as storage costs and inventory
personnel.
• Direct labor costs (dL):
wages of the factory workers for manufacturing the product.
• Indirect manufacturing costs (manufacturing overhead; MgO):
costs associated with manufacturing, such as machine maintenance and
production planning.
• Other direct manufacturing costs:
for instance patents and licensing fees.
• Indirect sales costs (sales overhead; SO):
costs associated with marketing, sales and advertising.
200 e> THE AU T HORS AND STUDENTLITTERATUI

• Indirect administrative costs (administrative overhead; AO):

costs associated with management, financial issues, etc. SO and AO are often
combined and then called Sales and Administrative overhead (S&A) .
• special direct sales costs:
e.g., commissions.
In order to make cost allocations as fair as possible, it is important to determine the

basis for each cost allocation, which means finding a link between each cost and each
cost unit. The aim is to match, as closely as possible, the consumption of resources to
each of the products. In many companies, equipment cost is a major cost of production.
If certain equipment is used exclusively for certain products, the equipment cost can
be considered a direct manufacturing cost. On the other hand, the wages of the equip-
ment operator (who may work on several machines) is an indirect manufacturing cost
(overhead) that must be allocated based on time worked per machine.
When we compare the costs of the two chairs on the basis of this calculation (see
example below) with the analysis made in the first example, we notice that they differ.
A fundamental weakness is apparent in the allocation method: a standardized method
will produce an approximate result. Yet, at the same time, that is the method's strength.
We can use the method to make allocations for products when the products are so
numerous that it is impossible to make detailed analyses.
The absorption method for full cost allocation is based on the fundamental assump-
tion that the relationships between the direct and indirect costs for the company as
a whole are also valid for each of the individual products. For Trebla, in the example
below, the same overhead charges (percentage rates) and the same bases for overhead
charge are used for all products. Since these costs are indirect, they cannot be easily
associated with specific cost units. Instead, they must first be attributed to different
co t centers. If it is possible to determine a basis for the overhead charge for one specific
product, it means that these costs actually are direct costs related to this product, and
con equently no indirect cost allocation is required.
f XAM PLE
lfTrebla manufactured many products, it would not be possible to make these cost allocations in
the way previously described. Instead, it would be necessary to determine the appropriate alloca-
tion bases and methods for assigning the indirect costs (overhead) to the products. The costs of
Inventory and handling are probably proportional to the number of products manufactured. The
campany can calculate a charge for materials overhead, i.e., a relationship between total indirect
llllterial cost (overhead) and total direct material cost, as follows:
MO charge= Total indirect material costs = 400,000 = 20 %

Total direct material costs 2,000,000

In the same way, indirect manufacturing costs (overhead) can be expressed as a percentage of
total direct labor costs.
M O charge= Total indirect manufacturing costs= 1,200,000 = 60 %

g Total direct labor costs 2,000,000
Trebla must also allocate sales costs to the products. Typically these are added to the administra-
tive costs and labeled S&A costs. Similarly, these costs can be expressed as a percentage ofTotal
Cost of Production (CoP).
S&A charge = Total indirect Sales & Administrative costs 400,000 = 7.2 %
Total Cost of Production 5,600,000
With this information, we can now calculate the full cost for Trebla's products. All figures are
shown in SEK.
Easy Office
Direct material costs (dM) 800,000 1,200 000
Indirect material costs (MO) 160,000 240,000 20 % of direct material costs
Direct labor costs (dl) 833,000 1,167,000
Indirect manufacturing costs 500,000 700,000 60 % of direct labor costs

(MgO)
Cost of Production (CoP) 2,293,000 3,307,000
Indirect sales and 165,000 238,000 7.2 % of Cost of Production

administrative costs (S&A)
Full cost 2,458,000 3,545,000
Full cost/chair 122.90 177.25
Using absorption costing

When a company uses the absorption costing method and makes indirect cost a/loca-
tions, the work requires four steps:
1 definition of bases for the overhead charge

2 allocation of the indirect costs (overhead) to the cost centers
3 calculation of the overhead charge
4 distribution of the overhead costs using the overhead charge percentages.
202 Cl THE AUTHORS AND ST UDENTL I TTERATUA

CHAPTER 8 • PRODUCT COSTI NG AND ANALYS IS
The idea behind cost allocation and the choice of bases for the overhead charge is that
costs are allocated to each product based on the quantity of resources the product
es Direct costs are often used as bases for the overhead charge, as in the Trebla
consum ·
Pie Of course, such allocations should not be made automatically; when better
exam ·
allocations bases are identified, naturally they should be used. Manufacturing overhead
costs, for example, are usually allocated on the basis of direct labor costs (as a percentage
of direct labor) but can also be allocated on the basis of direct labor time (in SEK per
labor hour) or on the basis of machine time (in SEK per machine hour), or using a com-
bination of these methods. Materials overhead costs are usually allocated on the basis
of direct materials (a percentage of direct materials). In certain situations, however,
it may be better to allocate materials overhead costs, or some portion of them, on the
ba is of how much material is used (in SEK per kilogram, SEK per square meter, etc.).
It is also important to avoid making these cost allocations to cost centers automati-
cally. The allocations often require several steps: costs are allocated to the organization
unit (cost center) where they occurred, and then further allocated using the allocation
method (described above) to the cost units. Costs should, of course, be allocated to
the cost centers where the bases for the overhead charge best reflect how the resources
are consumed.
In order that their calculations and allocations are as accurate as possible, the people
who do this work need to have an in-depth understanding of the relevant activities.
When a company's overhead costs are allocated routinely to cost units, as in full
co ting using the absorption method, situations will always arise where costs are mis-
allocated. For this reason, full costing is often criticized. We will come back to this
ue in the following section.
a.s Activity-based costing (ABC)

Activity-based costing (ABC) has emerged as a reaction to the criticism of the traditional
costing allocations. The main criticism is that those allocation methods treat too many
cost a indi rect costs.
A discussed above, direct costs are traced directly to the cost units, while indirect
ts are assigned to cost centers (often departments) and then allocated to the cost units
e g., products). This allocation is made using percentage rates on predetermined bases
overhead charges. In most industrial companies, the bases for overhead charges are
fact al most always related to production volume. This means that all indirect costs,
the allocation calculations, are treated as if they also vary with production volume.
course, there are costs that are not directly affected by volume changes. Examples
costs related to plant facilities, machines, and managerial activities. These costs are
ffected by small volume changes.
In ABC, cost concepts such as fixed/variable or direct/indirect are not in focus.
AUTHORS AND STUDENTL I TTERATUR 203

PART 111 • THE FINANCIAL SYSTEM
Activities Cost units

Type of costs
FIGURE 8.6
Activity-based costing
allocation principles.
Instead, ABC is based on a company's activities rather than on its departments. The
idea is that costs are incurred when these activities are performed, not by the organi-
zational units. Cost allocations are made after mapping these company activities and
determining their costs. See Figure 8.6 for an illustration of ABC.
In ABC, you look at what is concealed behind the indirect costs. The activities are
mapped, as well as the reasons for their amounts, at each cost center. For example, the
mapping can reveal that the costs of the production planning are determined by the
number of manufacturing orders, that the costs of making engineering changes are
determined by the number of change orders, and so on. These dimensioning facto rs
are called cost drivers in ABC.
EXAMPLE
Let us return to Trebla AB. Several years have passed . Both Easy Chair and Office Chair are still in
production along with many other products. Among the new products are Junior and Senior (also
chairs) that are part of a new marketing initiative. The following production facts are available for
Junior and Senior:

In the manufacturing process, it takes 0.05 hours of direct labor per chair (the same for both
chairs). Factory wages are SEK 200 per hour. Thus, each chair costs SEK 10 in direct labor.
Annual production volume is 1,000 Junior chairs and 25,000 Senior chairs. Total direct labor per
year for the whole company is 10,000 hours. Total indirect manufacturing costs (manufacturing
overhead) for the company are SEK 10 million per year. How much of these indirect costs should
each chair carry?
MgO charge= SEK lO million SEK 1,000 per hour

10,000 hours
or
MgO Char ge = 10,000 hours·

SEK 10 million
SEK 200 per hour
500 oy.O Of d' t I b
irec a or
204 © THE AUTHORS AND STUDENTLiTTERAT I

CHAPTE R 8 • PRODUCT COSTING AND ANALYS IS
This gives us the following calculation of manufacturing costs per chair (all figures are shown in
SEK):
Junior Senior
10 10
Direct labor
Indirect manufacturing costs 50 50 (500 % of direct labor)
Total 60 60
These traditional full cost calculations show that Junior and Senior cost the company the same for
direct labor and manufacturing overhead.
EXAMPLE
In our example, an investigation reveals that indirect manufacturing costs (overhead) are caused
by the following cost drivers:
• so% of MgO is caused by the cost driver number of direct labor hours
• 30 % of MgO is caused by the cost driver number of manufacturing orders
• 20 % of MgO is caused by the cost driver number of items (different versions of the chairs)
[yr= year]
We also assume the following information on the cost drivers:
Junior Senior Total
Drec ,abor hours 0.05 hr/unit 0.05 hr/unit 10,000 hr/yr
Manufacturing orders 20 orders/yr 125 orders/yr 1,000 orders/yr
N mbrr of items 80
ear, rnal 1,000 units. 25,000 units
With this information, we can now calculate the costs per unit for the three cost drivers:
r 11 t driver Cost/unit
bor nours (50 % of SEK 10 M)/10,000 SEK 500 per hr
anu ac uring orders (30 % of SEK 10 M)/l ,000 SEK 3,000 per order
(20 % of SEK 10 M)/80 SEK 25,000 per item per yr
AUTHORS AND STUDENTLITTER AT U R 205

Calculations for Junior and Senior are as follows:
Junior Cost/unit
Activity
Direct labor 0.05 hr · SEK 200 SEK 10
Labor hours 0.05 unit· SEK 500 SEK 25
Manufacturing orders 20 units · SEK 3,000 per 1,000 units SEK 60
Item numbers 1 unit· SEK 25,000 per 1,000 units SEK 25
Total SEK 120
Senior Cost/unit
Activity
Direct labor 0.05 hr· SEK 200 SEK 10
Labor hours 0.05 unit· SEK 500 SEK 25
Manufacturing orders 125 units· SEK 3,000 per 25,000 units SEK 15
Item numbers 1 unit · SEK 25,000 per 25,000 units SEK 1
Total SEK 51
The traditional full cost calculations revealed that the products' costs are the same. However,
by applying ABC, the investigation shows the activities that incur costs and how the different
products relate to these costs. Junior is 135 % more expensive than Senior. If the sales price were
based on the traditional calculation method, Senior would have subsidized Junior. The ABC
calculation reveals the significant difference in the cost of the two chairs.
The ABC example shows that when manufacturing overhead is allocated to product
based on activity volumes, certain products may often subsidize others. High-volume
products carry a disproportionate share of the indirect costs compared to low-volume
products. Standard products subsidize non-standard products, products that are man-
ufactured by old machines subsidize new products manufactured by special machine .
large-volume customers subsidize small-volume customers, and so on. The explanation
is that in traditional overhead calculations, manufacturing overhead costs are allocated
to all products by the same percentages.
In practice, however, it is difficult to make a complete breakdown of the costs of all
activities and their cost drivers. Companies that have introduced ABC have often retained
parts of their direct costs allocations (see Figure 8.7). In terms of indirect costs (overhead),
companies are often content to determine costs of introducing new products and cost
of handling orders by allowing, for example, the cost drivers of item numbers and order
lines to carry these costs. The remaining costs are often allocated in the traditional way.
206 © THE AU THORS AND STUDENTLITTERATUR

Direct costs
Type of costs Cost units
Activities
Cost centers FIGURE 8.7

Activity-based costing in
Indirect costs practice.
There is another criticism of ABC. Critics claim there are no significant differences
between traditional costing methods and ABC. It is claimed that the only real difference
is that ABC has introduced more cost allocation bases. In this view, ABC is merely
a refined method in which more care is taken in the allocation of the indirect costs.
s.6 Operations determine the costing methods

The chapter's introduction explained that product costing methods emerged in response
to companies' wishes to calculate the cost of manufacturing products and thereby
to et product prices. However, the complexity of these calculations increases when
companies begin to produce many different products. Historically, companies made
uch calculations for the entire company or factory rather than for individual products.
Today, there are many situations in which it is necessary to make cost calculations: to
prepare tenders to customers; to analyze the efficiency of different operations processes,
work methods, or manufacturing equipment; to allocate costs to various products;
or to prepare calculations for investment decisions. (See Chapter 9 for a discussion
of inve tment calculations). Thus, calculations can be made using various types of
object in focus.
It i the decision situation that determines which cost unit is the most logical for
the calculation in focus. This means that in every situation you should think about
which co t unit to use. Companies may want to calculate the profitability of different
ee<>graphic markets, of different market segments, or of different product designs. For
many activities, time is the appropriate cost allocation base. For example, a printing
pany may choose machine hours because it sells printing capacity rather than prod-
. A consulting firm may choose hours because it invoices customers by the hour.
It can ometimes be difficult to determine the most appropriate cost unit. When,
example, a telecommunications company sets prices, many questions arise. Are

customers paying for the ability to make calls? If so, the company should charge all
customers a fixed fee . Are customers paying for the length of their calls? If so, the
company should set prices based on the time customers spend using the telephone. Or
should the company set prices based on the broadband speed or transmission capacity
it provides? And, of course, which competing alternatives are available to customers?
These are difficult questions that should be considered in deciding on a cost unit.
Which cost units are appropriate for different types of operations? And when should
they be used? These questions are another way of formulating and thinking about the
various issues discussed above. Of course, the assumption is that the costing methods
chosen reflect a company's operations and different activities. Yet another consideration
may be relevant - costing methods influence activities and employee behavior at the
company. For example, in some situations, internal resources (e.g., machines) are so
expensive that units within the company may decide to purchase products produced
by these resources from external companies rather than producing them in-house.
Then, when fewer products use the internal resources, costs are allocated to fewer
products. These products then have a higher cost, reducing their profitability. Next,
those responsible for these products also consider looking outside the company for
cheaper alternatives. The situation becomes a downward spiral as people in charge of
the machines complain their machines are not used merely because of the allocation
principles used. An example of th is deteriorating situation was when some universitie
in Sweden changed the principles behind handling the costs of facilities - from allo-
cating these costs to a central university function to allocating the costs to the various
departments and institutions based on how much floor space they used. Overnight,
research activities that required large floor space became more expensive than other
research activities that required less floor space. This outcome affected department
with large laboratory spaces. Thus, because research in these areas was now more
expensive, fewer researchers used these facilities; instead, many researchers turned to
research projects driven primarily by theoretical simulations and which required litt le
use of the physical facilities. Consequently, the research priorities were controlled by
rental costs rather than by scientific needs. A fundamental idea behind product costing
is the need to gather information on decision-making alternatives.
This means that the way in which allocations are made will influence a company'
operations. For example, there is a tendency that what can be measured will be per-
formed. Thus, costing methods should be designed so that their intended purposes are
taken into consideration. Among other things, product costing is closely related to the
nature of a company's operations and to its objectives.
208 <> THE AUTHORS AND STUDENTLITTERAT

8 .7 Calculations - before and after

One of the main uses of product costing is the calculation of costs in advance of a
decision or an activity: cost estimates. To check for the accuracy of such calculations,
however, many companies also conduct follow-up costing calculations after the activity
is completed.
Follow-up costing requires information that is available in a company's cost account-
ing system (e.g., the expenditures for purchased raw materials, for salaries, and pro-
duction facilities). See Chapters 10 and 11 for a discussion of accounting systems. Thus,
the cost accounting system provides data on the resource consumption, or, in actuality,
the accounted value of the resources consumed during the period. For an accurate
allocation of these costs, more detailed cost accounting is required than is mandated
by law of the financial accounting system. In addition, efficiency analyses also require
data on company performance for the period under examination.
EXAMPLE
When Trebl a checked on how much raw material was used in a period, the cost accounting
records provided the following data:
• The manufacture of Easy Chairs used materials that cost SEK 1,275,000 .
• The manufacture of Office Chairs used materials that cost SEK 2,090,000.
However, these figures tell us nothing about the efficiency of the resource utilization. For this
calculation, we need to know how many Easy Chairs and how many Office Chairs were produced
- that is, th e amount of materials that should have been used to produce this number of chairs.
According to our estimates, each Easy Chair required materials at a cost of SEK 40, and each Office
Chair required materials at a cost of SEK 60. Records show that in this period the company manu-
factured 30,000 Easy Chairs and 35,000 Office Chairs.
Now we can make a follow-up cost comparison between the estimated cost and the actual
cost of the chairs. All figures are shown in SEK.
Easy Total Office Total

mate of materials 30,000 units· 1,200,000 35,000 units · 2,100,000
sage 40 per unit 60 per unit
a materials 1,275,000 2,090,000
ge
-75,000 10,000
AUTHORS AND STUDENTLITTER A TUR 209

PART Ill • THE FINANCI A L SYSTEM
The follow-up calculation reveals that the manufacture of Easy Chairs used materials costing SEK
75,000 more than estimated while the manufacture of Office Chairs used materials costing SEK
10,000 less than estimated. There are several possible explanations for these differences. Possibly
there were production problems - untrained staff, machinery malfunction, etc. - with Easy Chairs,
resulting in materials damage or waste. However, another explanation may be that the estimated
cost was incorrect because of overly optimistic estimates of materials usage or the time required
to complete the manufacturing. The follow-up costing helps focus the company on improving its
cost estimates.
Summary
In this chapter we introduced three basic pairs of concepts: revenues and costs; income
and expenditures; and receipts (cash in) and payments (cash out). Revenues are the
value received for a good or service delivered in a certain time period, and costs are the
value of resources consumed in a certain period. Income occurs in connection with a
company's sending of an invoice, while expenditures occur when a company receives
an invoice. Receipts (cash in) and payments (cash out) occur when a company receives
or makes cash payments.
A company receives revenue by selling its products. Costs, however, occur in dif-
ferent parts of the company's operations and can be divided into variable and fixed
costs; direct and indirect costs; and specific and common costs. Variable costs vary
with the activity volume, while fixed costs do not. Direct costs can be traced directly
to a specific cost unit (e.g., a product or a project), while indirect costs cannot. Specific
and common costs, on the other hand, relate to different decision-making alternatives.
If a company is going to execute an activity, only certain costs (the specific costs) for
the activity will change; all other costs are common costs.
Most companies need to know what their products will cost to produce. In order to
determine this, companies make different types of product costings. The most common
are contribution costing, step costing, full costing, and activity-based costing. In con-
tribution costing, the contribution margin that a product (or object) brings is calculated
by subtracting the specific costs from the specific revenues. In step costing, this i
done in several steps. First, the specific revenue is calculated and then specific cost
are subtracted at different levels, for example the specific costs of the product, product
group and division.
A disadvantage with the contribution method is that not all costs are allocated to
the cost units. With the full costing method, however, all costs are included. All of the
company's costs are, in other words, allocated to the products. Normally, there are a
number of direct costs that are relatively easy to establish, for example direct material
costs and direct labor costs. Indirect costs (overhead costs) are then added to the direct
210 © THE AUTHORS AND STUDENTLITTERATUI

costs in the form of percentages. All of the company's costs are then summed up and,
in this way, allocated to all of the products. Activity-based costing can be described as
a variant of traditional absorption costing where the cost of the company's different
activities (the cost drivers) are calculated and then allocated to the cost units.
Referen ces
Andersson, G. (2008). Kalky/er som beslutsunderlag: kalkylering och ekonomisk styrning.
Studentlitteratur.
Ax, c., Johansson, C. & Kullven, H. (2011). Den nya ekonomistyrningen med eLabb. Liber.
Cooper, R. & Kaplan, R. S. (1991). Profit priorities from activity-based costing. Harvard
Business Review, 69(3), 130-135.
Karen, M., Ljungren, S. & Lonnqvist, R. (2013). Kalkyleringfor produkter och investeringar.
Studentlitteratur.
Lantz, B., Isaksson, A. & Lofsten, H . (2014). Industriell ekonomi: grundliiggande ekonomisk
analys. Studentlitteratur.
l AUTHORS AND STUDENTLITTER A TUR 211

········· ·· ·
..........................................................................0
CAP ITAL INVESTMENTS AND
INV ESTMENT ANALYSIS
Avital issue for companies, for their long-term viability, is the need for resources
that allow them to compete in the market. A newly founded company needs
itial resources (e.g., capital). A manufacturing company that is planning to
rease its production capacity needs to determine how many new machines
required. Another company that is evaluating whether to enter a new market
st think about the investments needed for new production facilities, for
pliance with new rules and regulations (e.g., emission standards) and for
staff training programs. Another example is a mining company planning
open a new production level in one of its mines. This chapter addresses the
ncipal conditions surrounding companies' considerations for such long-term
stments.
yditferent activities can be described as investments. For an industrial company,

ting usually means a significant monetary transaction, such as the acquisition of a
ical resource like machinery, production facilities, or a major IT system. However,
ting may also mean initiating a new marketing campaign, starting a research and
lopment project, or purchasing staff training programs. In the financial markets,
ting means, for example, buying and selling of shares, options, or other secu-
. In practice, there is no single formal definition of an investment; however, an
ment is usually related to major financial commitments over a long time period.
ntly, the company and/or industry traditions and circumstances determine if a
rexpenditure is an investment or not. For the independent taxi driver, a new car
213
PART Ill • THE FIN A N CIAL SYSTEM
purchase is a significant investment; a large company may regard its new car purchase
as just another, routine business expenditure - one among many.
The commonality among these examples is that they all require the present outla
of money intended to produce a positive result in the future. Thus, an investment i:
by definition a major financial undertaking that will have long-term consequences.
Because investments involve resource consumption, the established techniques for
investment calculation are strictly built on the specific inflows and outflows of money
- the receipts and payments - related to a particular investment.
Investments
An investment is a capital outlay that has payment consequences over an extended time period,
at least more than a year.
Receipts and Payments
A receipt (cash in) occurs at the moment when money is received (e.g., when a customer pays an
invoice for goods or services the company has delivered).
A payment (cash out) occurs at the moment when money is paid (e.g., when the company pays an
invoice for goods or services a supplier has delivered).
Making investment appraisals (investment calculations) means looking at the com-

pany's cash flows (in and out). In making an investment, the investor pays out money
now in the expectation that money will be received later (in the amount of the original
investment plus more). Because investments, as defined above, are long-term, the inve -
tor needs to know (estimate) how much money will eventually be received and when.
By including all relevant receipts (cash in) and payments (cash out) in the investment
appraisal, it is possible to compare different investment alternatives.
In the appraisal, we include only those receipts and payments following the original
investment (payment). These receipts and payments are often illustrated using the cash
flow chart (see Figure 9.1). Typically, a large payment (cash outflow) occurs initially,
for example for a new machine. The cash inflows are the receipts as the result of the
investment: increased sales, for example. At the end of the machine's life, when it is old
for its residual value in the last year, another receipt (cash inflow) results.
The cash-flow chart shows the investment payments on a timeline. Receipts (r) are
shown above the horizontal line and Payments (p) are shown below the horizontal line.
The Original Investment (OI) is the initial cash payment, marked by the downward bar
at the end of Year O (i.e., at the beginning of Year 1). The future receipts (cash inflow)
214 r;:, THE A UT HO RS AND ST UDENTLITTERAT I

CHAPTER 9 • CAPITAL INVESTMENTS AND INVESTMENT ANALYSIS
Receipts
y: Economic life (7 years)

01: Original investment
r: Receipts
p: Payments
RV: Residual value
FIGURE 9.1
Investments illustrated as
Payments cash -Aow charts.
and payments (cash outflows) are graphed by period (usually yearly) with upward or
downward bars. The receipts and payments can be summarized by a single bar that
w the difference between them for each period. We can calculate the over (or under)
cash surplus for each year. The Residual Valu e (RV), that is, the amount the investment
worth at the end of its economic life (y), is also shown as a bar. A positive residual
ue i estimated, for example, when the company expects to take the machine out of
ice and sell it. A negative residual value is estimated when it is assumed the cost of
dispo ing of the machine will be higher than its estimated selling price. Possibly the
mpany can sell the machine in a second-hand market; possibly the company will
e to pay to have the machine removed.
It i important to differentiate between economic life and technical life. Economic
, the period in the cash-flow chart, refers to the time period until other investment
rnatives appear more profitable. In other words, continuing with the machine
pie, it is assumed that at the end of the machine's economic life, it will be more
fitable to make a new investment by replacing the original machine. Technical life
to the machine's total functional time, limited only by its physical and technical
cities. A machine that is still functional, for example, may be so expensive to
lain that it is more profitable to buy a new one. In some instances, technology
ops so rapidly that a company may decide that even a relatively new machine is no
r profitable compared with new models that require less energy or fewer repairs.
u e of maintenance issues and technological developments, economic lives are
considerably shorter than technical lives. By definition, economic life cannot be
r than the technical life. Computers are a good example. Many companies replace
AUTHORS ANO STUDENTLITTER A TUR

215
them long before they cease working. In many practical instances, however, because
it is quite difficult to imagine future technological developments, it is also difficult to
estimate an investment's economic life.
Economic life
The total time in which the investment achieves its maximum profitability. This is the time in
which investment calculations are made.
Technical life
The total functional time limited only by the investment's physical and technical capacities. Tech-
nical life exceeds or is the same as economic life.
Frequently, however, machines are used in production long after the end of their eco-
nomic lives or after they have been fully depreciated in the accounting records (see
Chapter 11). Depreciation is a bookkeeping calculation only, and depreciable life does
not necessarily coincide with economic life.
In practice, investment calculations often use standard depreciation periods as a
reasonable approximation of economic lives. This calculation, however, should not be
confused with actual depreciation, which is a bookkeeping/accounting event.
9.2 How are investments evaluated?

In the discussion of investments, it is important to remember that any calculation i
only a part of the comprehensive investment evaluation required. The reason is that
many different factors, even those that cannot be calculated in monetary terms, mu t
be considered.
A fundamental difficulty in making investment calculations is that many factors are
often unquantifiable. How can factory improvements designed to improve air or water
quality be evaluated monetarily? What is the monetary outcome of investing in a new
IT system? How do we quantify the results of initiating new marketing programs or of
opening new sales channels? Take the example of an investment in a new mine: beside
the cost of the original investment, how much can the company expect to pay for related
costs, such as the cost of the regulatory evaluations of the environmental impact?
In many cases, a company may make a large investment for strategic reasons even
though it is impossible to estimate the short-term economic profit. It is, of course, very
difficult to quantify the long-term effect on profitability of some investments. In such
216 10 T H E A UT H ORS A ND ST UD ENTLITTER~T

CHAPTER 9 • CAPITAL INVESTMENTS AND INVESTME NT ANA LYSIS
cases, investment evaluations require fairly extensive research of, for example, market
trends, technology developments, and competitors' actions. The final investment deci-
sion, then, requires many types of evidence besides the financial data that the formal
calculations provide (which are presented in later sections of this chapter).
In practice, an investment decision, whether for a small or large investment, almost
always involves factors and considerations that are not easily quantified. It is the unfor-
tunate situation that quantitative calculations are sometimes over-emphasized. What
can be measured in numbers is usually prioritized.
9 .3 Investment calculations
Investment calculations are an important part, but not the only part, of investment eval-
uations. The calculations deal with how investments influence the cash flows (receipts
and payments) - in other words, how much money moves in and out of the company.
These calculations answer questions such as the following: How much will we reduce
manufacturing costs if we invest in the latest machine model? How much will sales
increase if we invest SEK 20 million in a distribution network in Poland? How much is
the financial return if we procure new mining equipment or a new paper machine? As
tated above, although such monetary calculations are an essential part of investment
evaluations, they are not the only considerations in making investments.
The primary purpose of investment calculations is to provide a basis by which
to evaluate the profitability of an investment project. For companies with several
investment alternatives, these calculations also allow comparisons and ranking of
the alternatives. On the basis of their expected profitability, the company can decide
which investments should be made. As a simple example, in Figure 9.2 (on the next
page), we present two alternative investments: A and B. The question is, which of the
two investments is more profitable?
It is very simple to see that Alternative A is a better investment than Alternative B.
The original investment (the cash outflow or payment at the beginning of Year 1) is the
same ( EK 800,000). Alternative P.:s receipts (cash inflows) in the five years are either
larger or the same as Alternative B's receipts. By calculating the results in monetary
lerm over the economic lives (five years in both alternatives), we are able to compare
and rank the two alternatives. The cash-flow charts tell us that A is a better investment
n B. However, one question remains: Are the investments profitable? Should the
stor choose A, neither A nor B, or perhaps both A and B?
To answer this question, we must know the investor's required rate of return on
tments. This rate of return can be expressed in various ways depending on which
tment calculation method is used. Often the cost of capital is used to specify the
red rate of return. Another possibility is to specify the longest acceptable time
, the payback period, needed to repay the original investment. If the required

SEK
Investment alternative A Investment alternative B
300,000
150,000
FIGURE 9.2
Two capital investment
altern atives: A and B.
800,000
payback period in our example is three years, A is profitable but Bis not. It takes slightly
less than three years for A to repay the original investment but more than three years for
B. However, if the required payback period is four years, both alternatives are profitable
investments. If the required payback period is two years, neither A nor Bis a profitable
investment. Later in the chapter we will discuss how the cost of capital and the payback
period are determined. For now, we present the four most commonly used methods to
make investment calculations: the net present value method, the annuity method, the
internal rate of return method, and the payback method.
Net present value method

The net present value method is an interest rate calculation method. Using a prede-
termined interest rate (the cost of capital interest rate), the investment alternative '
receipts and payments are discounted to the same time point - to year zero, that i ,
when the original investment is made. One says the future payments are "discounted
to present time" using the cost of capital as the discount (interest) rate. At the same
time that the cost of capital interest rate expresses the required rate of return, it also
expresses the time preference. This means that a future receipt/payment is considered
less valuable than the same receipt/payment today. If we have money today, we can, a
an alternative to the capital investment, save it and earn interest from a bank account
or invest it in the current operations and earn short-term returns. Thus, the use of the
interest rate called the cost of capital interest rate is a way to take the long-term nature
of investment decisions into account.
218 © T HE A U THO RS A N D STUDENTLITTERAT

Time preference
Areceipt we receive today is worth more than the same receipt at some future date since today's
receipt can be used in the current operations and can earn short-term returns .
Let us take an example of the net present value method. The company Industrial Com-
ponents specializes in the manufacture of welded products and components. Turn-
over has increased significantly in recent years. Management, which is investigating
different expansion possibilities, asks the factory manager to report on the various
manufacturing investments needed. The factory manager reports that a new welding
machine is needed. After looking at alternatives, the factory manager must choose
between a welding robot and a manual welding machine. The welding robot is more
expensive, but does not require a manual operator. The manual welding machine is less
expensive, but requires a manual operator. Figure 9.3 shows two cash-flow charts that
pre ent the cash flows (cash in/receipts and cash out/payments) for the two alternatives.
SEK Welding robot Manual welding machine

500,000
400,000
300,000
200,000
FIGURE 9.3
Two investment alterna-
500,000 tives: a welding robot and
a manual welding machine.
Photo sources: Amnarj
Cost of capital interest rate, i = 20 %
Ta nong ratta na/sh utter-
stock.com (robot) and Sasin
1,000,000 T/shutterstock.com (manual
machine).
219
Management has set the cost of capital interest rate (the required rate of return) at 20 %.
Which alternative is better?
Using the cost of capital as the interest (discount) rate, we can discount the recei ts
back to the present time (also referred to as time zero), that is, to the beginnintof
Year 1. The principles for discounting receipts and payments are simple and follow the
usual interest calculation rules. The simplest way to demonstrate this calculation is to
calculate amounts forward in time. Suppose we have the opportunity to receive a sum
of money today (X) or some amount of money in one year. The question is the following:
how much money must we receive one year from now that is equal to the money we
receive today? Suppose also that the amount received today can be invested so that it
earns the same rate of interest as the cost of capital interest rate, say i percent. After
one year, we will have our original amount of money plus the accumulated intere t:
X. (1 + i). Receiving that future sum is the same as receiving X today.
Cost of capital interest rate
The cost of capital interest rate expresses the required rate of return on an investment and is used
in investment calculations for receipts and payments over time.
The cost of capital interest rate is decided internally in the company.
For different kinds of investments, different costs of capital interest rate are used.
IfX is SEK 1,000 and the cost of capital interest rate is 20 %, the corresponding amount
in one year is SEK 1,200. This amount is called the future value. The amount can be
calculated forward any number of years (y) by multiplying it by the future value factor.
The future value mathematical formula, which is the normal interest-on-interest for-
mula, is shown in the box.
Future value factor formula
FV=(l +i)Y
In a similar calculation, receipts and payments can be discounted backward in time.

An amount we receive in a year divided by the FV formula can be calculated to the
present time, which is referred to as its present value. The mathematical calculation for
discounting is thus the inverse of the FV formula. Discounting an amount backward
in time for a number of years is quite simple using the present value formula.
220 © THE AUTHORS AND STUDENTLITT ERATUI

make an investment calculation using the present value method. The

owwe Can
calculation is simplified, however, when we introduce the cumulative pre_sent value.
ith this formula, in a single step we can calculate the present value of a senes of equal
receipts (or payments), spaced at equal distances.
factors are presented in table form for different interest rates and different time
ods. You will find these tables at the end of this book. There are also software pro-
available for these calculations. Also see the box "Deduction of the cumulative
nt value factor (CPV)".

Deduction of the cumulative present value factor (CPV)
Assume that a capital investment generates equal annual receipts amounting to SEK a every year
for y years. All receipts are made at the end of each year. The company's cost of capital interest
rate is 20 % (see Figure 9.4).
a a a a a a a a a a
_____1_______
0
11______
11_____
11~11~1.
2 3 4 y
v,..
FIGURE 9.4 Receipts amounting to SEK a at the end of every year in y years.
By using the present value factors for each year we can calculate the net present value for the
investment in year Oto:
NPV =a· NPV [i %, 1yr]+ a· NPV [i %, 2 yr]+ ... + a· NPV [i %, y yr]=
=a· [ 1 / (1 + i) 1 + 1/{l+i)2 + ... + 1/(1 + i)>') =
= a · [ (1 + i).1 + (l+i)"2 + ... + (1 + i)"Y]
The expression in the parenthesis is the cumulative present value factor at cost of capital interest
rate i and period y years, i.e., CPV (i %, y yr). This can be simplified in the following way:
Multiply by (1 + i) in order to write the expression as a geometric sum, i.e., as

a + a · k1 + a · k2 + a · k3 + ... a · kY):
(1 + i) · NPV=
= (1 + i)1 ·a· [ (1 + 0·1 + (1 + i)"2 + ... + (1 + i)"Y] =
= a · [ (1 + i) 0 + (1 + i)'1 + ... + (1 + i)·Y+1] =
= a · [1 + (1 + i)"1 + ... + (1 + i)·Y+1]
Simplify the sum by subtracting NPV from (1 + i) · NPV, which thus gives i · NPV:
i · NPV = (1 + i) · NPV - NPV =
=a· [ (1 + i) 0 + 1 / (1 + i) 1 + ... + 1 / (1 + i)Y·1J - a· [1 / (1 + i)1 + 1 / (1 + i)2 + ... + 1 / (1 + i)Y] = ...
= a · [(1 + i) 0 - 1 / (1 + i)Y] = a · [1 - (1 + i)"Y]
Divide this expression by i, which gives:

NPV =a· [1- (1 + i)"Y] / i
The cumulative present value factor CPV[i %, y yr] thus is:

CPV [i %, y yr] = [1 - (1 + i)'Y] / i
222 © THE AUTHORS AND STUDEN TLITTE~AT

EXAM PLE
Net Present Value calculation: Welding robot or manual welding machine
We begin with the welding robot investment. First we subtract the Original Investment (01). Then,
for the fi rst three years, we use the cumulative present value calculation (CPV) to discount the
three equal receipts of SEK 400 each year. In Years 4 to 6, in which the amounts are unequal, we
discount th e receipts using present value calculations (PV).
Net Present Value= 01 + al-3 · CPV(20 %, 3 yr) + a4 · PV(20 %, 4 yr) + as · PV(20 %, 5 yr) + a6 .
PV(20 %, 6 yr)
CPV (20 %, 3 yr) = 2.106
PV (20 %, 4 yr) = 0.482
PV (20 %, 5 yr) = 0.402
PV (20 %, 6 yr) = 0.335
The net present value for the welding robot alternative is:
-1,000 + 400 · 2.106 + 300 · 0.482 + 200 · 0.402 + 500 · 0.335"" SEK 235,000
The calcul ation for the manual welding machine is simpler. First we subtract the Original Invest-
ment (01). Then we can use the CPV factor to discount all the equal payments to the present time
in one step.
Manual welding machine
SEK
500,000
400,000
300,000
200,000
500,000
Cost of capital interest rate, i = 20 %
1,000,000
FIGURE 9.s Receipts (cash in) and payments (cash out) for investment alternative Welding robot and
a Vf' Manual weld ing machine.

223
Net Present Value= OI +a· CPV(20 %, 6 yr)

CPV (20 %, 6 yr) = 3.326
The Net Present Value for the manual welding machine alternative is:
-500 + 200 · 3.326"' SEK 165,000
While the results of the calculations for both alternatives are positive, the net present
value is larger for the welding robot. Both investments return over 20 % (because the
net present value is greater than zero), but the welding robot is a better investment than
the manual welding machine.
Decision rules for the Net Present Value method
An investment with a present value greater than the original investment is a profitable invest-
ment. The difference is called the net present value and should be greater than zero.
The investment alternative with the largest net present value is the most profitable.
It is often the case that a company's access to capital limits its ability to make invest-
ments. In practice, different investments compete for capital. Therefore, it is useful to
examine how well different investments use the invested capital. This calculation is
possible using the net present ratio. The ratio is simply the net present value in relation
to the original investment.
Net Present Ratio
Net Present Ratio Net Present Value

Original investment
A high net present ratio is better than a low one. In the example we have used to thi
point, the welding robot has a net present ratio of 0.24. The manual welding machine
has a net present ratio of 0.33.
EXAMPLE
Net Present Ratio: Welding robot or manual welding machine
t
Net Present Ratio for the welding robot is: l,~3 0 "'0.24
Net Present Ratio for the manual welding machine is: ~~~ = 0.33
224 ro THE AUTHORS AND STUDENTLITTERATUR

he manual welding machine makes better use of capital invested even though
't ent value calculation shows that it is the worse alternative. Another way to
net pres
. . that the manual welding machine can produce a higher rate of return than
te t h IS IS . . .
the welding robot, which is also the result if the two alternatives are calculated usmg
the internal rate of return method (see below).
Although the net present value method is not as simple as the payback method (see
below), it is not particularly difficult. Moreover, it directly takes the time preference
with its use of the cost of capital interest rate. However, a disadvantage
tnto ace Ount
of the net present value method is that the method should not be used to compare
tments with different economic lives.
Ifwe know for certain the amount of the receipts (cash in) and the amount of the
yments (cash out) in perpetuity _(forever~ for t~e invest1:1ents, the net ~re_sent value
hod can be used without special considerat10n even if the economic hves of the
alternatives differ. In practice, however, this is difficult to know because you must know
what will occur after the end of the investment's economic life. Will we reinvest in or
ificantly change the activities related to the investment? If we reinvest, how much
uld we reinvest? If we know that the investment will be discontinued, there is no
concern because all results appear in our calculation. One way to deal with this problem
and till use the net present value method is to shorten the life of the alternative that
the longer economic life. Thus, you simply calculate two alternative investments
r the same time period: the shorter economic life. To compensate for the years
fflllOVed from the calculation for the investment with the longer economic life, you
a fictitious residual value for the final year. Then the net present value calculation
performed in the normal way. The residual value becomes an estimate of the receipts
received (or payments not paid) when the longer economic life is shortened.
Another consideration is that the size of the discount rate (i.e., cost of capital interest
nte) can influence the ranking of the alternative investments. In a simplified way, you
can ay an alternative with a larger original investment (like the welding robot in the
mple) benefits if the discount rate is low. Conversely, the alternative investment
th a mailer original investment benefits if the discount rate is high. The same result
po ible if the peaks of the future payment surpluses occur at different points in the
future for the two alternatives. It is of course expected then that the size of the discount
nte influences the ranking because the discount rate in fact measures how much the
future payments are discounted.
In the annuity method the original investment and all future receipts (cash in) and
JIIYments (cash out) are distributed over the investment's economic life in equal annual
unts. Such future receipts and payments are called annuities. See Figure 9.6 for an
E AUTHORS AND STUDE N TLITTER A TU R 225

PART Il l • THE FI NAN CIAL SYSTEM
illustration. A simple comparison is to use annuity loans that banks and other financial
institutions make. With such loans, the borrower pays the lender an equal month!
amount consisting of interest payments and loan principal payments. Thus, during th:
entire loan period, the borrower pays the same sum each month. The average month!
payment is calculated based on the total sum. Stating this calculation as an average i:
somewhat erroneous because the calculation uses the cost of capital as the discount rate.
In principle, the net present value method and the annuity method are two variations
of the same calculation.
Annuity factor formula
ANN= 1 - (1 + iJ-Y
Formula for annuity calculations
Annuity= Net Present Value · ANN(i %, y years)
ANN= annuity factor

i = cost of capital interest rate (discount rate)
y = economic life
Typically, the calculation of an investment's annuity is made first by calculating the

present value of the investment over its entire economic life. Then the present value i
multiplied by the annuity factor (ANN), which is simply the inverse of the CPV. The
annuity factor varies with the discount rate (i) and the economic life (y). The table at
the end of the book present these factors .
111111 l year
~
FIGURE 9.6
The annuity method
calculates an "average
annual" payment.
226 o THE A UTH ORS A N D STUDENTLITTERAT I

·t calculation· Welding robot or manual welding machine

Annu1 Y ·
have already calculated the present value of both alternatives, the annuities can be
Because We
easily calculated by multiplying the present value by the annuity factor (ANN). (An alternative
calculation for the manual welding machine is to multiply its original investment by the annuity
factor and then subtract this amount from SEK 200,000. This is possible because all the receipts in
Years 1to 6 are the same. In short, the payments are already annuities). The annuity factors are in
the table at the end of the book.
Annuity= Present value · ANN(20 %, 6 yr)

ANN(20 %, 6 yr)= 0.301
The annuity for the welding robot is:

235. 0.301 :: SEK 71,000
The annuity for the manual welding machine is:

165. 0.301 "'SEK 50,000
1be welding robot has a larger annuity than the manual welding machine (see
Figure 9.7). The decision rules for the annuity method are the same as for the present
ftluemethod.
tment in which the annuity of the future receipts (and payments) is greater than zero is
ble.
Investment alternative with the largest annuity is the most profit~ble.
us, the welding robot appears the better investment although both investments
profitable because their annuities are greater than zero. If the investments, when
pared, have the same economic life, the annuity method and the present value
hod will produce the same result.
SEK
;: :1 111111 11111 lyear FIGURE 9.7

Annuity calculation:
welding robot or manual
welding machine.
AUTHOR S AND STUDE NTLITTE RATUR 227

11111
FIGURE 9.8
Continuous replacement.
With one exception, the annuity method, therefore, has the same advantages and disad-
vantages as the net present value method. The exception is that the annuity method can
be used to compare alternatives with different economic lives if we assume continuous
replacement. By continuous replacement, we mean that the operations in which the
investment is made will continue after its economic life has ended (see Figure 9.8). For
all the alternatives compared, a new investment is assumed at this point in time. If we
assume that these future investments are the same as the investment made today, we
can then make a chain of investments for the different alternatives. Because the annuity
corresponds to an average year, we can calculate the first investment in each chain.
But if we cannot assume continuous replacement, the annuity method can result in
an incorrect decision.
In the same way that we use a ratio for the net present value method, we can u e
an annuity ratio to determine which investment provides the better return on the
original investment.
Annuity Ratio
Annuity Ratio= Annuity

Original investment
228 © THE AUTHORS A ND STUDENTLITTERAT

EXAMPLE
Annuity Ratio: Welding robot or manual welding machine
Annuity Ratio for the welding robot is: l,~~O"" 0.07
Annuity Ratio for the manual welding machine is: st~ = 0.10
Thus, the annuity ratio reveals that the manual welding machine provides the better
return than the welding robot.
Internal rate of return method

The internal rate of return method calculates an interest rate of return (usually an
annual rate) on an investment. This rate is called the internal rate of return (IRR). In
this method, you calculate the return on the investment in order to compare it to the
required rate of return (i.e., the cost of capital interest rate). In the calculation, you
calculate the interest rate at which the net present value of an investment equals zero.
1be net present value method and the annuity method begin with a predetermined
intere t rate (the cost of capital interest rate) in order to calculate the size of the surplus
over the original investment discounted at that rate. In the internal rate of return
method, the surplus is set to zero, and the interest rate that produces this result is the
internal rate of return.
This rate can be calculated by trial and error, but that is rather laborious. Advanced
calculators or spreadsheet software greatly simplify the calculation. Another, and more
Wu trative, calculation is depicted by a graph. The internal rates of return for the
ding robot and the manual welding machine are graphed in Figure 9.9. Both curves
w the present values plotted at different interest rates.
In Figure 9.9, we see that the welding robot has an internal rate of return of nearly
'11,, and the manual welding machine has an internal rate of return of around 33 %.
internal rate of return is the point where the curve crosses the X-axis. (Numerically,
can calculate the internal rates of return more exactly as 29.5 % and 32.7 %). Both
lntere t rates are thus greater than the cost of capital interest rate (required rate of
rn) that was set at 20 %. This means that both alternatives are profitable. We had
same result with the net present value method and the annuity method.
AUTHORS AND STUDENTLITTERA T UR 229

Net present value (SEK)

1,200
1,000
800
600 ••••• •••
400 _:::~, · .. ···-. ..
200 welding machine
FIGURE 9.9
Graphic il lustration of the 0.05 0.1 0.15 0.2
Internal Rate of Return. -200
Decision rules for the Internal Rate of Return method
An investment that has an internal rate of return that is greater than the cost of capital interest
rate is profitable.
The investment alternative with the highest internal rate of return is the most profitable.
However, we see that the internal rate of return method case does not provide the
same result as far as ranking the two alternatives. Using this method, the manual
welding machine is more profitable than the welding robot, which is the opposite of
the conclusions reached under the net present value method and the annuity method!
This is consistent because the internal rate of return method is completely independent
of the cost of capital interest rate. However, as Figure 9.9 shows, the net present value
are equal at an interest rate of just over 25 % (the point where the curves intersect). At
this rate, the net present value method and the annuity method provide the same con-
clusion. At higher interest rate calculations, the manual welding machine is the better
choice, and at lower interest rate calculations, the welding robot is the better choice.
Thus, the internal rate of return method gives a different result, when comparing the
alternatives, than the other two methods. However, the results are the same as far a
whether an investment is profitable or not.
230 © THE A UT H O RS AND STUDENTLITTERAT I

Payback method
The payback method is the simplest of these investment calculations. According to the
ayback method, you simply determine the time it takes before the original investment
rs repaid (i.e., recovered). This period of time is called the payback period. As we have
already seen, the decision criterion is expressed as a requirement for the repayment
time (instead of as a required interest rate).
In our example, it takes two and a half years for both the welding robot and the
manual welding machine to repay their original investments. The payback period is
thus two and a half years for both alternatives; by this method, they are equally prof-
itable. However, the payback method does not tell us which (if any) of the alternatives
that should be selected.
The advantage of the payback method is its simplicity. The calculation is intuitive
and easy to understand. Therefore, it is a commonly used method. Another advantage
i that indirectly the method takes the investor's uncertainty and liquidity into account.
You only need be concerned with what happens to the investment before it is repaid.
Jn addition, the payback method points to the investment with the shorter repayment
period as the more profitable. A company can then use these funds to make other
investments. An interest rate is not needed to discount the receipts (cash in).
However, the simplicity of the payback method is also a disadvantage. Time prefer-
ence is expressed as the alternative that repays the investment the soonest, not by the
value of the future receipts calculated using an interest rate. Another disadvantage is
that the payback method does not deal with any considerations following the repay-
ment period. If the alternatives have different consequences after the payments (cash
out) are repaid, the payback method does not deal with these consequences.
Investment that has a payback period that is shorter than the required repayment time is
ble.
Investment with the shortest payback period is the most profitable investment.
231
Summary of the methods

TABLE 9.1 Summary of the various investment calculation methods.
Method Calculation Decision rules Advantages

Disadvantages
Net present All payments Profitable if net present value Explicit reference to time
value method discounted back is positive. preference in use of cost
to time zero by The higher the net present of capital interest rate.
using cost of capital value, the better. Doubtful with
interest rate. differences in economic
lives (in comparisons).
Annuity method All payments are Profitable if annuity is positive. Explicit reference to time
distributed equally The higher the annuity, the preference in cost of
over the economic better. capital interest rate.
life by using cost of Can be used with
capital interest rate. different lengths of
economic lives, if
continuous replacemen
is assumed.
Internal rate of Calculation of the Profitable if internal rate of Can give different
return method interest rate that sets return is larger than the cost of ranking of alternative
the investment's net capital interest rate. compared to the net
present value to zero. The higher the internal rate of present value method
return, the better. and annuity method.
Payback method Calculation of the Profitable if payback period is Simplicity.

time required to shorter than the required time.
recover investment. The shorter the payback
period, the better.
9.4 How is the required rate of return calculated?

Investment calculations are mathematically simple. None of the methods is particularly
complex. Moreover, the calculations are greatly simplified by the use of the pre ent
value and annuity tables, calculators, and computers. However, we should not be
deceived by the simplicity of the calculations.
One of the greatest difficulties in investment calculations involves the required rate
of return - that is, determining the cost of capital interest rate and the limit of the
acceptable payback period. How do we set the required rate of return for investment r
232 /ll THE AUTHORS AND ST UDE NTL I TT ERAT

To begin with, the cost of capital interest rate (i.e., the required rate of return used in
the net present value and annuity methods) in most companies is decided for relatively
Jong time frames, typically a year or two. If the cost of capital interest rate changes too
often,1·t 1·s difficult to compare investment requests made at the beginning of the budget
year with those request~ made later i_n the year. In practice,_ the number and amount
of investments are limited - many mvestments compete m the budget. Therefore,
whenever possible, the different investment alternatives must have the same condi-
tions independent of the time when they arise. To compare an investment proposal
made in February with one made in November, it must be assumed that the annual
mvestment budget is sufficient for all proposals that meet the required rate of return.
1hi assumption implies that the budget, which is prepared at the beginning of the
year, will be sufficient for all investment proposals even though they are unknown at
that point. Therefore, typically a template is used to calculate the cost of capital interest
rate, especially at industrial companies in which the investments are directly related to
their primary activities (e.g., new equipment, machinery, and marketing efforts). Thus,
the co t of capital interest rate can vary from company to company and from case to
case. Despite all this, there are still other factors that influence the size of a company's
cost of capital interest rate.
In ituations where the decision is whether or not to make a particular investment
e g., when comparing this investment with other investment alternatives), the cost of
capital interest rate (i.e., the required rate of return) is often determined by the type
alternatives. Sometimes all companies in the same industry use a common interest
nte that is based on international practice.
In reality, different investments are often evaluated using different costs of capital
intere t rates. For example, it is possible to differentiate between strategic investments,
,tlaptation investments, and rationalization investments. A strategic investment is bind-
ing on the company for a long time. Some examples are the investments required for
loping a product group, building a new production plant, or opening a new market.
adaptation investment, which is more a tactical investment, is made to ensure that
company can sustain its operations for a relatively long time. Some examples are
investments required for investing in a new manufacturing process or in new
inery. A rationalization investment is operational and is made to improve normal
tion . Some examples are the investments required for developing new work
ods and routines or eliminating bottlenecks in production. Typically, a lower cost
capital interest rate is used for a strategic investment than for an adaptation invest-
t. Similarly, typically the cost of capital interest rate for a rationalization investment
still higher. The forest industry example that follows explains this conclusion.
233
EXAMPLE
A small investment in an existing pulp and paper plant (that is, a rationalization investment) can
be very profitable. If, for example, the company can increase its operational capacity throughout
the entire manufacturing facility by eliminating a bottleneck in operations, then the investment
will most certainly be very profitable. Typically, an investment in a completely new manufacturing
process cannot compete with this rationalization investment. For this reason, a higher required
rate of return is used with a rationalization investment and a lower required rate of return is used
for a new manufacturing process.
For an investment in forests (a strategic investment in this industry), usually the discount rate
is even lower. Without the security of a supply of raw materials in the long term, the company
cannot use its production facilities profitably. In addition, forests are very long-term investments
for biological reasons. An investment in a large forest can almost never be measured against
either a short-term rationalization investment in an existing business or an adaptation investment.
Another distinction can be made between non-mandatory investments and mandatory

investments. Most examples so far have been in the first category (i.e., investments made
to improve financial results). An example of a mandatory investment is one required by
legislation. In such cases, a discount rate might not even be used because the company
has no choice other than to make the investment.
Clearly, interest rates provided by different investment alternatives, such as bank
interest rates or bond interest rates, affect the determination of a company's cost of cap-
ital interest rate. In the long term, a company cannot use a required rate of return for it
investments that is lower than bank interest rates. If a company's required rate of return
only equalled bank interest rates, what would be the point of operating a business? Put
simply, we can say that general interest rates in the economy have a strong impact on
a company's cost of capital interest rate. A high interest rate will drive a company's
cost of capital interest rate higher, and vice versa. The higher the cost of capital intere t
rate - that is, the higher the required rate of return - the fewer investment alternative
will seem profitable. As a result, the investment climate deteriorates. Higher intere t
rates also mean that a company's financing costs become higher, which is also reflected
in its choice of cost of capital interest rate.
In this discussion, of course we also have to consider the requirements of a com-
pany's investors (e.g., owners) as far as their required rate of return. A company that
borrows money and successively invests these sums at a rate of return that is lower tha
the interest rate on the borrowed money will be unprofitable over the long term. Th
company's investors will be less inclined to invest more money in the company in th
future . Thus, a company's required rate of return should at least equal its average co
of financing its investments and operations. However, it is quite difficult to calculat
234 © THE AUTHOR S A ND STUDENTLITTERAT

the company's average cost of capital exactly. One reason is that historic financing costs
are often poor predictions of current or future financing costs.
Because most companies try to finance their activities in the long term, they are
often disinclined to earmark certain funds for certain investments. This is true even
when general interest rates are low at the time the company plans to borrow for most of
a articular investment. The company will probably use a standardized cost of capital
i!erest rate to evaluate the investment. One reason is that the company can compare
different investments made at different times. Furthermore, it is very difficult, if not
impossible, to calculate the cost of the share of the invested capital that will be provided
internally by the company. Therefore, all financing costs, such as interest rates for loans,
are assumed to be included in the company's cost of capital interest rate.
Risks and sensitivity analyses

A key factor that influences the cost of capital interest rate is the investment's risk.
High-risk investments are evaluated using a higher cost of capital interest rate than
le ri ky investments. Usually, the cost of capital interest rate includes a risk premium
(i.e., it is set at a higher value than is technically necessary). In addition, inflation also
influences the cost of capital interest rate because future receipts decline in value in
inflationary times (compare with the time preference discussion above). A period of
high inflation will cause the cost of capital interest rate to increase and the amount and
number of investments to decrease. Normally, it is assumed that inflation is included
in the cost of capital interest rate. However, it is important to point out that inflation is
only one factor among many factors that influence the size of the cost of capital interest
nte. Even if inflation were zero, companies would still use a discount rate.
Finally, companies often use the cost of capital interest rate as a managerial pri-
ontization tool. Because of budgetary limitations, alternative investments must be
compared with each other. It is quite common that a company's investment proposals
mg from a rather low level in the hierarchy - from the employees who work directly
operations. However, investment decisions are typically made at a higher level, even
some cases at the Board level. A high cost of capital interest rate is thus a way to
ritize (even eliminate) investment proposals. If the cost of capital interest rate is
fairly high, then only the really profitable proposals will work their way up in the
rchy of investment proposals.
During the investment analyses, often some form of sensitivity analysis is conducted
that is, key components of the calculation are changed. For example, changes may
made in the receipts (usually the selling price of goods and services resulting from
investment), in the payments (such as the cost oflabor), or in the discount rate.
235
9.s Capital investment analysis in practice

Determining the required rate of return is not the only difficulty in making invest-
ment evaluations. In practice, the evaluations are much more complex than the mere
calculations suggest. How do we evaluate non-financial consequences? How do we
value payments/receipts in the distant future? How long is the economic life of the new
equipment we plan to procure? How does a particular investment influence the oppor-
tunities for future investments? The answers to these and other questions lie behind
our investment calculations; they may even be more important than the calculations.
Non-financial consequences
As we have already discussed in the context of investment risks, it is not uncommon to
be blind to investment consequences that cannot be measured monetarily (e.g., work
environment improvements, human resources development, and long-term research
efforts). Often there is a tendency to under-emphasize these consequences. However,
the very fact that we cannot measure them in numbers means they deserve special
attention. Thus, it is clear that the investment calculation is only part of the broader
investment evaluation.
Evaluation of future payments and receipts

Of course, there is a fundamental difficulty in evaluating the future payments and
receipts (several years in the future) related to a particular investment. The more distant
these amounts, the more difficult the task. It is here that the personnel with the mo t
experience should be involved. Although both payments and receipts are difficult to
predict and measure, future receipts are especially complex. Their calculation often
requires predictions about uncertain market conditions, new technologies, and so on.
In some cases, there is a relatively extensive body of data to refer to. Consulting firm ,
financial institutions, and international organizations, for example, are good source of
these data. Such support is often used in calculations where precision is a high priority.
Furthermore, it is often quite difficult to determine which payments and receipt are
associated with a specific investment. One example is the situation when a manufac-
turing firm invests in a new machine that is only one step in a series of manufacturing
steps. How do we know if the quality improvements in the product can be attributed
to this specific machine?

Additional investments and investment limitations

·ce it is often difficult to investigate which additional investments are required
Inprac t1 , . . . .
. e the potential of the ongmal mvestment. A company that acqmres a new
to ac hrev
. 1·ntended to eliminate manufacturing bottlenecks may later discover that a
111ac h me
bottleneck has now appeared in another place in the production system, reducing the
benefits of the new machine. In other situations, problems with peripheral equipment,
commissions, or employee training may be overlooked.
It is the nature of investments that they create opportunities at the same time that
the limit other opportunities. For example, new limitations may pop up when a man-
ufa~turing company establishes a new assembly plant. The plant location may be in
1 country with special laws and regulations. Or the plant, with limited capacity, may
require additional investments. And so on. As an example, the acquisition of a new
paper machine, which might co~stitu~e-the ~latform for a ~trategic chang~ by a pulp and
paper company, is usually a maJor ongmal mvestment with a very long life. Thus, such
an investment will limit the opportunities for making other investments. Because this
the natural result oflong-term investments, it is crucial that managers investigate all
aspect of investments when they compare various investment alternatives.
1bt chapter has looked at investment analysis, that is, analysis of a capital investment
that has payment consequences over an extended period of time. It is important to
distinguish between the investment analysis and the actual investment calculation. The
tment calculation quantifies the payment consequences that the investment entails
r the company. The investment analysis is more comprehensive. In addition to the
calculation, the analysis also considers issues other than those that can be quantified.
In other words, investment calculations only look at payments (cash in) and receipts
h out), not costs or revenue. In order to make an investment calculation, the eco -
nomic life needs to be determined, that is, the time period until the investment has
hed maximum profitability. When it comes to physical investments it is impor-
t to separate economic life from technical life, which refers to the functional time
the object.
Another fundamental question is to establish the company's required rate of return
the investment. The required rate of return is expressed in terms of a cost of capital
t rate or by specifying the longest acceptable payback time.
The investment calculation analyzes the original investment, which is made "today",
the future cash inflows and outflows of the investment during its economic life.
most common calculation methods are the net present value method, the annuity
od, the internal rate of return method, and the payback method.
AUTHORS AND STUDENTLITTER AT UR 237

The net present value method means that the value of the investment today_ pres-
ent value - is calculated by discounting all receipts and payments, that is, they are
recalculated using a predetermined cost of capital interest rate to get their estimated
present value. If the discounted payments exceed the original investment it means that
the investment is profitable at the current cost of capital interest rate. By comparing
different net present values, the company can rank different investments. The inve t-
ment with the highest net present value is the best alternative.
The annuity method means that all payment consequences of an investment alterna-
tive are divided into equal annual amounts using the current cost of capital interest rate.
When comparing different investment alternatives, the one with the highest annuity
is the best alternative.
The internal rate of return method is really the same as the net present value method
but instead of calculating the net present value, the interest rate at which the net presen;
value of the investment is zero is calcuated. This interest rate is called the internal rate of
return of the investment. The order of priority between the investment alternatives may
differ between the internal rate of return method and the net present value method/
annuity method.
In the payback method, you determine the time it takes for the cash receipt surplu
(the difference between receipts and payments) of an investment alternative to equal the
original investment. This period of time is called the payback time of the investment.
Determining the required return and the economic life are two challenges facing
all investment analyses. Other challenges are that usually there are consequences that
cannot easily be quantified and that, for natural reasons, it is difficult to determine the
size of receipts and payments that are expected several years ahead.
References
Armerin, F. & Song, H-S. (2014). Investeringsbedomningens grunder: fran traditionella
metoder till realoptioner. Studentlitteratur.
Ax, C., Johansson, C. & Kullven, H. (2011). Den nya ekonomistyrningen med eLabb. Liber.
Bergknut, P., Elmgren-Warberg, J. & Hentze!, M. (1993). Investering i teori och praktik.
Studentlitteratur.
Ljung, B. (1999). Investeringsbedomning: en introduktion. Liber.
Nilsson, S-A. & Persson, I. (1999). Investeringsbedomning. Liber.
Olsson, U. (1998). Kalkyleringfor produkter och investeringar. Studentlitteratur.

············· ......................................................................~
~
ACC OUNTING
nyevents in which a company interacts with its environment can be accounted

as financial transactions. Such events include purchases (e.g., raw materials,
lies, or services), salary payments to employees, sales of goods and services,
k deposits, loans, and so on. These are events that must be recorded in the
pany's record-keeping system. This system uses various rules and standards
systematically record financial transactions in order to provide information
ut the company and its operations. This chapter is focused on accounting as
I as on the basic rules and principles of bookkeeping.
10.1 What is bookkeeping?
There are two main reasons why companies and other organizations are required to
ord all their financial transactions. Firstly, recording these events allows a company
monitor its financial situation on an up-to-date basis. Secondly, recording these
mot provides protection (as well as information) for a company's stakeholders (e.g.,
owner , customers, suppliers, government agencies, etc.). For example, suppliers are
rested in a company's ability to pay for goods and services; potential and current
itors are interested in evaluating whether given loans will be repaid; owners are
re ted in the return on their investments; tax authorities are interested in whether
company has paid its payroll taxes, VAT, and corporate income taxes.
Bookkeeping is a system that uses various rules and standards to systematically
rd financial transactions monetarily. The term bookkeeping is used to describe the
process of recording, classifying, and valuing these events; the term accounting
used to describe the process of analyzing, interpreting, and communicating these

PART 11 1 • THE FINA NCIAL SYSTEM
events. However, although the two terms are often used interchangeably, accounting
takes a more analytical perspective on the results that bookkeeping produces (e.g., the
annual financial statements).
Bookkeeping and accounting thus provide stakeholders with information about the
financial status of the company and how it is managed. The bookkeeping/accounting
records and financial statements must therefore comply with the governing principles,
practices, and laws.
Bookkeeping requirements
The bookkeeping requirements include:
to maintain a current record of financial transactions so that they can be presented

chronologically in the Journal (also called the day book) and systematically in the General
Ledger
to ensure that written documentation supports all bookkeeping entries
to archive these financial records properly and safely for specific time periods (these periods
vary by legal jurisdiction; in Sweden, the time period is 7 years)
to prepare the annual financial statements or annual report.
In Sweden, according to the Swedish Bookkeeping Act, a company generally has the
following obligations [translated]:
• to maintain a record of all financial transactions
• to ensure that vouchers (supporting documentation) exist for all bookkeeping
entries, and that the system documents the historical record of such entries
• to maintain all accounting information and the equipment/systems needed to
present this information in the required form
• to prepare a balance sheet and to end the accounting period according to required
procedures.
Current recording of transactions

The current recording of transactions means recording the financial transaction that
take place between two year-end closings. During a fiscal year, the company's financial
transactions have to be recorded systematically. This means that the transactions mu t
be recorded in various types of accounts. For many companies, such transaction
occur many times a day (e.g., purchasing of material which subsequently mean that
an invoice is received). Figure 10.1 shows an example of a typical invoice in Sweden.
240 © T H E A UTHORS AN D ST UDENTLITTERAT

CHAPTER 10 • ACCOUNTING
STORVIK [ Faktura
FINMEKANIK Faktura nr/Kund nr Fakturadatum
3332 50208 2017-01-07
Leveransadress Fakturaadress
CONSTELLATION AB CONSTELLATION AB
Bulevligen 1 Box 134
bSTERBYMO 570 60 OSTERBYMO
Er referens ANDERS LARSSON var referens SVEN AXELSSON

Er order Var order
Lev villkor Bet villkor 15 DAGAR NETTO

Lev satt FOrfallodatum 2017-01-22
DrOjsmAlsranta 17,00%
Art nr Ben3mning Antal Enhet A pris Rabatt Summa
77125 Hallare till styrenhet 2000 40,00 80 000,00
1 etto Moms % Momspl belopp Moms kr ATTBETALA

0000,00 0,00 25 80 000 ,00 20 000 ,00 100 000,00
Telefon Plusgiro Org nr

0381-123 45 98765-4 05 1234567890 FIGURE 10.1
Telefax Bankgiro A typical invoice for the
570 60 OSTERBYMO 0381-234 56 987-6543 lnnehar F-skattebevis
purchase of materials by a
mid-size Swedish company.
241
Invoice requirements per Swedish law
According to law, an invoice (supporting voucher) must include, among other things, the
following:
date of invoice
customer details
date of delivery
description of goods/services delivered (specification)
total amount.
SOURCE: SWEDISH TAX AGENCY
In bookkeeping terminology, an invoice received is the written, supporting voucher,

or evidence, that supports the company's payment for a good or service. The invoice
provides proof of the specific financial transaction. Other verification documents are,
for example, purchase receipts, lease contracts, and bank statements (the latter verifies
interest revenue received/paid in a certain time period). All such documents should be
filed chronologically and numbered so that they can easily be retrieved as evidence for
a bookkeeping entry. In Sweden, there are laws that specify how these records should
be maintained.
Invoice requirements per VAT laws
The invoice requirements in Sweden regarding VAT are also regulated by law. According to the
laws for VAT, an invoice must contain at a minimum the following information:
a unique serial number

the seller's VAT registration number
the seller's and purchaser's name and address
the quantity and type of goods and/or services delivered
the price of the goods/services before VAT
the applicable VAT rate(s)
the VAT due.
SOURCE: SWEDISH TAX AGENCY
The idea behind these laws is to facilitate the tracking of all financial transaction
so that it is possible to go back and see what was done, by whom, and in what con-
text. The underlying purpose, of course, is to protect a company's creditors and other
stakeholders, and to ensure that the financial information provided to the tax author
ities is accurate.
242 © THE AUTHORS AND STUDENTLITTERAT

curre nt accounts and vouchers (Chapter 5, Swedish Bookkeeping Act)

[transl ated/summarized]
vouchers:
Paragraph 6 - Every financial transaction must be verified by a supporting invoice.
Paragraph 7 - The invoice shall contain all required information, including invoice number, details
of the business event, terms, etc.
Paragraph 8 - Relative to Paragraph 7, information may be omitted (if there are difficulties), and
the omission is consistent with good accounting principles.
Paragraph 9- Revised/corrected invoices must give full and applicable details.
When an invoice is received, the invoiced amount is coded and entered in the bookkeep-
ing system. The invoice is coded with the relevant account numbers and the amounts
are allocated to each account. In the double-entry bookkeeping system, at least two
accounts are involved for every bookkeeping entry: a debit account and a credit account.
In addition, the account numbers, cost centers, and invoice approval are entered.
As an example, we can use the invoice data from Figure 10.1 to make a bookkeeping
entry in the Journal, as shown in Figure 10.2 where we see a printed table with three
rows and five columns. The three rows represent the financial event as shown on the
upplier's invoice. Using bookkeeping terminology, we can state the following: (1) SEK
8o,ooo is debited to account Material purchase for the purchased materials; (2) SEK
20,000 is debited to account Input VAT for the VAT (bookkeeping for VAT is described
in Section 10.5); (3) SEK 100,000 is credited to account Accounts payable (not to a cash
account because at this point the invoice has not been paid). In the following section,
we explain the basic bookkeeping concepts.
Amu1t Cost center Approval Debit Credit

Material purchase 80,000
Input VAT 20,000 FIGURE 10.2

Coding table of the invoice
Accounts payable 100,000
received.
A THORS AND STUDENTLITTERATUR 243

10.2 T-accounts and double-entry bookkeeping

The voucher, i.e., the invoice received, is in this case recorded in three different accounts.
Account Material purchase is used to record the expenditure for materials purchased.
Account Input VAT is used to record the amount of VAT the supplier is required to
charge (in Sweden, 25 % of the materials cost). Account Accounts payable is used to
record the liability (money owed to the supplier). We will return later to the system for
structuring the accounts.
Every entry in bookkeeping has two sides: a debit side and a credit side. Therefore,
the descriptive term is a T-account, as shown in Figure 10.3.
The invoice is recorded using the double-entry bookkeeping system. This means,
for every financial transaction, the total of the amounts on the debit side must equal
the total of the amounts on the credit side. Compare this rule with the bookkeeping
entries in Figure 10.2.
In Figure 10.2, materials and VAT are debited for a total of SEK 100,000, and the
liability to the supplier is credited for a total of SEK 100,000. The reason for coding
the financial transaction in this way relates to the structure of the General Ledger
accounts. There are two principal groups of accounts: balance sheet accounts and income
statement accounts. The accounts for assets, owners' equity, and liabilities are balance
sheet accounts. The accounts for income and expenditures (sometimes referred to as
revenue accounts and cost accounts) are called income statement accounts.
T-account
Debit Credit
FIGURE 10.3 T-account.
244 () T H E A UTH O RS AND STUDENTLITTE~AT

EXAM PLES OF ...
... assets: Intangible assets (e.g., patents), land and buildings, machinery and equipment,
financial assets (e.g., leases and investments), inventories, accounts receivable
from customers, cash in bank, and cash on hand.
. . . liabilities: Accounts payable to suppliers, bank loans, taxes payable, and bank overdrafts .
... income: Sales, interest, and royalties .
. . . expenditure: Materials, salaries, rents, repairs, work supplies (e.g., work clothes), office
supplies, and travel expenses.
All these categories have one or more accounts in the standard chart of accounts BAS, that is used
by many Swedish companies. It is also worth noting there are many more expenditure accounts
than income accounts.
The principal rules for the various accounts are as follows:
• asset accounts are increased with debits; that is, a debit to an asset account
represents an increase in amount
• liability accounts are increased with credits; that is, a credit to a liability account
represents an increase in amount
• income accounts are credited (except for, e.g., corrections)
• expenditure accounts are debited (except for, e.g., corrections).
There are a number of memory tricks you can use to remember these rules. One way is
to learn how a particular account (e.g., Cash) works. Then you can use this knowledge
to remember how other accounts work. First, Cash is an asset account and increases
with debits. We know that the rule for liabilities is the opposite (liabilities increase with
credits). If a company receives income in cash we debit (increase) the Cash account
and we credit (increase) the same amount to an income account. An expenditure paid
in cash works the opposite way: we credit (decrease) the Cash account and we debit
increa e) the same amount to an expenditure account. See Figure 10.4 for an illustra-
tion of the bookkeeping rules using T-accounts.
AUTHORS AND STUDENTL I TTER A TUR 245

Balance sheet accounts

Asset accounts Liabilities accounts
Increased by Increased by
debits credits
(
Income statement accounts

Income accounts Expenditure accounts
FIGURE 10.4
Principal accounting Credits Debits
rules for various account
categories.
If we compare these accounting rules with our invoice example, we see they agree with
how we record invoices. In the invoice example, it is clear the company has purchased
materials - expenditures until the materials are consumed and sold (as cost of good
sold). The VAT is recorded as an asset, since the government owes the company the
input VAT. (For practical reasons, the account for input VAT is classified as a liability
account - see Section 10-4.) Finally, we owe the supplier for the total sum. Figure 10_5
uses T-accounts to illustrate the transaction.
Input VAT Accounts payable

Material purchase
(liabilities account) (liabilities account)
(expenditure account)
FIGURE 10.5 Materials:
Materials: Materials:
Accounting for recording SEK 20,000 SEK 100,000
SEK 80,000
the invoice.
If an invoice is correct, it is paid. If the invoice appears incorrect, it must be que -

tioned. The individual who approves the invoice also verifies that the delivery of the
goods/services stated on the invoice is correct. Payment of an invoice is handled a
a separate event. Typically, when a company pays an invoice from its bank account,
two bookkeeping events occur. The amount in the Cash in Bank account (an asset) i
reduced by the amount paid, and the Accounts Payable account (the liability) to the
supplier is reduced by the same amount. Figure 10.6 illustrates the payment of the
invoice from our example.
Accounts payable Cash in Bank
FIGURE 10.6
Payment:
Payment:
SEK 100,000
Accounting for paying the SEK 100,000
invoice.
© THE AUTHO RS AN D ST U DENTLiTTERAT

246
Making corrections
When a mistake is made in the bookkeeping, a correction is required. The general
intention is that the correction should not eliminate the previous (incorrect entry or
entries) so that it remains possible to determine afterwards who made the correction
and why it was made.
A correction is made that reflects the actual financial transaction. The correction
is made in two steps: (1) reversing the incorrect entry and (2) recording the correct
entry. In this way, a trail of the bookkeeping events is maintained. The correction
is made by simply changing the debit in the original transaction to a credit (or vice
versa). Thus, the erroneous coding, so to speak, is corrected, after which you can post
the transaction correctly.
Why do we use double-entry bookkeeping?

If a company uses double-entry bookkeeping and follows the rules outlined above for
the different account categories, the result will be an elegant description of the financial
events of the year and the financial position (i.e., assets and liabilities) at the end of the
year. Two financial statements prepared at the year-end are the balance sheet and the
income statement. The balance sheet is a snapshot of the company's financial position at
certain point in time (e.g., the last day of the accounting year). The income statement
presents the revenues and costs for the year. Figure 10.7 illustrates these two statements.
(loss)= Change in assets - Change in liabilities (see the balance sheet)
Income statement Balance sheet
Costs Revenues Assets

(expenses) Profit
-
FIGURE 10.7
Profit Liabilities
Diagram of the company's
income statement and
balance sheet.
AUTHORS AND STUDENTLITTE RA TUR 247

Thus, a company's profit appears both on the balance sheet and on the income state-
ment. The difference between the revenues and costs is the year's profit (or loss if costs
exceed revenues). Or, from another perspective, the company's profit (or loss) is the
difference between the change in assets and the change in liabilities during the year. If
assets have increased more than liabilities, the comp,a ny has made a profit; ifliabilities
have increased more than assets, the company has sustained a loss. If the rules of
double-entry bookkeeping are followed, the financial transactions will be recorded
properly. The financial result in both statements must be the same.
Closing the accounts and preparing the annual financial

statements
In practice, company revenues and costs are reconciled and closed at the end of the
fiscal year (large companies, especially publicly listed companies, also prepare quarterly
or interim financial statements). This procedure is called closing the books or year-end
closing. This means the company determines its total revenues and total costs for the
year as well as the totals of its assets and liabilities on the closing date (e.g., the last day
of the fiscal year). At this point, the current accounts are closed. A simple way to think
about this is that the current accounts are closed against two summary accounts: the
Income statement (IS) and the Balance sheet (BS). All income statement accounts (i.e.,
income and expenditures) are closed to zero, and their difference is transferred to the
Income statement account. The totals of balance accounts (i.e., assets and liabilitie )
are calculated, and the difference in each account is entered in the Balance sheet. As an
example, consider how the Cash in Bank account (from above) is calculated. We mu t
state that the single financial transaction in our example would, in reality, have been
only one of many transactions. In reality, numerous transactions are recorded in the
Cash in Bank account during the year. Assume, then, that the Opening Balance of the
Cash in Bank account was SEK 1,000,0 0 0 (as the result of many previous transactions).
See Figure 10.8.
The sum on the debit side is SEK 1,000,000 and the sum on the credit side is the
payment of SEK 100,000. The difference (SEK 900,000) must be carried to the credit
side of the account so that it balances (see Figure 10.9). The account is an asset account
(money that the company has in the bank must naturally be an asset), and therefore it
Cash in Bank
Opening balance: Invoice payment:

SEK 1,000,000 SEK 100,000
FIGURE 10.8 The Cash in Bank account before closing.
248 ,;:, THE AUTHORS A N D STUDENTLITTERAT

CHAPTER 10 • ACCO UNTING
Balance sheet Cash in Bank
Cash in Bank: Opening balance: Invoice payment:

SEK 900,000 SEK 1,000,000 SEK 100,000
Balance sheet:
SEK 900,000 FIGURE 10.9
The Cash in Bank account is
Total: SEK 1,000,000 Total: SEK 1,000,000 closed to the Balance sheet.
is closed to the Balance sheet. As the Cash in Bank account is credited, so then is the
Balance sheet debited.
All other accounts are closed in the same way, which means that all income state-
ment accounts (i.e., the income and expenditure accounts) are closed to the Income
statement, and all balance sheet accounts (i.e., the asset and liability accounts) are closed
to the Balance sheet. This is illustrated in Figure 10.10.
Finally, the Profit and Loss account and the Closing Balance account are closed. The
difference between the total debits and total credits for each account, as the result of
the double-entry bookkeeping, must equal. If the difference is a credit for the Closing
Balance account, the company has made a profit for the year; if the opposite is true,
the company has sustained a loss for the year. The number that balances (total debits
= total credits) for both accounts is the year's profit or loss. In our extended example,
there is a profit of SEK 843,000 (see Figure 10.n).
From the presentation shown in Figure 10.n of the company's assets and liabilities
and its revenues and costs, we recognize the principal features of the balance sheet and
the income statement that were presented previously in the chapter (see Figure 10.7).
The difference between the debits and the credits constitutes the year's profit. We can
see that the year-end balances of both sets of accounts are equal (debits= credits), and
thu that the bookkeeping follows the principles of double-entry bookkeeping.
Balance sheet accounts Income statement accounts

(1) When a company's
Liabilities accounts Expenditure accounts Income accounts accounts are closed,
the debits and credits
are totaled for every
account.
(2b) The difference between

the income and expenditure
accounts is transferred to the FIGURE 10.10
Income statement.
Closing of the company's
(3) The Balance sheet and the Income statement accounts to the Balance
are totalled as a debit or credit as the company's sheet and to the Income
profit is calculated.
statement.
249
PART Il l • TH E FINANCIA L SYSTE M
Balance sheet
Assets SEK Liabilities & Equity

SEK
Buildings 3,025,000 Share capital 500,000
Machinery 2,312,000 Statutory reserve 100,000
Inventory 2,017,000 Balance carried forward 3,944,000
Accounts receivable 3,570,000 Profit for the year 843,000
Cash in Bank 900,000 Bank loans 4,000,000
Cash 347,000 Customer advances 400,000
Accounts payable 2,011,000
VAT 373,000
Total 12,171,000 Total 12,171,000
Income statement
Costs SEK Revenue SEK
Purchase of goods and material 3,736,000 Net sales 9,080,000
Facility costs 17,000 Other operational revenues 212,000
Energy cost 480,000 Interest revenues 47,000
Office consumables 43,000
Telephone and postage 125,000
Salaries 3,082,000
Depreciation 678,000
Other operational costs 40,000
FIGURE 10.11 Interest costs 295,000
Closing Balance and Profit/ Profit 843,000
Loss accounts. Total 9,339,000 Total 9,339,000
In practice, most companies today use bookkeeping software that automatically gener-
ates the income statement and balance sheet. In the year-end financial statements these
are presented according to the Bookkeeping Act (in Sweden). The accounts presented
in the simplified figure are organized in the order specified by this law. The design of
the financial statements, and related rules, are described in more detail in Chapter 11.
10.3 Systematic order of the accounts

As described above, usually a company's accounts are classified in four groups: a sets,
liabilities, income, and expenditures. This classification is further refined to create a
detailed structure for revenues and costs. Most Swedish companies use a standardized
chart of accounts called BAS 2017 that is updated annually (see http://www.bas.se).
In the example in this chapter, we use account names/classifications from this chart
of accounts. The advantage of applying the chart of accounts is that it lists standard
250 10 TH E A UT H ORS A N D STUDENTLITTERATUl

mes numbers, and classifications. With minor adjustments, most busi-

coun t na '
sociations, and government agencies in Sweden can use the BAS chart of
ne ses, as
and most software accounting programs in Sweden support the BAS chart of
accoun ts ,
In addition, most textbooks use this account structure as their starting point.
accou nts ·
B the use of such a standardized chart of accounts, a Swedish company meets the
1egairequirements on the externa~ ~nancial accounting. In add~tion'. the use of the
tandardized chart of accounts facilitates managament accountnmg, 1.e. the internal
use of the accounts as data sources for cost calculations and other analyses. However,
there are no legal requirements for such internal usages.
Systematically and chronologically

ccording to the Swedish Bookkeeping Act, all financial transactions should be
counted for systematically and chronologically. Use of the Journal (in which trans-
actions are recorded in a sequence according to time of occurrence) meets the chron-
ological requirement. Use of the General Ledger (in which transactions are sorted by
account) meets the systematic requirement. The year-end results, when the balance
meet and income statement are prepared, are recorded in the Annual Accounts Book
Figure 10.12).
ormally, the Journal and the General Ledger are not separate records. In very
pie accounting, for example a cashbook (often referred to as the column diary),
each column is an account and each row a transaction (see Figure 10.13). The column
diary atisfies both the systematic and chronological requirements.
Today, nearly every company, even small companies, uses a bookkeeping software
program that simplifies the arithmetic calculations of bookkeeping. In a computer-
besed bookkeeping system, every invoice is a separate entry. These records have approx-
Voucher------+ Journal ------> General Ledger----+ Annual Accounts Book
Voucher: 99 Date Account

Income statement
January S, 2016 1.1.2016 1030
.• _..,,-,..:! Costs Revenues
2.1.2016 1039
3.1.2016 1960 0
,' :
4.1 .2016 . -· • 1069 Profit
i--s_.1_.2_01_6_-+-~--
-·-· _·:., ,_-_-J-·ee.-1_1~1o_ _.,___ _
·-·..
::--\--~ Balance sheet
Assets
SEK 12,SOO • • - -· Liabilities &
Equity
FIGURE 10.12
Profit Principal fo rmats fo r
double -entry bookkeeping.
AUTHORS AND STUDENTLITT ERA TUR 251

PART Ill • THE FINANC IAL SYSTEM
Cash Cash in Bank Sales Material Salaries Other

Date
(debit) (credit) (debit) (credit) (credit) (debit) (debit) (debit)
January 7, 2017 100 '-- 100
January 10, 2017 7,200 7,200
January 15,2017 1, 100 1,100
FIGURE 10.13
Column diary.
imately the same information fields as an accounting table (see Figure 10.2). See also
Figure 10.14 for an example of an entry in a simple bookkeeping system.
A computer-based bookkeeping system can sort the financial transactions both
chronologically and systematically (i.e., in the same way as the Journal and General
Ledger). Such programs can often perform other functions, for example, year-end
closing, preparation of financial statements, and VAT calculations. They can also link
to the company's other financial systems.
Transaction date Recording date

IJanuary 7, 2017 IJanuary 7, 2017
Specification
I Purchase of materials
Line Account Description Debit Credit
2440 Accounts payable 700,000.00

2 4010 Material purchase 80,000.00
3 2641 Input VAT 20,000.00
4
FIGURE 10.14 Difference: 0.00 Total: SEK 100,000.00 SEK 100,000.00

Bookkeeping entry.
252 © THE AUTHORS A ND STUDENTL ITTERAT

10 .4 Bookkeeping for VAT

VAT (value added tax) is a government tax on the value added that goods and services
provide to the purchaser. Companies in Sweden and in most EU countries are required
to add VAT (a nationally mandated percentage of the sales price) when they sell goods/
services. In turn, companies can deduct the VAT from the total cost of goods/services
they purchase. Thus, a company pays VAT to the government only on the difference
between the input and the output VAT. Therefore, VAT is assessed at every step in the
value creation process.
VAT in EU
The main rule is that VAT will be added on the sales price when a product in Sweden is sold and
transported to a buyer in another EU country. However, it is possible to sell without adding VAT to
1 buyer in another EU country if that buyer is VAT-registered in that country. The buyer shall then
report and pay the VAT in the other country. EU countries mean countries within the EU's VAT area.
OURCE: SWEDISH TAX AGENCY [TRANSLATED]
In Sweden, the VAT percentages vary with the types of goods or services the company
j elling. Three percentages are used (2015): 6 %, 12 %, and 25 % (which is added to the
ba ic sales price).
Four separate accounts are used for recording VAT in BAS 2017, three accounts for
output VAT (one for each percentage rate) and one for input VAT.
The VAT paid for a purchased product is called the purchaser's input VAT. As in our
example, the input VAT is recorded as a "negative liability" (i.e., on the debit side of a
liability account). In other words, input VAT is a form of asset that the tax authorities
are required to refund. When a product is sold, the VAT paid to the seller by the
purchaser is called output VAT, which is recorded as a liability to the tax authorities.
If a company has more output VAT than input VAT, it pays this difference to the
tax authorities. If input VAT instead exceeds output VAT, the company may deduct
thi amount in its tax return. In other words, input VAT is deductible for companies.
Of cour e, this rule does not apply for expenses that are not deductible, for example,
certain representation expenses. Moreover, private individuals (the end-consumers)
always have to pay VAT for the goods and services they purchase and are, in practice,
the ones who in the end pay the VAT.

VAT bookkeeping
A company that buys goods/services (without immediate cash payment) records the following:
a debit to an expenditure account (e.g., Material purchase)

a debit to a VAT account (Input VAT)
a credit to a balance sheet account (e.g., Accounts Payable - trade).
A company that sells goods/services (without immediate cash receipt) records the following:
a credit to an income statement account (e.g., Sale of goods)

a credit to a VAT account (Output VAT)
a debit to a balance sheet account (e.g., Accounts Receivable - trade).
10.5 Accurate bookkeeping is not easy in practice

In theory, bookkeeping is a rather simple system to keep a record of the money asso-
ciated with a company's financial transactions. By following the bookkeeping rules,
a company can create a comprehensive structure for recording all kinds of revenues,
costs, assets, and liabilities. In practice, however, it is the comprehensiveness of thi
structure that makes bookkeeping difficult.
Often someone in the company wants to know the cost of a particular resource. Or
someone needs information for product costing or investment decisions. The source
of such information is generally the bookkeeping records, where all the revenues and
costs have been recorded. For example, when recording an invoice, someone mu t
decide which accounts to use. This decision means that the way the actual activity of
recording is done has a significant impact on how various costs are officially reported.
Typically, many individuals are involved in the different steps of the bookkeeping
process. Therefore, there is ample room for misunderstandings and misinterpretation
in classifying financial transactions and in the choice of accounts.
Summary
This chapter has looked at the two closely related concepts accounting and bookkeep-
ing. Bookkeeping usually refers to the actual work of keeping accounting records, while
accounting usually refers to the final products of bookkeeping (e.g., the annual report).
Companies need to keep an ordered record of their business activities in order to
maintain control of the company's financial situation and to protect various stakehold-
ers with economic interests in the company by providing insight into the company'
operations. The bookkeeping and accounting records must therefore comply with the
governing laws and practices in the field.
254 © THE AUTHORS AND STUDENTLiTTERAT

Current recording of transactions means that the company systematically records

all business events that take place during the financial year. The intention is for the
company's financial events to be traceable so that you can go back and see what has been
done, by whom, and in which context. When the company receives or sends an invoice,
it is assigned an invoice number and the amounts are recorded on the proper accounts
in the accounting plan. There are four types of accounts: assets, liabilities, income,
and expenses. Through double-entry bookkeeping, business events are recorded by
crediting at least one account in the accounting plan and debiting at least one account.
When the financial year has ended, the company prepares annual financial state-
ments. This means that the company reconciles the books and determines the total of
its revenues and costs during the year, as well as its total assets and liabilities at the end
of the year. The result of the year is also calculated. In connection with the financial
statements, the company's input VAT, i.e., the VAT paid when making purchases, is
deducted against its output VAT, i.e., the VAT that the company receives on its sales. If
the company has a surplus of output VAT, it needs to be paid to the tax authorities. If the
company instead has a surplus of input VAT, the amount is deducted in the tax return.
References
Broberg, A. & Lunden, B. (2017). Bokforing. Bjorn Lunden information.
Heden triim, E. & Malmquist, H . (2015). Redovisning och bokforing - med utgangspunkt i
BAS-planen. Studentlitteratur.
Johansson, R., Ridderstriim, C. & bstgren, C. (2013). Bokforingfran borjan,Jaktabok. Liber.
Marton,)., Sandell, N. & Stockenstrand, A-K. (2016a). Redovisning: fran bokforing till analys.
tudentlitteratur.
Marton, J., Sandell, N. & Stockenstrand, A-K. (2016b). Redovisning: fran bokforing till analys:
ovningsbok med fullstiindiga losningar. Studentlitteratur.
Tullgren, S. (2008). Bokforing & bokslut - grundkurs. Studentlitteratur.

L
········ ·
..............................................................................~
~
FINANCIAL ACCOUNTING
All companies and organizations are required to prepare an annual report in

order to provide external stakeholders with information about their annual
results and financial position. Based on the annual report, it should be possible
to determine if a company is profitable, if it can pay its bills, if it can repay its
lenders, if the company has paid its taxes, and so on. This chapter describes how
companies prepare the financial statements in their annual report (income state-
ment and balance sheet) based on their accounts, and discusses how to interpret
these financial statements. The chapter mainly describes rules and procedures
that apply to large limited liability companies but the same principles apply to
most other companies and organizations as well.
t companies are required by law to prepare an annual report, also called annual
~ncial statements, at the end of each year. The annual report typically consists of an
acome statement, a balance sheet, and an administration report (management report).
ether, these documents report on the company's annual results and its year-end
cial position. Attached to the annual report is the independent auditor's report that
rts on the external examination of the company's annual report and on company
gement by the Board of Directors and the Managing Director (also referred to as
CEO, ChiefExecutive Officer).
Through financial accounting, the company determines a financial result (profit or
) for a certain period as well as the financial position at the end of that period. The
and principles that govern financial accounting, prevents resources from being
ed from the company in an irregular fashion without anyone noticing. This
reason why an external, independent auditor examines the accounts and the
257
PART I l l • TH E FI NANCIAL SYSTEM
Civil laws Accounting principles

Bookkeeping Act FAR (Swedish Institute of Authorized Public
Companies Act Accountants) '--
Annual Accounts Act BFN (Swedish Accounting Standards Board)
Economic Associations Act Swedish Financial Reporting Board
(formerly, Accounting Council)
Taxation laws
Municipal tax law
Financial Analysis
Balance sheet Balance sheet

Income statement Income statement
FIGURE 11.1 Administration report
Laws governing companies' Cash-flow analysis
financial accounting. Auditor's report
financial statements. After this examination, the independent auditor issues a report
on the fair presentation (according to generally accepted accounting principles) of
this information.
Thus, financial accounting is mainly directed at external stakeholders such a
shareholders, suppliers, customers, financiers, governmental authorities (e.g., the tax
authorities), and the general public (see Figure 11.1). The boundary between financial
accounting and management accounting (described in Section 13.3), however, is fluid.
The current recording of transactions provides input for both. Furthermore, financial
accounting is often used in management accounting as well. This situation is particu-
larly common in smaller companies that sometimes only maintain financial account .
Unlike management accounting, financial accounting is regulated by law. In Sweden,
these laws are the Annual Accounts Act, the Bookkeeping Act, the Municipal Tax Law,
the Companies Act, and the Economic Associations Act. These laws govern financial
accounting, bookkeeping, taxation, and so on. Moreover, common practice that ha
developed over time regarding these activities is also important. This is called "good
accounting practice" as determined by the professional association Swedish Institute
ofAuthorized Public Accountants (FAR). Recommendations from, among other , the
Swedish Accounting Standards Board (BFN) and the Swedish Financial Reporting Board
are also important.
A fundamental principle behind these laws, principles, and practices is that society is
based on the economics of business and trade. Therefore, it is essential that accounting/
auditing laws, principles, and practices support these activities. For the benefit of all
society, people must be able to trust one another. Society as a whole suffers when tacit
258 c, T HE A U T H O RS A ND STUDENTLITTE~AT
CHAPTER 11 • FINANCIAL ACCOUNTING
Balance sheet
Assets Liabilities
& Equity
Valuation of assets FIGURE 11 .2

according to tax laws Civil law and tax law have
different objectives. In the
diagram, for illustrative
-i--1--Least "allowable" purposes, the company's
Profit
+--------+-------, profit profit appears farthest
Valuation of assets : : :- ---Most "allowable" down on the liability side of
according to civil laws_____ _:_ _____ __________ _L_ ______________ L___ _1:xofit the balance sheet.
of trust undermines people's willingness to invest in companies, deliver goods and

services, and lend money.
Civil law and tax law, to some extent, have conflicting objectives with respect to
financial accounting (see Figure 11.2). The main objective of civil law (e.g., the Annual
Accounts Act, the Companies Act, and the Economic Associations Act) is to protect
owners, lenders, suppliers, customers, and other stakeholders from the possibility that
1 company will over-state its earnings and financial position. The objective of the tax
law (primarily the Municipality Tax Law) is to protect society from the possibility that
a company will under-state its earnings and thus under-pay its taxes.
Business can be conducted under different legal forms. The most important cor-
porate legal form in Sweden is the limited liability company. In principle, all large
companies (in Sweden and elsewhere) are limited liability companies. When a limited
liability company is started, the capital that the owners invest is converted to the com-
pany's share capital. The share capital thus constitutes the foundation of the company's
equity, i.e., the capital that belongs to the owners This chapter mainly describes rules
and procedures that apply to large limited liability companies but the same principles
apply to most other companies and organizations as well.
.2 The annua l financial statements - balance sheet and

come statem ent
first tep in the preparation of the annual report is to prepare the annual financial
ment , which consist of two main reports: the balance sheet and the income state-
t. This step can be illustrated using T-accounts (see Figure u-3).
One simple way to understand these statements is to draw an analogy between the
any's assets (i.e., cash on hand, cash in bank, accounts receivable, inventories,
inery, buildings, etc.) and the water in a basin (see Figure 11.4). The income state-
259
Income statement Balance sheet
i---P-ro_fi_t_ __,I,icy
FIGURE 11 .3
Costs Revenues Assets
Diagrams of income
statement and balance Liabilities
sheet illustrated as Profit
T-accounts.
FIGURE 11.4
Revenues and costs
illustrated as cash flows, in
and out, of the company.
,,,I Costs
ment shows the inflow of water (revenues) and the outflow of water (costs) during the
year. The balance sheet shows the water level in the basin (value of equity) at the end
of the year. Profit can be calculated in two ways: the difference in the basin's inflow
(revenues) and outflow (costs) during the year, or the difference in the basin's water
level (value of equity) from the beginning of the year to the end of the year.
The balance sheet - a review

Figure 11.5 presents a simplified version of a balance sheet, following the format
mandated by the Swedish Annual Accounts Act. Figure 11.7 presents a complete
balance sheet.
The balance sheet has two sides: the asset side and the liability and equity side. The
sum of the assets equals the sum of the liabilities (debts) and equity.
. Assets are classified under two main headings:
1 fixed assets
2 current assets.
Fixed assets include assets that are used and wear out over long time periods. Their
purchase expenditures are allocated over several years through the depreciation process.
Examples of such assets are vehicles, machinery, equipment, buildings, patents, et.:.
260 0 THE A UTH O RS AND STUDENTLITTE RATUR

CHAPTER 11 • FINANCIAL ACCOUNT ING
Assets I Liabilities & Equity
Fixed assets Equity
Intangible assets Share capital

• Patents, goodwill, etc. Funds
Tangible assets Profit/loss brought forward
• Buildings and land Annual profit/loss
• Machinery
• Equipment Untaxed reserves
Financial assets
• Shares in other companies Accumulated additional depreciation
Tax allocation reserve
Current assets
Inventories etc.
• Inventories and finished products Non-current liabilities
• Advance payments to suppliers
Current receivables
• Accounts receivable - trade
Current liabilities
• Other receivables
• Interim claims Advance payments from customers
Investments in securities etc. (i.e., Accounts payable - trade
short-term investments) Current tax liabilities
Cash and bank balances Interim liabilities
FIGURE 11.5
Commenr: In order to simplify the text, th e book will sometimes use the shorter terms "Accounts receivable" and
Simplified presentation of
"Accounts payable" instead of the full terms "Accounts receivable - trade" and "Accounts payable - trade". the balance sheet
O,rnnt assets include assets that are consumed (or replaced) within one year. Examples
uch assets are cash on hand, bank balances, accounts receivable (from customers),
materials inventory, products in process, finished goods inventory, etc.
1he liabilities and equity side is structured under four main headings:
equity
untaxed reserves
non-current liabilities (long-term debts)
4 current liabilities .
.,.,ity is the part of the company's capital that belongs to its shareholders or owners,
tis, the people who have invested in the company. This investment has (hopefully)
sed over the years as a result of company profits. In other words, company equity
ist of share capital, annual profit, and profits brought forward (i.e., profits from
·ous years that have not been distributed to shareholders).
Untaxed reserves are a company's profits that have not yet been taxed. See Section
for a discussion of how untaxed reserves are managed.
AUTHORS AND STUDENTLITTER AT UR 261

Non-current liabilities are a company's long-term debts, which means loans with a
maturity date of more than one year. These debts are often loans from banks etc.
Current liabilities are a company's debts with a maturitX date of one year or les
than one year. Examples of these liabilities are accounts payable (to suppliers), advance
payment from customers, and tax liabilities.
The Annual Accounts Act regulates the presentation of the balance sheet. The bal-
ance sheet in Figure 11.7 follows this presentation. The assets are listed in reverse order
ofliquidity. Thus, the assets that are most difficult to convert to liquid assets are listed
first, and the assets that are readily available (i.e., cash on hand and bank balances) are
listed last. The order for equity and liabilities is the same as the order for assets. Equity
is listed first, followed by the untaxed reserves (in part equity and in part deferred tax
liability). Next are the non-current liabilities and finally the current liabilities. Asset
on the left side of the balance sheet, are resources that are used in the company oper~
ations and have value; the liabilities and equity, on the right side of the balance sheet,
finance these assets. In Sweden, the asset side (left) is referred to as the active side; the
liability side (right) is referred to as the passive side.
The annual profit appears on the liability (passive) side of the balance sheet as a part
of equity. The reason for this is that the profit as well as the rest of the equity belongs to
the owners. Thus, the company has a kind of debt or liability to its owners.
The amount of liquid funds (cash) a company has is, of course, unrelated to the
amount of its profit. If we assume that a company's liabilities and equity are the same
at the beginning of the year as at the end of the year, but that the assets have increa ed
by, for example, SEK 10 million, then the company's profit for the year is SEK 10 million.
However, a profit of SEK 10 million tells us nothing about how the company's ca h
changed or was used during the year. The SEK 10 million may be anywhere in the
company's assets: cash on hand, cash in bank, inventories, machinery, etc.
By annual profit, we refer to taxed profit. A company is allowed to allocate a portion
of its profits (before tax) to the untaxed reserves. These untaxed reserves are a hybrid
between liabilities and equity because they partly consist of a deferred tax liability. If
necessary, a company can use these untaxed reserves to offset future losses and thereby
equalize the tax burden between profitable and unprofitable years.
There are two types of equity: restricted equity and non-restricted equity. Restricted
equity includes, among other things, the share capital and associated funds, while
the non-restricted equity (disposable equity), among other things, includes profit or
loss brought forward (i.e., the accumulated profits/losses from previous years) and the
annual profit (loss). Successful limited liability companies often distribute dividends
to their shareholders every year. Dividends to shareholders are only allowed from the
non-restricted equity. The Board of Directors proposes the dividends at the Annual
General Meeting (AGM), which makes the formal decision.
262 ,:, THE AUTHOR S AND STUDENTLITTERAT I

,epremium reserve (in Swedish: overkursfond)

share premium reserve is used for new capital issues (see Section 12.3) and is part of the
. ed equity. A new capital issue is based on a set price for the new shares. However,
times this price is higher than the quota value of the shares; the capital issue is subscribed
1 premium. The part of the price that exceeds the quota value is added to the share premium
. The remaining part is added to the share capital.
/uation reserve (in Swedish: uppskrivningsfond)

certain circumstances, a company's fixed assets may be revalued (written up), i.e., their book-
can be increased. However, such revaluations may not affect the company's profit. These revalua-
are instead added to the revaluation reserve, which is included in the company's restricted equity.
ry reserve (legal reserve) (in Swedish: reservfond)
purpose of the statutory reserve is to protect external stakeholders who have, for example,
loans to a limited liability company. Part of the company's profit can be allocated to the
reserve. Since the statutory reserve is part of the company's restricted equity, these funds
no longer be distributed to the shareholders as dividends. The statutory reserve may only be
for specific purposes, for example to cover losses. Only certain types of companies, such as
ic associations, must, by Swedish law, allocate part of the annual profit to a statutory reserve.
method reserve (in Swedish: kapitalandelsfond)

equity method reserve is used in consolidated statements (i.e., for a group of companies).
alimited liability company acquires another company (i.e., buys at least 50 % of the shares
the acquired company becomes a subsidiary), the value of the acquired company that
ed in the books is different from the acquisition value (i.e., the price that the buying
ny paid). If the book-value exceeds the acquisition value, the difference is added to the
method reserve which is included in the company's restricted equity.
fair value reserve is part of the company's non-restricted equity. Normally, changes in the
value of an asset should be reported as a revenue or a cost in the income statement. An
n is financial assets that are not intended for active trading on stock exchanges. For such
I assets, changes in market value should be added to the fair value reserve, i.e., recorded
against equity.
e income statement - a review

income statement, as mandated by the Annual Accounts Act, presents the compa-
revenues and costs during the year. Figure 11.6 is a simplified presentation of an
me statement. Figure 11.8 presents a complete income statement.
l AUTHORS ANO STUDENTLITTERATUR 263

Net sales
- Operating costs
Operating profit/loss before depreciation
+/- Other operational revenues/costs
- Depreciation according to plan
Operating profit/loss after depreciation
+/- Financial revenues/costs
Profit/loss after financial items
+/- Extraordinary revenues/costs
Profit/loss before appropriations and tax
+/- Appropriations
Profit/loss before tax
FIGURE 11.6 - Tax
Simplified presentation of Annual profit/loss
the income statement.
The income statement is usually presented in report form, unlike the balance sheet,
which is usually presented in account form, and revenues and costs are listed in a
particular order. The Annual Accounts Act approves two variations of the income state-
ment as far as the presentation of the operating costs. These costs can be classified by:
1 function of expense
2 nature of expense.
The difference lies primarily in how the company divides its accounts for operating
costs into more detailed sub-accounts. These sub-accounts are listed either on the
basis of the company's various functions (production, sales, administration, etc.) or
on the basis of the company's classification of its costs (raw materials, labor, etc.). In
the presentation below, we follow Figure 11.6, which has one heading for all operating
costs. Compare Figure 11.6 with Figure 11.8, which presents an income statement cla ·
sified by the function of the expense, and an income statement classified by the nature
of the expense.
Two common abbreviations
EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization)= Operating profit before
depreciation (and amortization)
EBIT (Earnings before Interest and Taxes)= Operating profit after depreciation (and amortization)
264 © THE A UTH O RS A N D STUDENTLITTERATUR

CHAPTER 11 • FINANCIAL ACCOUNT ING
lso called net turnover (i.e., sales excluding VAT), is the first item in the
et sa Ies, a
ement This is the sum of the company's revenues from the sales of goods
1ncome stat ·
and services that are part of the normal business operations. Normal business oper-
. of course may be anything from Internet-based services (music and movie
at1ons, '
subscriptions, payment se~vic_es, etc.) or manufacturing_(cars, refrigerato_rs, etc.).' to
consulting services (investigative tasks, management advice, etc.) or financial services
(asset management, etc.).
Operating costs (expenses~ are the costs incurred in ~he comp~ny's normal bu_si_n_ess
rations. Operating costs mclude, for example, salanes, supplies, rents, and utilities.
opeOther operating revenues and costs are incurred in the business operations, but these
revenues or costs are not directly part of the normal operations. For example, when a
company sells an obsolete machine (a fairly common occurrence), the revenue from
this ale is not part of normal operations. The company's business is selling products
manufactured by the machine, not selling machines. An example of other operating
costs is the cost associated with scrapping a machine that has no market value.
Depreciation according to plan is the annual decrease in value of the company's
fixed assets (long-term assets such as vehicles, machinery, equipment, and buildings).
In general, the company acquires most such assets with the intention of using them for
eral years. Therefore, to match the costs of these assets to the revenue they generate
over many years), the company depreciates (writes off, in ordinary usage) these assets
over their expected economic life. For example, if the economic life of a machine is 10
,ar , we could annually depreciate 10 % of the machine's original expenditure over a
period of 10 years. The assumption is that this procedure reflects the consumption of
the asset. For certain intangible assets (e.g., patents), amortization is the English term
i,r this kind of annual expensing.
Profit/loss from financial items, which, for example, includes interest on bank bal-
ances, is not generated from normal business operations. Industrial companies, for
aample, are not primarily in the financial investment business, but they can still gen-
erate substantial financial revenues. Similarly.financial costs arise when the company
borrows money from banks and other financial actors.
Extraordinary revenue arises from unusual and non-recurring events. Industrial
companies, for example, may have such revenue from the sale of a subsidiary or the
e of a license (such as the right to use a patent). These events occur rather rarely.
Extraordinary costs are equally rare and typically the result of isolated events.
The last items in the income statement are the appropriations and taxes. Under the
Swedish tax law, a company may exclude (or rather, postpone) a portion of its profits
from taxation by creating untaxed reserves through appropriations. A company can
choose between two appropriation methods: (1) additional depreciation (more depre-
dation than planned depreciation) and (2) tax allocation reserve (in Swedish: periodi-
ltringsfond). See Section 11.4. Appropriations are essentially methods for moving some
HE AUTHORS AND STUDENTLITTER A T UR 265

ASSETS EQUITY AND LIABILITIES

Subscribed capital unpaid Equity
Fixed assets
Restricted equity
Share capital
Intangible assets
Capitalized expenditure for research and Revaluation reserve
development and similar Statutory reserve
Concessions, patents, licenses, trademarks and Non-restricted equity
similar rights Share premium reserve
Rights of tenancy and similar rights Profit or loss brought forward
Goodwill Profit (loss) for the year
Advance payments for intangible assets
Tangible assets Untaxed reserves
Land and buildings Provisions
Plant and machinery Provisions for pensions and similar obligations
Equipment, tools, fixtures and fittings Deferred tax liability
Construction in progress and advance payments Other provisions
for property, plant and equipment
Non-current liabilities
Financial assets Bond loans
Participations in group companies Liabilities to credit institutions
Receivables from group companies Liabilities to group companies
Participations in associated companies Liabilities to associated companies
Receivables from associated companies Other liabilities
Other securities held as non-current assets
Loans to partners or related parties Current liabilities
Liabilities to credit institutions
Deferred tax asset
Advance payments from customers (may also be
Other long-term receivables
accounted for as a deduction from Inventories
Current assets etc.)
Account payable -trade
Inventories etc.
Raw materials and consumables Bills payable
Products in progress Liabilities to group companies
Finished products and goods for resale Liabilities to associated companies
Work in progress Current tax liability
Advance payments to suppliers Other liabilities
Accrued expenses and deferred income
Current receivables
Account receivable - trade MEMORANDUM ITEMS
Receivables from group companies Pledged assets and contingent liabilities
Receivables from associated companies Pledges and equivalent collateral to secure
Other receivables own liabilities and commitments reported as
Prepaid expenses and accrued income provisions, classified by type
Other pledges and equivalent collateral, classified
Investments in securities etc.
FIGURE 11.7 bytype
Participation in group companies
Balance sheet according to Other investments in securities etc. Contingent liabilities
Pension obligations not recognized as liabilities
the recommended format Cash and bank balances or provisions and not covered by pension fund
of FAR Swedish Institute assets
of Authorized Public Other contingent liabilities
Accountants.
Source: FAR, 2011 .
o:, THE A UTHO RS AN O STUOENTLITTERAT l

266
OME STATEMENT FOR ... (year) INCOME STATEMENT FOR ... (year)
FAR's format for the income statement
5 format forthe income stat~ment
fied by nature of expense, in classified by function of expense, in
ance with RedRl* accordance with RedRl*
Net sales
sales . Cost of goods sold
e in inventories of products m progress,
ed goods and work in progress Gross profit (loss)
performed by the company for its own use
Selling expenses
capitalized Administrative expenses
operating income Research and development costs
·ng expenses: Other operating income
materials and consumables Other operating expenses
for resale Operating profit (loss)
external costs
benefit expenses Profit (loss) from financial items
· tion/amortization and impairment Profit (loss) from participations in group
well as reversals) of property, plant and companies
lpment and intangible assets Profit (loss) from participations in associated
rment of current assets in excess of normal companies
lrment Profit (loss) from other securities and receivables
operating expenses accounted for as non-current assets (with
ting profit (loss) separate disclosure of income from group
companies)
Other interest income and similar profit (loss)
items (with separate disclosure of income from
group companies)
Interest expense and similar profit (loss) items
(with separate disclosure of expenses referring
to group companies)
Profit (loss) after financial items
Extraordinary income
Extraordinary expenses
Appropriations
Tax on profit for the year (income tax, current
and deferred)
Other taxes
Net profit (loss) for the year
FIGURE 11.8
Income statement
accord ing to the two
recommended forma ts
of FAR Swedish Institute
of Authorized Public
luset of recommendations for good accounting practices published by FAR. Accountants.
Source: FAR, 2011.
I AUTHORS AND STUDENTLITTER A TUR 267

PART Ill • THE FI NANCIAL SYSTEM
of the company's profit from the equity to the untaxed reserves on the balance she t
e.
This procedure is as follows: debit a cost account, which reduces profit (which is part
of equity), and credit a liability account for untaxed reserves.
Administration report, cash flow analysis, interi m

11.3
report, and the auditor's report
In addition to the two main financial statements (the balance sheet and the income
statement), the annual report includes an administration report (also called a manage-
ment report) prepared by the Board of Directors. Major companies are also required to
include a cash flow analysis. In the auditor's report, which accompanies the financial
statements in the annual report, the independent auditor confirms the examination
of the financial statements as well as presents an opinion on the fairness of these state-
ments in accordance with good accounting practice and the law. Most major share
companies also prepare and publish quarterly reports.
The administration report describes the company's activities and results in the pa t
year and comments on its future plans. According to the Swedish Companies Act, the
administration report is required to present a fair review of the company's operation ,
financial position, and results. For example, the following information may appear in
the administration report:
• events and conditions not recognized in the financial statements but which are
nevertheless of importance in assessing the company's financial position
• important events during the fiscal year, or after the end of the fiscal year
• a description of the company's research and development activities.
The administration report of limited liability companies and economic association

should also include proposals for how the year's profit or loss should be handled.
Many companies must also provide information on the environmental effects of their
operations if they are engaged in activities that fall under environmental reporting
requirements.
Major companies also attach a cash flow analysis report to the annual report. A
the name suggests, this analysis reports on, among other things, how operation were
financed and which capital investments were made during the year. In short, the cash
flow analysis shows how the company acquired and used capital during the year. The
company's cash flow analysis is an important supplement to the balance sheet and
income statement. See Chapter 12-4 for more discussion of cash flow analysis.
The auditor's report is the external auditor's analysis from the examination of the
company's financial statements and the Board's and the CEO's management of the com
pany. The auditor, who is appointed at the Annual General Meeting (AGM), primarily
268 © THE AUTHORS AND STUDENTLITTER~T

CHAPTER 11 • FINANCIAL ACCOUNTI NG
exam1·nes the company on behalf of its owners. In addition, the auditor also checks
bat the company has reported and paid the correct amount of income taxes, employer
:ontribution taxes, and VAT. Major corporations and other publicly listed companies
(e . ., companies listed on the Stockholm Stock Exchange) must appoint an authorized
u!lic accountant as the auditor. The auditor's reports for limited liability companies are
Publicly available. These reports include an opinion on whether the current accounts
~nd the financial statements comply with generally accepted accounting principles and
the law. In addition, the auditor's report includes a statement on whether the Annual
General Meeting (AGM) has any reason not to grant the Board of Directors and the
CEO discharge from liability for the past year. If the auditor finds mistakes or other
problems in the accounting records, the auditor notes them in the auditor's report so
that they are brought to the attention of the AGM. Furthermore, the auditor has to
send the auditor's report to the tax authorities if serious errors are found in how the
taxes and other charges were handled.
The limited liability company submits its annual report and its auditor's report to the
shareholders at the AGM no later than six months after the financial year-end. The AGM
approves the balance sheet and the income statement and decides on the appropriation
of the company's profit. In addition, the AGM decides on the discharge from liability for
the Board of Directors and the CEO, which means that they will not be held responsible
ifclaims of mismanagement are brought against the company in the future.
Major limited liability companies and other publicly listed companies must submit
an interim report at least once a year. This report, which contains an income statement
and key balance sheet items, describes the company's operations and financial results,
Including information on investments, financing, and changes in liquidity since the
pttvious year.
.4 Preparation of the financial statements

Preparation of a company's financial statements involves a number of revisions and
additions to the information in the company's bookkeeping records. Besides these revi-
s and additions, which we discuss below under the headings "Allocation of income
expenditure" and "Valuation of assets and liabilities (debts)", a number of control
are required. Each account in the records must be reviewed and reconciled. This
ns checking the recorded amounts against invoices and other documents. Even for
companies, this is quite a time-consuming task. Generally speaking this work
Ives the following:
allocation of income and expenditure to a particular period

valuation of the assets and liabilities (debts)
allocation to untaxed reserves.
AUTHORS AND STUDENTLITTERA T UR

269
Allocation of income and expenditure

During the fiscal year, the company records many items of income and expenditure
in the books. These amounts can be verified by referen~e to invoices received and
invoices sent. In preparing the financial statements, these amounts must be allocated
to the correct period. Allocation means determining which receipts agree with the
"value of the delivered goods/services" during a specific period (i.e., revenues) and
which expenditures agree with the "value of resources consumed" during a specific
period (i.e., costs).
The allocations are of four types:
1 prepaid expenses
2 deferred income
3 accrued expenses
4 accrued income.
Prepaid expenses represent expenditures during a period but without an associated co t

(i.e., payments for goods/services that have been paid in advance of their consumption
or use). Typical examples are rents (generally paid in advance), and insurance fee
(which may apply to both the current year and the next year). Prepaid expenses are
assets on the balance sheet instead of costs on the income statement.
Deferred income represents income during a period without an associated revenue
(i.e., payments recorded in advance for goods/services that have not yet been earned
or delivered). A typical example is a customer prepayment. The company has recorded
the receipt of cash as an asset, but is required at a later date to provide the service or
deliver the product that has been paid for in advance. Deferred income is recorded a
a liability on the balance sheet, not as revenue on the income statement.
Accrued expenses represent resources that have been consumed (i.e., costs) but have
not yet been recorded because the company has not yet received an invoice for the
goods/services purchased. Therefore, the company has accrued the cost, but has not
(yet) recorded the associated expenditure. A typical example is a telephone bill that
is paid quarterly. The bill from the telephone company may then overlap two fi cal
years, i.e., the first bill to be received at the start of a new year may include costs that
relate to the current as well as the previous year. Often, a company is aware that a
number of invoices have not yet been received by the end of the year, but that these
costs nevertheless belong to the year that is about to end. The company either know
the exact amount or must make an estimate it in order to record these accrued co ts.
Accrued expenses are liabilities on the balance sheet and costs on the income statement
Accrued income represents revenues earned that the company has not yet invoiced.
Therefore, the company has not been paid. The simplest example is the situation when
270 <> THE AUTHORS AND STUDENTLITTERAT

CHAPTER 11 • FINANC IAL ACCOUNTING
Income account
Deferred
Interim liabilities i-~~~-~-~ - -- ---- - -- - -l
~------
•----- --------- Expenditure account
Accrued
expenses
---·
Income account Accrued
+---- income Interim claims
·-·----------
Expenditure account
·--·-· FIGURE 11.9
_.-·--······-··
4- ----·-
Coding of accrued and
Prepaid prepaid/deferred expenses
expenses
I and income.
a company has performed a service or delivered a product but has not yet sent an
invoice to the customer. The company usually knows the exact amount of the accrued
revenues, which are assets on the balance sheet and revenues on the income statement.
In bookkeeping, one often comes across the term interim claims in reference to
financial statement preparation and the allocation of prepaid expenses and accrued
income to the correct accounting period. In the same way, one finds interim liabilities
(debts) in reference to financial statement preparation and the allocation of deferred
Income and accrued expenses to the correct accounting period.
Figure 11.9 illustrates these four concepts.
Valuation of assets and liabilities (debts)

we recall from Chapter 10, a company's profit can be determined in two ways - firstly,
by subtracting costs from revenues; secondly, by calculating the difference between
change in assets (beginning of year to end of year) and the change in liabilities or
&bts (beginning of year to end of year). In other words, the year's profit appears on
lloth the balance sheet and the income statement. Because the assets' recorded value
the bookkeeping (to be distinguished from their actual market value) is crucial in
determination of annual profit, it is necessary to value these assets as correctly as
ible. Asset valuation is performed for both current assets and fixed assets, in part
different rules.
weden, like many countries, has two sets of laws for the valuation of assets; these
have different purposes. Firstly, there is civil law (e.g., the Annual Accounts
• supported by the external auditor's examination, which is intended to protect

Low valuation High valuation

of assets of assets
Assets Liabilities &

Equity
Assets Liabilities &
______Eq_u_it_y~ ······ ···· ·· · · ····· ··r·

r - - - - - + ················· · ······ ..... .. .- 1·· Profit
Profit
FIGURE 11.10
The influence on profit of
asset valuations.
a company's stakeholders from over·valuation of the assets. Over-valuation of assets

may include, for example, that the company owners and financiers receive an inflated
presentation of the company's financial position. Secondly, there is tax ation legislation
(the Tax Code), which is intended to protect the government from under-reporting tax
liabilities by companies. If a company under-values its assets, at least in the short term,
it will report lower profit and thus pay less tax. Figure 11.10 illustrates how the valuation
of the company's assets influences the calculation of profit, assuming liabilities and
equity are unchanged (cf. Figure 11.2).
In addition, the company's liabilities need to be properly recorded. However, thi
task is generally easier than the valuation of assets because the amount of most liabil-
ities can be traced to formal documents (invoices, loan contracts, etc.).
Fixed assets
A company's fixed (long-term) assets are those assets that are used over longer time
periods (i.e., longer than a year). Valuing such assets involves the bookkeeping proce
of depreciation, which is a systematic method for allocating the cost of a fixed asset (e.g.,
a machine) to the years in which the asset is used in company operations. For example,
consider a truck. The company purchases the truck at a considerable cost in Year 1 and
expects to use it for a number of years (e.g., five years). Thus, the cost of the truck is it
·depreciation in years 1 through 5. The Bookkeeping Act governs this calculation, which
is called depreciation according to plan.
Different fixed asset categories are valued differently, predominantly because of the
differences in their estimated economic lives. A building, for example, can be assumed
to have a longer life than a truck. Buildings, therefore, are depreciated over longer time
periods. In the following, we review the rules for depreciation according to plan for the
four asset categories:
272 © TH E A UTH O RS A N D STUDENTLITTERAT I

1 machinery and equipment

2 goodwill
3 real estate
4 land improvements.
The highest valuation allowed (by the Bookkeeping Act) for machinery and equipment
is its cost of acquisition (i.e., the value it had when acquired). This determines the upper
limit of its depreciable value. The assumption is that machinery and equipment contin-
uously decrease in value according to a predetermined plan. If the useful (economic)
life is estimated at ten years, the planned depreciation rate each year is 10 % of the cost.
If the economic life is five years, the planned depreciation rate each year is 20 % of the
cost. This is depreciation according to plan. The Tax Code determines the lower limit
of the depreciable value of machinery and equipment. This law allows companies to
depreciate machinery and equipment at an accelerated annual rate. Thus, the company
may report lower values for these assets in the financial statements than the amount
of depreciation calculated according to plan, resulting in lower profit and, thus, lower
tax (the tax rules are discussed in more detail under the heading "Appropriations for
untaxed reserves in the financial statements"). In some cases, equipment may be fully
depreciated (at 100 %) in the first year, which means that the asset is treated as a cost
in the year of its purchase. This is called accelerated depreciation for consumables (i.e.,
equipment that will be used up in less than 3 years, or equipment that is oflow value,
that is, half of the price base amount, which in 2017 meant half of SEK 44,800, or less).
Goodwill is the difference between the amount of money a company paid for pur-
chasing another company and the value at which the acquired company is recorded
(known as the book value of the acquired company). In the purchaser's accounting
records, the difference is recorded as Goodwill. Goodwill is an asset on the company's
balance sheet and is depreciated at the same rate as the asset's real value declines. When
goodwill is depreciated (as a one-time event or over a period of years), it means the
goodwill decreases on the balance sheet and it becomes a cost on the income statement.
Real estate is generally depreciated according to the Tax Authority's tax tables
that prescribe different depreciation rates for different kinds of buildings. Thus, the
annual rates may vary from 2 % to s %. Note that only the buildings are depreciated,
not the land.
Land improvements, for example, parking lots and landscaping, are depreciated at
5"' a year. Note that undeveloped land is not depreciated.
The bookkeeping records typically use separate accounts for different asset cate-
pries. These assets are recorded at their cost of acquisition. Depreciation according
plan of these assets is recorded in separate accounts. For example, an account for
mutated depreciation of machinery (on the balance sheet) is used for the total
depreciation taken on the machinery. In a sense, one may think of accumulated
l AUTHORS ANO STUOENTLITTERATUR 273

Purchase of machinery
Accounts payable Machinery&

(liabilities to supplier) equipment
(liabilities account) (asset account)
~···································~
Depreciation of machinery
Accumulated depreciation, Depreciation,

FIGURE 11.11 Machinery & equipment Machinery & equipment
Example of accounting (asset account) (expenditure account)
for the purchase and
depreciation of machinery & I ~···································~ I
equipment.
depreciation as a negative asset, since the account is credited. Of course, there is also a
cost account used for the annual depreciation amount (which appears on the income
statement). Figure 11.11 illustrates how purchase and depreciation of a piece of machin·
ery are recorded in the books.
Current assets
The valuation of current assets, mainly raw materials inventories, products in process,
and finished goods inventories, may pose some ambiguities. For other current as et ,
such as cash on hand, bank balances, and accounts receivable, precise information i
usually available (e.g., from bank statements and invoices).
Inventories should be valued using the principle of lower of cost or market. Thi
means that they should be valued at the lower of either their cost at acquisition, or
their current market value. Cost at acquisition is normally the purchase price. Market
value may be the estimated selling price at year-end, or an estimated replacement
cost. In practice, inventories are usually depreciated (expensed) annually by 3 % for
obsolescence. Obsolescence means that some of the inventory is unsellable or unu able
because it is too old, out of date, or damaged.
In practice, the value of inventory is determined by a physical count of all raw mate-
rials, components, and products, which are listed according to types and then valued.
Very often, this is an extensive process, especially in large companies, because there may
be thousands of different materials and products in various stages of completion. The
inventory count takes place at least once every year (in conjunction with the preparation
of the financial statements), and more often if a company presents interim financial
statements. A list of inventory items is prepared, and then the lower of cost or market
rule is applied to items or groups of items.
274 O THE AUTHORS AND STUDENTLITTERAT I

CHAPTER 11 • FINANCIAL ACCOUNTI NG
Appropriations for untaxed reserves in the financial statements

Swedish tax law allows businesses, within certain limits, to reduce their reported profit
through appropriations. These are reported as costs recognized in the income statement
and create untaxed reserves on the balance sheet (see Figure 11.12).
Companies have the option to choose between two types of appropriations. Firstly,
the tax law allows larger depreciation than the depreciation according to plan forcer-
tain fixed assets. This appropriation is called additional depreciation. The second type
of appropriation results from the allocation of profit to a tax allocation reserve, which
can be made as a percentage of the profit before tax.
Additional depreciation
A discussed above, fixed assets are depreciated according to plan, based on its esti-
mated economic life. Tax law, however, allows certain fixed assets to be depreciated
more rapidly. This amount is determined by calculating the so-called depreciation
as recorded in the books, which can be described as a "tax-related depreciation". The
difference between depreciation as recorded in the books and depreciation according
to plan is called additional depreciation. The additional deprecation is recorded as an
appropriation in the income statement and as an untaxed reserve (accumulated addi-
Befo re appropriations After appropriations

Balance sheet
Assets Liabilities & Assets Liabilities &
Equity Equity
Equity Equity
,____---<I Profit . .. ---------:::: : ____________ "-!____,!Profit
Assets Untaxed Assets Untaxed
reserves reserves
Liabilities Liabilities
Income statement
Costs Revenues
Costs Revenues
Appropriations
---- - ----------- ---t ------------- FIGURE 11 .12
Profit Appropriations and untaxed

~- ::::_________ -------- -- -------- -- -- + Profit
L __ _ _..L__ _ __J
reserves.

Machinery&
equipment
Depreciation
Depreciation according to plan (
as recorded ,'
in the books Lowest

Additional allowed
depreciation value of
machinery &
equipment
per books
FIGURE 11.13 The limit for the lowest allowed value of machinery and equipment
Different depreciation is determined by the main depreciation rule (30 o/o rule)
concepts. or the additional depreciation rule (20 o/o rule).
tional depreciation) in the balance sheet. Figure 11.13 illustrates the relation between
depreciation according to plan, additional depreciation, and deprecation as recorded
in the books,
The assets eligible for additional depreciation are machinery, equipment, vehicles,
ships, patents, rented apartments, and goodwill. As Figure 11.13 illustrates, the depre-
ciation as recorded in the books determines the lowest allowed recorded value of these
assets (machinery, equipment, etc.) in the bookkeeping records. This minimum value,
Main depreciation rule (30 o/o rule) Additional depreciation rule (20 o/o rule)
Book value of machinery & equipment 80 o/o of acquisition for machinery &
beginning of the year equipment acquired in the year and
remaining at year end
+ value of year's acquisitions of
machinery & equipment + 60 o/o of acquisition value of machinery
& equipment acquired in the previous
- value of year's sales of machinery &
year and remaining at year end
equipment
+ 40 o/o of acquisition value of machinery
depreciation base
& equipment acquired 2 years ago and
The lowest allowed value of machinery remaining at year end
& equipment, per books, is 70 o/o of
+ 20 o/o of acquisition value of machinery
FIGURE 11.14 depreciation base
& equipment acquired 3 years ago and
Ma in depreciation rule remaining at year end
(30 % rule) and additional The lowest allowed accounting value
depreciation rule of machinery & equipment, per books
(20 % rule).
276 © THE A UTHO RS A ND STUDENTLITTERAT I

. t rn , is determined by two rules: the main depreciation rule (30 % rule) and the
in u
additional depreciation rule (20 % rule). Each rule determines an asset value, and the
company may choose the lower of these values each year. However, the same rule must
be used for all assets during the same year. Figure 11.14 shows how these values are
calculated under the two rules.
EXAMPLE
Calculating and recording additional depreciation in the annual financial statements
Acompany has bought a fixed asset (e.g. machinery) during the fiscal year for SEK 100,000 and had
no fixed assets when the year started. The company estimates the economic life of the new asset
to 10 years .
• The depreciation according to plan amounts to SEK 10,000 per year for 10 years (100,000 / 10).
• The depreciation base for calculating the depreciation as recorded in the books is SEK
100,000. The company calculates the lowest allowed value of the asset in the books to SEK
70,000 according to the main depreciation rule (70 % of SEK 100,000). Thus, the depreciation as
recorded in the books (i.e., the biggest decrease in value allowed by the tax law) is SEK 30,000.
• The additional depreciation is SEK 20,000, i.e., the difference between the depreciation as
recorded in the books (SEK 30,000) and the depreciation according to plan (SEK 10,000). The
additional depreciation is recorded as an appropriation (i.e. a cost) in the income statement
and as an untaxed reserve (i.e. a liability) called accumulated additional depreciation in the
balance sheet.
The rationale behind the additional depreciation rule (20 % rule) is that a company
that follows the main depreciation rule can never reach a zero value for its depreciable
t . Even without additional investments, under the main depreciation rule, there is
alway a certain book value. However, if the company makes investments continuously
in such assets, following the main depreciation rule will be more advantageous (i.e.,
will give the lowest value of the assets).
These two rules set the maximum limits of the depreciation (i.e., the lower limits on
asset's value). The amount of depreciation a company actually takes could be lower.
the bookkeeping, the additional depreciation amount appears in a cost account and
accumulated additional depreciation appears in a liability account.

Sale offixed assets

When a company disposes of (i.e., sells or scraps) a fixed asset, it needs to be removed
from the books. The disposal may mean that the fixed asset:
1 is sold with profit (so-called capital gain) - the sale price exceeds the book value
2 is sold at a loss (so-called capital loss) - the sale price is less than the book value
3 is sold at a price that is the same as the book value.
The book value is the asset's value in the balance sheet, i.e., the cost of acquisition
(the price paid by the company when the asset was obtained) minus the accumulated
depreciation. The book value is not the same thing as the asset's market value. The
market value may be higher or lower than the book value.
An asset must be registered in the company's fixed assets register as long as it remain
in the company. This applies even if it has been fully depreciated (i.e., the book value i
zero). The fixed assets register, which is updated at each year-end closing, shall contain
information about:
• name, identity, and location of the asset

• year when the asset was acquired
• acquisition value
• estimated economic life
• accumulated depreciation (or write-down)
• book value .
The tax allocation reserve

In addition to the additional depreciation, a company is allowed to set aside a percent-
age of its profit before tax in the tax allocation reserve, which gives the company the
opportunity to distribute its profits over several years. The allowed amount has varied
somewhat. In 2017, the percentage was 25 %. This applies to legal entities, for example
limited liability companies. A sole proprietorship, which is considered to be a natural
person and taxed as a private individual, is allowed to set aside 30 % of the annual profit
before tax to the tax allocation reserve. Different legal forms for running a company
are described in chapter 16.1.
The transfer to the tax allocation reserve is the last step before the company's taxi
calculated. All other costs, including additional depreciation and other adjustment
must be recorded before the transfer. The allocation is subtracted on the income tate
ment in the same way a normal cost is subtracted. The allocated sum may remain in
the tax allocation reserve for six years; after that, it is subject to taxation. The sixth year:
the company simply adds the amount to its annual profit. The tax allocation re erve
for financial year 2017 thus needs to be dissolved (i.e., added to the annual profit) no
278 o:, T HE AUTHOR S AN D STUDENTLITTERAT

CHAPTER 11 a FINANC IAL ACCOU NTING
later than the financial year 2023. However, a company may also add the allocated sum
to the annual profit at an earlier time, for example in a year when there is a loss. In
this case, the company can use this untaxed reserve (it is an untaxed reserve because
·sts of a share of untaxed profit) to cover a loss instead of using taxed capital, in
it conSl
the form of profit brought forward.
The bookkeeping for allocation to the tax allocation reserve is handled in much the
same way as additional depreciation.
In conclusion, it should be mentioned that the tax allocation fund in a limited liability
company is taxed according to a standard tax rate. The tax is calculated by multiplying
the total of the tax allocation funds at the beginning of the fiscal year by 72 percent of the
average government bond yield (the average government bond yield for 2016 was 0.34 %).
This amount is included in the company's tax return as an income, thus increasing the
profit for the year and therefore the corporate income tax that the company shall pay.
1,. 5 Taxed profit compared with accounting profit

Like private individuals, companies file an annual tax return with the tax authorities.
The tax return determines how much tax and other charges the company is required
to pay. In addition to tax on profit (corporate income tax) the company also pays other
taxes and fees (e.g., property tax and VAT). Examples of fees are employers' social costs
for labor and social security costs.
When a company prepares its financial statements for the year, its corporate tax
appear on the income statement as a cost. The item in the income statement, which
called "tax on profit for the year", is a calculated amount. In 2107, the corporate tax
sate in Sweden was 22 %.
Ba ed on a company's tax return, the tax authorities determine the exact amount of
tax owed. In addition to the corporation tax, the company must also pay (or recover)
difference between output VAT and input VAT, and pay applicable property taxes.
reover, not all company costs are deductible in the tax return. Such costs, in whole
m part, may not be subtracted from revenues. Examples of such costs that cannot be
claimed fully for tax purposes are certain automobile leasing costs and certain business
rtainment costs (a maximum is allowed).
In addition to tax on profit (corporate tax), tax on assets (property tax), and VAT,
panies are required to pay different types of fees. These include, for example,
layers' social costs for labor and social security costs, which are calculated as a per-
ge of salaries. In 2017, these fees were approximately 45 % of most employees'
·es in Sweden, which means that if a company pays an employee SEK 100 per hour,
ectively has to pay SEK 145 per hour. Just like private individuals, companies need
pay several of these charges, as well as some of the taxes (e.g., VAT), periodically
ghout the year.

PART Il l • THE FI NANCIAL SYSTEM
Once the company has filed its tax return and the tax and fees have been calculated
the company records this amount as a tax liability (tax debt) in the current liabilitie~
on the balance sheet. This liability is netted against the total of taxes and fees paid
throughout the year. If an amount is due, this amount is then paid, and the tax account
returns to a zero balance.
11.6 What do the financial statements tell us?

The financial statements present an overview of a company's performance and its con.
sumption of resources in a certain time period, often a year (the income statement:
revenues less costs) as well as a picture of its financial position at one point in time, often
at the end of the fiscal year (the balance sheet: assets, liabilities, and equity). One way to
analyze the financial statements is to use business and financial ratios in the financial
analysis. Different business and financial ratios can, of course, be used to describe many
company conditions as well as company finances. In financial analysis, we often use
three groups of ratios: earnings ratios, liquidity ratios, and ratios offinancial strength.
In using these ratios, it is important to remember that the ratios themselves do not tell
us much about a company. The ratios must be considered in relation to something, for
example, the company's historic ratios, industry average ratios, competitors' ratio , etc.
These key ratios are useful to us only when we use them in comparisons.
It is also important to point out that many of the kay ratios have no strict and
generally accepted definition. It is not uncommon for different authors, journalist ,
and companies to use different key ratios and sometimes they label the same key ratio
differently. It is therefore important to understand how a certain key ratio is defined
in, for example, an annual report, newspaper article, or textbook. In this book we have
made a selection of key ratios that are common in Sweden and tried to define them a
clearly and accurately as possible.
It is especially important in financial analysis to be aware of what types of operations
the company is running. Traditional business key ratios are, for example, not par-
ticularly useful for government agencies (which are not profit-seeking) or companies
with monopolies (which have no competitors). Using these types of ratios to analyze a
company is only relevant if the company has competitors.
Different companies present balance sheets and income statements that look rather
different. In part, this is because they are in different industries. Table 11.1 show the
balance sheets of three companies that operate in three different industries: the mining
company LKAB; the truck manufacturer Scania; and the IT consulting company HiQ
Their balance sheet numbers (presented here as percentages) are from the years 2012
and 2013 . By using percentages, we are better able to demonstrate the differences in the
structure and composition of their balance sheets.
The first line item, fixed assets (non-current assets), constitutes 57 % of LK B
280
Ex amples of balance sheets from three companies in three different industries: The numbers
TAILE11,1 . . .
!ag es of the total capital. Source: LKAB, Scan1a, and H1Q.
percen
LKAB Scania HiQ
57 58 40
Fxed assets
urrent assets
43 42 60
100 100 100
otal assets
45 31 72
Equity
ntaxed reserves 34
12 37 3
9 32 25
100 100 100
total a sets and 58 % ofScania's total assets but only 40 % of Hi Q's total assets. At first,
the e differences do not seem very large. An examination of these companies' com-
ments (footnotes) to their annual reports is useful. We see that LKAB's fixed assets are
mostly mines, roads, and installations needed to access ore in the mountains. Scania's
hed as ets consist primarily of different interest-bearing assets (also called financial
ts). These are predominantly customer leases of vehicles manufactured by Scania.
addition, Scania's fixed assets also include factories, machinery, and equipment.
For a consulting company, HiQ has a relatively high proportion of fixed assets.
ever, almost 90 % of these assets consist of intangible assets. A consulting company
clearly does not require the extensive facilities (e.g., factories and heavy machinery)
that a mining company or a vehicle manufacturer needs. HiQ's intangible assets are
tly goodwill - the difference between the price HiQ has paid for acquired companies
those companies' book value. Thus, HiQ has partly grown by acquiring smaller
ulting companies, which affects the intangible asset goodwill.
The next line item is current assets. LKAB's current assets are inventories and a
ificant number of short-term investments (investments expected to be held for a
or less). Scania also has a number of short-term investments. About half ofHiQ's
ent assets are accounts receivable (claims to payment for consulting contracts
pleted and invoiced, but not yet paid).
The third line item, equity, varies in size among the three companies. For example,
ia's equity is the lowest (31 %), and HiQ's is the highest (72 %). This means that
ia is 69 % financed by liabilities, and HiQ is 28 % financed by liabilities. One
nation for these differences relates to the willingness of banks and other financiers
lend money to companies, as well as to companies' attitudes toward borrowing.

For example, the banks are relatively willing to lend money to LKAB because it is a
company owned by the government. Therefore, lenders are at less risk. Furthermore
as noted above, LKAB's fixed assets are tangible and therefore relatively easy to val '
ue.
Finally, LKAB's business is rather secure given the existence of the iron ore and the
market demand for iron. By contrast, HiQ's is not government-owned and has few
tangible assets. Its main asset, the knowledge and expertise of its employees, is not
even included in the balance sheet.
Earning capacity (return on capital and profit margin)

Earning capacity (or profitability) is a measure of a company's economic performance
in terms of profit and loss in relation to some other measure. If a company's earning
(i.e., its profit) are compared to its capital (e.g., its equity or total assets), we can calculate
various ratios in order to find out how profitable the company is.
Four of the most commonly used earnings ratios are:
1 return on equity, ROE

2 return on total capital (or total assets), ROT
3 return on capital employed, ROCE
4 profit margin.
Return on equity expresses the return on the shareholders' capital in a company, i.e., the
company's ability to generate profit in relation to the portion of the company owned
by the shareholders. This calculation is made using the income statement profit after
financial revenues and costs, commonly after tax. Thus, compensation to other financ-
ers has been considered when the ratio is calculated.
Return on equity
ROE= Profit after financial revenues and costs. {1- tax rate)
Adjusted equity
Adjusted equity is equity plus the part of the untaxed reserves that are assumed to
belong to the owners (i.e., equity + untaxed reserves . (1 - tax rate)). This number IS
used as the capital measurement in the denominator. Often an average adjusted equ,'7
is used (i.e., the average of this year's balance sheet and last year's balance sheet).
Return on total capital (or total assets) expresses the company's return on total cap-
ital invested, i.e., the profitability on all capital, not only equity. For this calculation.
282 c, THE AUTHORS AND STUDE NTLiTTERA

financial costs (e.g., interest costs) are not considered because these costs can be seen
ments for financing the company. Here also, an average adjusted total capital is
:~~yused (i.e., the average of this year's balance sheet and last year's balance sheet).
Qperatinq profit after depreciation+ financial revenues

:r = Total capital
Return on capital employed (ROCE) is calculated in a similar way. However, capital that
acompany does not pay interest on is not considered in this ratio (e.g., its accounts pay-
able_ trade, which are the amounts owed to suppliers). There is no generally accepted
definition of this measure. Different definitions are used in different contexts.
Finally, profit margin is another common earning capacity ratio. The profit margin
mates the annual profit after financial items to the turnover (i.e., total net sales, which
are ales excluding VAT).
. Profit after financial revenues and costs

margin= Turnover
uidity refers to the relationship between a company's current assets (or portion
eof) and its current liabilities (or portion thereof), or its turnover. Liquidity ratios
us an idea of the company's ability to pay its bills in the short term. The term
ency is also used to describe a company's liquidity.
commonly used liquidity ratios are the following:
Current ratio
Liquid assets as a percentage of the turnover.
acid test ratio expresses the relationship between a company's most liquid assets
it current liabilities. The most liquid assets consist of Current assets less Invento-
etc. (i.e., Inventories and finished products and Advance payments to suppliers),
ding to Figure 11.5. Remaining assets will therefore be: Current receivables (i.e.,

283
Accounts receivable, Other receivables, and Interim claims), Investments in securities

etc. (i.e., short-term investments) and Cash and bank balances. The ratio should be at
least 1.0, which means there are sufficient current assets to pay the current liabilities
if circumstances so require. ( '
Acid test ratio= Current assets - Inventories and finish~d . rn_ducts - Advance
Current hab1ht1es
The second liquid ratio - the current ratio - sets all the current assets in relation to the
current liabilities. As a rule of thumb for a manufacturing company, this ratio should
be at least 2.0.
Current ratio
Current ratio= Current as~~~s

Current hab1ht1es
Another ratio that is sometimes used is cash and bank assets over total turnover (sales).
In general, a company's need for liquid assets depends on its size. Thus, a company
with higher turnover generally requires more current assets than a company with
lower turnover.
Financial strength - Equity ratios

The Equity ratio (also referred to as financial strength) is a ratio in which a company'
equity is compared to its total liabilities (debts). This calculation is an indication of how
stable the company is should it incur future losses because losses are charged again t
equity. A company with a high equity ratio, for example, can more easily tolerate higher
production costs or new market expansion costs than a company with a lower equity
ratio. In fac·t, a company with a low equity ratio may be unable to take such action ·
In Sweden, three commonly used equity ratios are the following:
1 Equity ratio 1
2 Equity ratio 2
3 Debt/equity ratio.
o THE AUTHORS AND STUDENTLiTTERll
284
CHAPTER 11 • FINANCIAL ACCOU NTING
E uity ratio 1 sets the adjusted equity in relation to the company's total capital. Thus,
t:e ratio illustrates the owners' share of the company. Adjusted equity is equity plus
the part of the untaxed reserves that are assumed to belong to the owners (i.e., equity
+ untaxed reserves · (1 - tax rate)).
Equity ratio 1
. . _ Adjusted equity
Equity ratio 1- Total capital
Equity ratio 2 is a variation of the same ratio. Here, risk-bearing equity is used in the
numerator. Risk-bearing equity includes 100 % of the untaxed reserves. The reason is
that the company must first meet possible losses by using such reserves before it can
charge them against equity.
Equity ratio 2
Risk-bearing equity
Total capital
Debt/equity ratio sets liabilities or debts (including the deferred tax debts in the untaxed
reserves) in relation to the adjusted equity (i.e., equity plus untaxed reserves . (1.0
tax rate)).
Liabilities+ Untaxed reserves · tax rate

Adjusted Equity
ous financial conditions can be investigated based on information in a company's

cial statements. For example, it is often of interest to examine how much of the
pany's capital is invested in various current assets. The size of a company's inventory
its accounts receivable may give us an indication of how efficiently the company
ucts its operations. It may be of interest to compare the total of accounts receivable
total of the company's annual turnover. For instance, if accounts receivable are
285
SEK 5 million, and annual turnover is SEK 60 million, it means, on average, that it takes
the company about one month to collect payments from its customers.
11.7 Consolidated financial statements

A group of companies consists of a parent company and one or more subsidiaries,
wholly or partially owned. The parent company owns, or controls, more than 50 %
of the voting rights of its subsidiaries. The subsidiary may in turn have control over
other companies, which the parent company then indirectly controls. Figure ius is
an example of such parent-subsidiary relationships. As the figure shows, the parent
company directly owns three subsidiaries, and one subsidiary owns a subsidiary. Thu ,
there is a group within the group.
Most large industrial companies, including most of Sweden's publicly listed com-
panies, are parent companies in parent-subsidiary groups. Since the mid-19oos, there
have been many business mergers and acquisitions in Sweden and around the world.
Economies of scale and synergies in operations, as well as internationalization and glo-
balization of markets, are common explanations for this surge. As a result, the Swedi h
business community has become increasingly concentrated, especially in mature indu .
tries, as companies have bought their competitors and other companies have merged.
The group is a legal concept. Extensive legislation exists related to the creation of
groups, their structure, and their annual financial reports. There is thus an impor-
tant difference between subsidiaries in a group and the divisions in a single company.
A division is an organizational concept. No legislation or mandatory rules govern it
creation or structure.
Group
(consolidated
company)
of voti ng shares
Subsidiary A Subsidiary B
'
Subsidiary D
FIGURE 11.15
A group (consolidated
company).
286 c, THE AUTHORS AND STUDENTLITTERAT

Why do we have consolidation accounting?

fter the notorious Kreuger crash in Sweden in the early 1930s, it was apparent that
A al stakeholders needed more reliable financial information on large business
extern
rou s. Ivar Kreuger, a Swedish industrialist, had created a parent company, Kreuger
~toil, with over 600 subsidiaries. Behind this activity, among other things, was Kreu-
ger's intent to hide ~osses and fabricate profits by submitting false invoices between
companies under his control.
The purpose of consolidated financial statements is to provide the stakeholders
with a clear and comprehensive picture of the entire group. Through transfer pricing
mechanisms and group contributions, a parent company can, in principle, decide where
profits or losses should be recognized in the group. The transactions (e.g., purchases
and ales) between members of the group are eliminated in the consolidated financial
statements. In this way, the entire group (the parent and its subsidiaries) is treated (for
reporting purposes) as one large company.
Legislation also prevents groups from distributing too large sums to shareholders.
Therefore, the consolidated financial statements also provide protection against exces-
e dividends to shareholders who, with a relatively modest capital investment, can
control a large number of companies through indirect ownership.
Consolidated financial statements: the content

Con olidated financial accounting is a very complex field. Here we only briefly describe
main features. The basic principle is that the consolidated annual report, as far as
ible, imitates how the financial statements would have appeared if the consolidated
p,up had actually been a single limited liability company. As mentioned above, this
mean , among other things, that all purchases and sales between the parent and its
idiary companies, and between subsidiaries, are eliminated in the consolidated
inancial statements.
The group's annual report should, therefore, contain the same elements that a normal
pany's annual report does:
consolidated balance sheet

con olidated income statement
administration report
ca h flow analysis (for larger groups).
addition, each company in the group (parent and subsidiaries) prepares its individual
ual report and submits a tax return on its profit. The parent company's individual
cial statements are also included in the group's annual report.
Profits may be transferred between companies in the group if the parent company

PART Ill a THE FINANC IAL SYSTEM
owns at least 90 % of the voting rights of the subsidiaries. This is called the group
con-
tribution. The rules for group contributions are designed so that the group's total tax
liability is not larger than it would have been if the group had been a single com pan
We illustrate this idea in the following example. y.
EXAMPLE
A group consists of a parent company and a subsidiary. The parent company shows a profit of
SEK 500,000 before tax for the year, while the subsidiary shows a loss of SEK 200,000 for the same
year. If the group were only a single company, the profit would have been SEK 300,000. Without
the rules for group contributions, the parent company would have to pay tax on its profit of SEK
500,000 while the subsidiary would owe no taxes. Thus, in that scenario, the total tax liability
would be higher than it would have been without the group contribution. In practice, then, the
parent company can make a group contribution of SEK 200,000 to the subsidiary to cover its loss.
As a result, the parent company shows a profit of SEK 300,000, and pays tax on that amount.
The basic principles behind consolidated financial statements suggest their prepara-
tion is simple and straightforward. In practice, this is not the case. There are special
valuation rules for the consolidated financial statements. The most important rule i
that the parent company's valuation principles are used throughout the group. Thu ,
the subsidiaries' assets and liabilities are recalculated in accordance with how the
parent company values its assets and liabilities. The Annual Accounts Act specifies how
subsidiaries' assets and liabilities should be valued, how subsidiaries' revenues and co t
should be recognized, and how acquisitions of subsidiaries should be accounted for.
Summary
The main purpose of financial accounting is to provide an opportunity for the compa-
ny's stakeholders to assess the company's financial position and results.
One of the most common legal corporate forms in Sweden is the limited liability
company. Almost all large companies (in Sweden and elsewhere) are limited liability
companies, but the majority of all limited liability companies are small. Most limited
liability companies are liable by law to prepare annual financial statement and an
annual report. The annual report should include an income statement, a balance sheet
a management statement, and an auditor's report. The annual report establishe the
company's financial results for the financial year and its financial position at the end
of the year. Financial accounting is regulated by law.
The preparation of financial statements for the annual report includes different types
of processing of, and additions to, the information that is registered in the company
288 <> THE AUTHORS AND STUDENTllTTERA

urrent recording of transactions, for example allocation of income and expenditure,

~luation of assets and liabilities (debts), and allocation to untaxed reserves. The finan-
cial statements also require a number of control steps. Each account in the bookkeeping
records must be reviewed and reconciled. The annual report thus constitutes both
a depiction of the goods/services that the company has delivered in relation to the
re ources consumed (income statement), and a snapshot of the company's assets and
bow these have been financed (the balance sheet). Through a financial analysis you
can also calculate different key ratios, for example earnings ratios, liquidity ratios, and
ratios of financial strength, which can be used to compare the company's development
in relation to previous years, in relation to the industry average or in comparison
with competitors.
Many large companies are organized as a group of companies, consisting of a parent
company that owns one or more subsidiaries. Through transfer pricing mechanisms
and group contributions, a parent company can, in principle, decide where profits
or los es should be recognized in the group. The purpose of consolidated financial
statements is, thus, to give external stakeholders a clear picture of the financial status of
the group as a whole. Consolidated financial statements should therefore eliminate dif-
ferent types of internal transactions, for example trading between different subsidiaries.
Arvidson, P., Carrington, T. & Johed, G . (2016) . Den nya affiirsredovisningen . Liber.
Atrill, P. & McLaney, E. (2014) . Accounting and finance for non-specialists (9 th ed.). Prentice
Hall.
Jerk, J. & DeMarzo, P. (2013). Corporate finance. Pearsons.
Carl on, M. (2004) . Att arbeta med foretagsanalys . Liber.
Danielsson, A. (1983). Foretagsekonomi - en oversikt. Studentlitteratur.
Erik on, G. & Johansson, P. (2015). Att forsta externredovisning - Faktabok. Liber.
i4R:s engelska ordbok (2011). (14 th ed.)
i4R:s samlingsvolym - redovisning (2017 and earlier years).
Grojer, J. E. (2002). Grundliiggande redovisningsteori . Studentlitteratur.
Han on, S. (2006). Extern riikenskapsanalys. Studentlitteratur.
Johansson, C., Marton, J., Pautsch, G . & Johansson, R. (2013). Extern redovisning- faktabok.
Sanoma utbildning.
fobans on, S-E. & Runsten, M . (2017). The Profitability, Financing and Growth of the Firm.
tudentlitteratur.
masson, J. (2011) . Extern redovisning och finansiell analys. Liber.
E AUTHORS ANO STUDENTLITTER ATUR

289
..........................................................................~
············ ~
CORPORATE FINANCE
Most companies need financial capital to run their operations. Capital is needed
to acquire equipment, hire staff, rent premises, purchase raw materials and com-
ponents, engage consultants, and to create a financial safety margin to with-
stand unexpected events. How much capital is required and how that capital is
used vary, depending on the type of business. At any rate, the company must
somehow acquire this financial capital, it needs to be financed . Corporate finance
can be discussed from two perspectives: (1) from the view of the company that
requires capital to conduct its operations; or (2) from the view of the external
ors who provide the company with financial capital by share purchases, loans,
and other forms of financing . In this chapter, we focus on the first perspective. We
analyze how to calculate the capital requirements of a company, how a company
n raise financial capital for operations, and what consequences this might have
.1 Capita l req uirements

most industrial operations, there is a time lag between payments (cash out) and
ipt (cash in). As an example, a company pays for raw materials, these materials are
put into production and finally, the finished products are sold and the company
·ves revenue. Another example is an investment in a new machine that the company
s to use for a number of years. The company pays for the machine at the time of
a e and the machine will then generate cash receipts during a number of years
it i used in the manufacturing of the company's products. There are of course
tions, but generally companies have money (financial capital) tied up in materials,
inery, buildings, work in progress, inventories, etc.
AUTHORS AND STUOENTLITTERATUR 291

PART Ill • THE FINA NCIAL SYSTEM
Some companies tie up extensive capital in fixed assets, such as production pl

ants
manufacturing equipment, and real estate. Examples of such companies are found. '
l In
industries like mining, forestry, pulp and paper, chemicals, telecommunications ,and
power generation. Other companies, such as retailers and wholesalers, tie up most of
their assets in inventories required to provide customers with the necessary goods and
services. Consulting firms, on the other hand, rarely have these types of inventor'1es.
Instead a significant part of their capital is commonly tied up in client projects that
have been carried out but have not yet been paid for (i.e., accounts receivable).
The capital required to run a business thus arises because companies often need to
make large payments in order to produce and sell goods and services long before they
receive payments from customers. Three common types of such capital are:
1 Fixed asset capital:

to invest in assets for permanent use, for example, machinery, equipment, and
real estate.
2 Working capital:
to finance ongoing operations, that is, purchase of various goods and service
used in the production process, such as raw materials, components, and
consumables, and the cost for inventory of finished goods and for products that
have been delivered but not yet been paid for.
3 Safety capital:
to create a buffer to cope with disruptions and unforeseen problems, usually a
liquidity reserve in the form of cash or bank deposits.
Fixed asset capital requirement

The requirement of fixed asset capital is, at least in theory, relatively easy to deter-
mine. Put simply, this capital is equal to the original investment in the classic inve t-
ment calculation.
In practice, however, there are several examples oflarge construction projects that
become significantly more expensive than originally calculated. In addition, major
investment projects are often commercially risky and may take a long time to imple
ment, which means that it often takes a long time before the company begins to receive
receipts (payments from clients) on an investment. It is, among other things, this risk
that companies try to take into account when they establish their cost of capital interest
rate to be used in their investment appraisals.
One way to reduce or eliminate the need for fixed asset capital is to rent, or lease
premises and equipment instead of buying and owning them, thus avoiding the need
to finance a large initial investment. At the same time, these types of solutions might
292 © THE AU T HORS AND STUDENTL iTTERAT

CHAPTER 12 • CO RP ORATE FINANCE
be difficult to identify and they often mean higher overall costs in the long term. In
add I·t·10n, there might be several reasons why a company actually wants to own, and
thereby completely control, its facilities.
working capital requirement

It is not enough, however, just to finance the fixed assets. Companies also tie up capital
in their current assets, that is, in the ongoing operations. The need for this capital
arises because companies often have to make significant cash payments long before
they get paid for goods and services delivered. It takes capital to acquire raw materials
and components, pay wages, rents, etc., and these payments must be made even if the
company has not yet received any receipts from sales of its products. The company must
meet these working capital requirements because of this time lag between payments
and receipts. A lack of working capital, and the subsequent inability to pay the bills, is
one of the most common reasons why companies file for bankruptcy.
An established company, with ongoing activities, can usually finance at least part
of the operations with money from its sales. However, additional financing of parts of
the working capital is often needed since large amounts of capital can be tied up in the
ongoing operations. In companies producing goods, working capital is needed when
raw materials and components are purchased and stored in inventories, during man-
ufacturing of the products (work in progress, WIP), in inventories between production
step , in inventories for finished goods waiting to be sold and delivered to customers,
and sometimes in road transport of goods to customers. In addition, it may take time
before the company is paid. If sales are not made in cash, the buyer usually has a certain
credit time, for example a month, which means that working capital is also tied up in
the company's accounts receivable (i.e., invoiced amounts that have not yet been paid).
Similarly, accounts payable (i.e., the company's unpaid invoices) reduce working capital
Rquirements. This is also true for advance payments from customers.
At the end of the fiscal year, during the preparation of the annual financial state-
ment , it is necessary to obtain an inventory of how much capital is tied up in current
ts, that is, inventories, work in progress, accounts receivable, etc. and the current
bilities, that is, accounts payable and advance payments from customers.
level of capital tied up might thus be significant in many operations. The capital tied
needs to be financed, which in turn often leads to interest expenditures for loans and
r liabilities. Moreover, the capital tied up in production processes, inventories, etc.
s business risks, since materials, components, and products may become obsolete.
E AUTHORS AND STUDENTLITTE RA T UR 293

Many companies, therefore, actively work to minimize the capital tied up in operations
without decreasing production efficiency or the ability to deliver to customers Th· .
· IS IS
called capital rationalization and can be accomplished in several ways, for example:
• by keeping inventories as small as possible
• by having as short lead times in production as possible
• by receiving frequent Just in Time-deliveries from suppliers, instead of keeping
large inventories of raw materials and components
• by producing to customer order rather than selling from an inventory of finished
goods.
Another way is to exercise good business negotiation skills so as to obtain long credit
periods with suppliers and provide short credit periods for customers. In addition, the
billing and payment systems should be designed so that the suppliers' credit terms are
maximized while receipts from customers are received as early as possible.
As a consumer, you might observe how different companies have adapted their
operations to reduce capital tied up. Retail stores such as Lid! and Ikea, for example,
have large parts of their inventories among customers, inside the stores. Many store for
consumer electronics regularly run large advertising campaigns for certain products in
order to sell them before the invoices from the suppliers of the products must be paid.
Another example is designer furniture stores. If you buy an expensive sofa or a dining
room table, it may take several months from order and payment until the furniture i
delivered. Such furniture is usually manufactured to order.
In an industrial company, a large part of the engineering work in production, logi -
tics, and sourcing is focused on material flows and capital tied up. For a long time,
the aim has been to reduce all types of inventory in production as far as possible,
for example by not producing anything until the products are ordered and allowing
component deliveries to arrive just in time, that is, exactly when they are needed, and
by obtaining a rapid flow through the production. Many large corporations, for example
the major automotive manufacturers, have therefore transferred the responsibility for
the inventories of different components to their suppliers.
Consequently, it is important not to tie up more capital than necessary. The efficiency
of capital utilization is typically reviewed and assessed regularly with the use of var-
ious key performance indicators, for example, inventory as a percentage of turnover,
inventory turnover rate (how many times the inventory is sold over a period of time),
average shelf life, average credit times, amount of work in progress, and turnover of
accounts receivable.
294 © THE A UTH O RS A ND STUDENTLITTERAT

CHAPTER 12 • CORPORATE FINANCE
Retail company Manufacturing company Service company
cash/bank cash/ bank cash/bank
+ accounts receivable + accounts receivable + accounts receivable

+ other current assets + other current assets + other current assets
+ raw material
+ work in progress + accumulated project work
+ finished goods inventory + finished goods inventory
FIGURE 12.1
_ accounts payable - accounts payable - accounts payable
Difference of capital tied
= working capital = working capital = working capital up in different types of
operations.
Calculating working capital requirements

Working capital is, by definition, the capital tied up in operations that cannot be
financed using the current (short-term) liabilities (primarily accounts payable). Instead,
this capital requirement needs to be covered by long-term debt and/or company equity.
Worki ng capital is thus defined as follows:
The working capital requirement, of course, differs for different types of operations.
Figure 12 .1 describes where working capital typically is tied up in different companies
and how the working capital requirement can be calculated. Retail companies mainly
have working capital tied up in inventory and accounts receivable, while manufacturing
a>mpanies in addition have much capital tied up in their production processes. Most
ice companies are not as capital-intensive, even though there are exceptions. In
companies, most capital is tied up in work already performed in various client
jects that have not yet been paid for.
We will now briefly describe how to calculate the working capital requirement in a
nufacturing company. The model applies to all types of operations, but a goods-pro-
ing company provides the most comprehensive calculation.
l AUTHORS AND STUDE N TLITT ERA T UR 295

EXAMPLE
Figure 12.2 provides an example of how working capital can be tied up in a manufacturing
company. In this company, capital is, on average, tied up in the following way: raw material is
stored for 45 days, supplier credit time is 30 days, production time is 10 days, finished goods are
stored for 25 days, and the credit period offered to customers is 30 days. Thus, the company does
not receive receipts for the finished goods until 80 days after the raw materials need to be paid for.
Payments (SEK)
I Labor
SEK 200/ unit
I Material
SEK 100/ unit
Raw material inventory Credit to clients

45 days 30 days
- - - - - -- - - - - - _ _ _ __, + - - - - - - - - +
Production Finished
Credit from time goods
suppliers 10 days inventory
30 days 25 days
FIGURE 12.2 Example - Working capital tied up in a manufacturing company.
During the production process, manufacturing costs are allocated to the products, making
them increase in value so that the finished goods inventory is valued much higher than the raw
materials inventory. Having finished products in stock is therefore very expensive. In the example,
the material in the raw materials inventory is worth SEK 100 per product unit while the finished
products are worth another SEK 200 per unit in labor. If the company produces 300 products per
day, we can calculate how much working capital is tied up in these operations. The working capital
requirement can be calculated in two ways: (1) the time method and (2) the balance method.
Fundamentally, the total area under the curve in the figure is calculated and adjusted for the
supplier credit time (which reduces the capital tied up) and then multiplied by the production
volume. A basic assumption in the model is that the value of the raw materials inventory, the work
in progress, and the products in the finished goods inventory are actually matched by payments
of equal amounts.
The company in the example thus ties up SEK 6,000,000 of working capital in its operations. This
means that if it is a newly established company it needs to invest SEK 6,000,000 in payments for
raw materials, wages, etc. before it receives any revenue whatsoever. Alternatively, we might say
that the company continuously needs to achieve a return on its operations that is large enough to
finance working capital of at least SEK 6,000,000 in loans and other capital contributions.
296 c, THE AU T HOR S AND STUDENTL ,TT ERAT I

Time method
Capital tied up= Number of days · Cost per unit· Production volume per day
Days material= (45-30) + 10 + 25 +30 = 80 days
Days work in progress=~+ 25 + 30 = 60 days
Capital tied up material= 80 · 100 · 300 = SEK 2,400,000

Capital tied up work in progress= 60 · 200 · 300 = SEK 3,600,000
CAPITAL TIED UP= SEK 6,000,000
Balance method
Capital tied up= Number of days· Cost per unit· Production volume per day
Raw material inventory= 45 · 100 · 300 = SEK 1,350,000
Credit from suppliers= -30 · 100 · 300 = SEK -900,000
Work in progress= 10 · 100 · 300 + ~ · 200 · 300 = SEK 600,000
Finished goods inventory= 25 · (100 + 200) · 300 = SEK 2,250,000

Credit to clients= 30 · (100 + 200) · 300 = SEK 2,700,000
CAPITAL TIED UP= SEK 6,000,000
Useful formulas
Clpital turnover rate [times/year] = Sales [per year]

Total capital (at year's end [SEK])
Inventory turnover rate [times/year]= Turnover period [365 days]

Average time in inventory [days]
age credit tim e to clients [days]=

Average credit to clients [SEK] . 365 [days] _
Sales [per year] -
Average accounts receivable [SEK]. 365 [days]

Sales [per year]
age credit time from suppliers [days]=

Average credit from suppliers [SEK] . 365 [days] _
Purcha se costs [per year] -
E AUTHORS AND STUDENTLITTERATUR

297
PART Ill a THE FINAN CIAL SYSTEM
12.2 Capital structure

A company's capital structure is of great importance in decisions regarding its financ-
ing. The three main financial sources for a company, in terms of time to maturity, are
the following:
1 equity (including untaxed reserves)

2 interest-bearing liabilities (debts)
3 operational liabilities (non-interest-bearing debts).
A company's equity, including its untaxed reserves, and parts of the interest-bearing
liabilities carry the highest risk if the company defaults. Therefore this capital is often
called risk capital (see Figure 12.3). In Sweden, the term risk capital is sometimes also
used to stress the risky nature of business ventures.
Equity
Equity, that is, the owners' stake in the company, is the basis of the company's capital
structure. Equity includes share capital, the profits brought forward (i.e., earnings
from previous years), and, in a financial context, a proportion (1.0 - tax rate) of, or all
of, the untaxed reserves (previously called adjusted equity and risk-bearing equity).
Equity is the most long-term financing source because it exists as long as the company
exists. The company owners, who supply this specific capital, take the greatest risk in
the event of company default. A default may result in a restructuring of the company or
bankruptcy. In either case, some or all of the equity is lost. As we recall from Chapter
11, which dealt with the company's annual report, in the event of an annual loss, the
loss is first offset by the company's untaxed reserves (i.e., part of equity). Becau e of
the risk oflosing their invested capital, owners also require the highest return on their
investment (in p articular, because of the double tax ation of company profit and of
shareholder dividends). From the company's perspective, when it calculates its cost
of capital, equity has the highest cost of all the financing alternatives. See Figure 12.3.
Share capital (owners' equity)

. It is essential to understand the capital structure of a company if we are to understand
how power is distributed. In a limited liability company, ownership is divided equally
by a system of shares that owners can purchase (and sell).
Shares of publicly listed companies can b e bought and sold freely (not counting
transfer costs) in the financial markets. Shareholders in unlisted companies can place
limitations on how shares can be tr ansferred. All limited liability companies mu t
m aintain a shareholders' register of the names of shareholders and the number of share
298 10 T H E AUTH ORS A ND ST U DE NT LITTERATUl

Equity&
,.-
Assets
Fixed
assets
Liabilities
Equity
Untaxed
-- Adjusted equity I\
------------------ - -----------------------
Risk:bearing
equity
Risk capital
reserves
1Subordinated liabilities
Current
Non-current
liabilities IInterest-bearing liabilities Foreign capital
FIGURE 12.3
assets The company's capital
Current
----r ~perational liabilities -------------- structure.
liabilities
they own. Only shareholders listed in the register are entitled to the stated shareholder
rights (e.g., voting rights and dividend payments).
A company's share capital is the sum of the quota value (previously, nominal value)
of all issued shares. The nominal value used to be printed on the shares; this is no
longer the case in Sweden as share certificates are no longer issued. All company shares
in a given class have the same quota value and the same rights. However, a company
may issue different classes of shares, distinguished by different voting rights, various
dividend preferences, or certain share transfer restrictions .
• In Sweden, shares with different voting rights are usually referred to as Class A
shares and Class B shares. Today, the difference in voting rights between the two
classes cannot be more than 10 times, although older companies may allow larger
differences.
• hares with certain preferences as far as dividends and distribution of assets are
called preferred shares; other shares are called common shares.
• Previously there were also restrictions on share purchases, for instances that only
wedish citizens could buy shares in Swedish companies. These shares were called
restricted shares, as distinct from unrestricted shares that could be acquired freely.
Thi restriction is today very unusual in Sweden.
minimum share capital in a limited liability company in Sweden is currently SEK 50,000, which
lobe evenly distributed among all the shares. The amount per share is called quota value
usly called nominal value). Thus, in a company with SEK 50,000 in share capital, there can
500 shares at SEK 100 or 250 shares at SEK 200, and so on. The quota value is not the same as the
t value of the share, which is the price a buyer of a share is willing to pay.
l AUTHORS AND STUDENTLITTERATUR

299
This division of shares with different voting rights was once common in Sweden given
its industry and ownership structure with large companies and major investors exert-
ing great influence. By issuing different classes of shares, large companies could raise
capital while the major owners still maintained control. Furthermore, shareholders
with preferred shares, and their special rights, could reduce their risk.
Other types of risk capital

A company's risk capital consists of its equity, all its untaxed reserves, and its subordi-
nated liabilities. A typical type of subordinated liability is a convertible loan, which is a
liability that can be exchanged for company shares according to an advance contractual
agreement. In the event of company bankruptcy, it is primarily the financiers who
made interest-bearing loans to the company under subordinate terms who are at risk.
Unlike ordinary interest-bearing debts, subordinated liabilities are ranked below other
liabilities as far as payment in the event of company bankruptcy. Because the lenders
with subordinated liabilities have a lower priority than other lenders, they are at greater
risk. Therefore, they naturally require a higher rate or return (i.e., interest rate) than
the lenders with unsubordinated liabilities, but lower than the share owners.
Although the risk capital involves more than just the equity, the real power in a
company belongs to the owners of the equity: the shareholders. They control the com-
pany - its formation and its operations. Nevertheless, the company's other financiers
often exert a strong influence on the company.
Interest-bearing liabilities
Interest-bearing liabilities are loans in which the cost of capital takes the form of an
interest rate. A company borrows a certain amount of money (e.g., from a bank) and
makes interest payments on the loan. Typically, the bank requires some form of security
for a loan. For example, with mortgage loans, a property can function as security. Thi
means that in the event of a company default on the loan, the bank has the legal right
to the property. Given this arrangement, the bank may set an interest rate that is le
than the owners' required return on their investment.
·Operational liabilities
Operational liabilities (current liabilities on the balance sheet) consist mainly ofliabil-
ities that the company has to its suppliers. Because these types of!iabilities are usually
interest-free, they are the cheapest form of company financing. However, the maturity
dates of operational liabilities are usually quite short (e.g., a few weeks or a month).
300 Cl THE AU TH O RS A ND STUDENTLITTERATUI

Matching of assets and liabilities

A basic principle in all business financing is matching the maturity date of the financ-
ing source to the life of the financed asset. One usually refers to this as matching the
maturity date of a liability to the economic life of an asset. The maturity date is the
payment due date of the loan.
For reasons related to liquidity, the total of a company's most liquid assets - its Cur-
rent assets less Inventories and finished products and Advance payments to suppliers
(see Figure 11.5) - should be greater than the total of its current (operational) liabilities.
That is, the company should have a liquidity position in which its acid test ratio is greater
than 1. Otherwise, the company will likely experience short-term payment problems.
Preferably, the rest of the current assets, i.e., Inventories and finished products and
Advance payments to suppliers, should be financed by medium-term current liabilities.
Other assets (i.e., the fixed assets) should be financed with long-term liabilities, untaxed
reserves, and equity. The ideal balance between financing sources and financed assets
depends on the nature of a company's operations. If the business is capital-intensive
(e.g., the pulp and paper industry), asset financing must be long-term. If the company
produces and sells consumer electronics with frequent launches of new products on
the market, the financing considerations must allow for frequent replacements of pro-
duction equipment as a consequence of the product changes.
12.3 Financing the operations

All the company's purchases affect, more or less directly, the liquid funds . When a
company buys a new machine, cash (a liquid asset) becomes a fixed asset (the machine).
Maintaining a reasonable level of liquid assets is, therefore, a fundamental principle
offinancing. A second fundamental principle is designing an appropriate structure
ofliabilities for the company's operations while still maintaining a reasonable level of
equity. Here, we review the most common sources of financial capital (both internal
are capital and external capital).
Generating capital from operations

'lhe annual profit is a part of the company's equity. This means that a company generates
apital for its operations through its earnings. Self-generated capital is one of a compa-
s most important sources of capital. The terms organic growth and self-financing are
n used to describe this method of capital creation. In a situation where the company
s without any changes in the relation between equity and debt (a constant equity
), it is called growth under financial balance. If a company wishes to maintain
th under financial balance, its total assets cannot grow more rapidly than its
'ty. This means that the return on equity sets the limit for how fast the company
AUTHORS AND STUDENTLITTE RATU R 301

can grow. If the company intends to grow faster, without decreasing its equity rar10,
the owners must make some form of financial contribution.
It is important to observe that a very profitable company does not necessarily gen-
erate surplus cash. Later in this chapter, when we discuss cash flow analysis, it will
become clearer how the company's profit (or loss) and the change in its operational
liabilities are linked. At this point, we will only remark that changes in liquid asset
of course, depend on how the company used its financial capital during the year, and
on how much capital came into the company from various sources (the profit is only
one source). A company that is very profitable one year, and at the same time makes
significant investments in fixed assets, will probably decrease its liquid assets.
Issuing shares
Ifa company is unable to self-generate enough financial capital, for example to increase
the scale of operations, it can seek financial contributions from existing owners and
from potential new owners in the form of share issues. The most common way to
increase the share capital is to launch a new share issue (see Figure 12.4).
A share issue means that a company issues a number of new shares that may be
purchased by investors. Current shareholders have preferential rights as far a the
New share issue:

Liabilities &
Assets Equity
Share capital
Share capital
increases
Cash on hand
increases ~ t--- - ----1
Cash
Issue for non-cash consideration:

Liabilities &
Assets Equity
Share capital
Fixed assets
FIGURE 12.4
New share issues and
Example of /
increase in
fixed assets
"
Share capital
increases
non-cash share issues. for company
302
urchase of the new shares is concerned (this is often referred to as a rights issue). If
~he share price exceeds the share quota value (i.e., the shares are sold at a premium),
this difference is accounted for in the share premium reserve. In practice, most share
issues are sold at a premium.
A share issue of, for instance, 1:3 means that a shareholder who has three shares
before the new issue is entitled to buy one new share at a fixed price. If the shareholder
subscribes to the issue and purchases the new share, he or she then owns four shares.
Investors who are not shareholders may purchase subscription rights from shareholders
who do not wish to subscribe to the share issue.
Share issues may be directed to specific groups, such as the existing owners, or to
specific potential investors, such as pension funds. These types of share issues are called
private placements.
In special cases, the new shares are not purchased with cash but rather with some
formof property. This type of in-kind share issue is called an issue for non-cash consid-
eration (see Figure 12-4). A common example is when a company pays for the purchase
ofanother company with its own shares.
A share dividend (or stock dividend) is a share issue that does not bring any new
financial capital into the company. A share dividend means that non-restricted equity
(i>r instance, profits brought forward) is converted to restricted equity (see Figure 12.5).
share dividend only changes the internal structure of the passive side of the balance
t; there is no change in the total assets or in total equity. A share dividend of, for
tance, 1:2 means that a current shareholder receives one share for every two shares
or she owns (thus, after the share dividend, the shareholder has three shares for every
hares previously owned). A share dividend might be issued because the potential
ncers want to control that the shareholders actually have long-term commitments
the company before they loan the company money. Since it is possible to distribute
unrestricted equity to shareholders, banks and other lenders often require that
e portion of the unrestricted equity must be converted to restricted equity in order
lock it into the company.
A company may also split the shares by reducing their quota value. A possible
n for this action is if the market value of the shares is considered too high to be
Equity
Share capital
Restricted
equity Non-restricted equity
converted to restricted
Non- equity (part of restricted
restricted equity)
FIGURE 12.5
equity
Share (stock) dividend issue.
THORS AND STUDENTLITTERATUR 303

manageable. This procedure is called a share split. In a 1:4 split, for instanc
e, current
shareholders receive four new shares for one old share. After the split the sh h 1
, are oder
has four shares instead of one share.
Unlisted limited liability companies (the vast majority) cannot raise financ· 1 .
ra capital
by selling shares on the public stock exchanges (e.g., the Stockholm Stock Exchan
'T' fi h · · h h · ·
10 nance t eir operat10ns, t ey ave to turn to vanous pnvate equity fir ms . ge).
. . . . . , private
md1v1duals (referred to as busmess angels), foundat10ns, or other institutions. In som
cases, even public agencies and institutions provide capital. e
Borrowing
There are a number of institutions that lend money to companies. Banks, the most
important of these institutions, make both short-term and long-term business loans.
Typically, banks require companies to offer collateral (security) for these loan . Col
lateral may take different forms. One form is a pledge of a specific property, which
means that the lender has the right to that asset and may sell it if the borrower cannot
repay the loan. Most banks have relationships with different types of corporate finance
companies. Such companies can act as lenders in specific situations, for example, when
a company needs to extend credit to its customers. Other actors in the credit market
are insurance companies.
In consolidated groups, the parent company may lend money to its sub idiari
These loans are generally subordinated liabilities. Even if these loans are not legally
subordinated, the parent company may, for moral reasons, treat them as subordinated.
Large companies may also issue bonds as a way to raise financial capital. A larp
bond issue (bond loan) is divided into a number of equal bonds at, for example, EK
1,000 each. The company agrees to pay the bondholders a fixed rate of interest at fixed
dates every year. Typically, bonds are secured by a mortgage on a specific property.
Except for the supplier liabilities (accounts payable), the company's short-term loam
are mainly bank loans. One example is a checking account; a variable credit that can
be used up to a specified maximum limit. Because these types of checking accoun
may continue for several years, they are sometimes listed in the company's long-term
liabilities on the balance sheet.
In addition to the collateral terms, other loan terms are the interest rate, the maturity
date of the loan, and the interest and principal payment conditions. These conditiODI
are determined in negotiations between lenders and borrowers. Loan repayment IDaJ
be structured in different ways. For example, the loan may either be amortized uc
sively over its life (each payment consists of one part principal repayment and one
interest), or the entire loan may be due in a lump sum at the maturity date. The e te
depend on a number of factors, including the kind of company applying for the I
A small engineering company probably has little room to negotiate a bank loan
304 © THE AUTHORS AND STUDENTLITTEI

CHAPTE R 12 • CORPORATE FIN A NCE
. r bank. On the other hand, when a large global corporation raises capital, there
};be a number of banks competing to offer loans. In this situation, the company
an advantage in the loan negotiations.
pff-balance-sheet financing
the modern era of corporate finance, companies can also finance some of their
rations in a way that avoids balance sheet recognition. This is referred to as off-
t,u,nce-sheet financing. The most commonly used forms are the following:
factoring means that the company has borrowed against its invoices (its claims
to payment from customers). The invoices are the collateral. In practice, the
company exchanges its invoices for cash (at a fee).
Leasing is an alternative to borrowing money, especially for production
equipment. The company enters into a lease contract with a financial institution
that purchases the equipment and then rents it to the company.
Sale/leaseback is similar to leasing. In this scenario, the company sells an object
e.g., a production plant or a building) to a financial organization and at the same
time promises to lease the object for a specific time period. The financial risk (as
well as the possibility of an increase in the object's value) is transferred to the
financial institution.
Outsourcing is both a way to finance part of a company's operations and a way
to manage its operations. Outsourcing basically means that a company pays
another company to conduct various aspects of its operations (see Section 3-4). To
outsource services such as printing, copying, or cleaning has been common for a
long time, but it is becoming increasingly common that many technology-based
companies also outsource parts of their production process to suppliers special-
izing in manufacturing. The financial objective of outsourcing is often to reduce
costs as well as capital tied up in fixed assets.
Cash flow analysis

cash flow analysis allows us to see how a company was financed and how the finan-
capital flowed through the company during a specific year. The analysis reveals the
ionship between company performance (its profit or loss) and the cash with which
id its invoices, etc. Cash flow analysis also allows us to distinguish between the
any's internally and externally generated cash and to identify its working capital
irement (raw materials, products in process, inventories, and accounts receivable),
its fixed asset capital requirement (machinery, buildings, etc.). See Section 12.1.
addition to the balance sheet and the income statement, large and/or listed

limited liability companies are also required to present a cash flow analysis in their
annual reports. The structure of the cash flow analysis is not formally specified in
detail. Swedish Institute of Authorized Public Accountants (Foreningen Auktoriserade
Revisorer, FAR) has, however, a standardized template for the cash flow analysis that
most Swedish companies use.
The cash flow analysis is useful for understanding changes in a company's capital
structure. Sometimes another format than the recommended FAR template may be
preferred, for instance when making financial forecasts. Whereas financial analysis
is made after-the-fact, financial forecasts are made in advance, for example, in order
to calculate how much capital to raise or how many shares to issue. In such cases, the
company needs to forecast changes in working capital and its Funds Utilized and Funds
Provided (cf. the presentation in Figure 12.6). Based on this information, the company
can make the relevant decisions on borrowing and share issues.
A - FUNDS PROVIDED
From the year's operations internally generated funds X
Sale of fixed assets X
Decrease in non-current (long-term) receivables X
New share issues (and other financial contributions)
Increase in non-current (long-term) liabilites
Total funds provided
B - FUNDS UTILIZED
Investments in real estate, buildings, machinery, and equipment
Investments in shares and bonds
Increase in non-current (long-term) receivables
Decrease in non-current (long-term) liabilites
Dividends to shareholders
Total funds utilized
CHANGE IN WORKING CAPITAL (A - B)
CHANGE IN WORKING CAPITAL, IN DETAIL

Increase(+)/ decrease Hof inventories
Increase(+)/ decrease Hof current (short-term) receivables
Increase(+)/ decrease Hof liquid assets
FIGURE 12.6 Increase H /decrease(+) of current (short-term) liabilities
Statement of cash Aow
(TOTAL X - TOTAL Y) =
presentation per FAR's CHANGE IN WORKING CAPITAL
recommendation.
Cl THE AUTHORS AND STUDENTLITT

306
Preparing a cash flow analysis

lhe first step in preparing a cash flow analysis is to determine the internally generated
funds from the company's operations (see Figure 12.6). This is calculated based on the
profit before appropriations and tax from the income statement. The year's depreciation
(a non-cash expense on the income statement) is then added. Looking at the balance
sheet, we can see that depreciation reduces total assets through the accumulated depre-
ciation account. At the same time, the liabilities are reduced since the year's profit is
reduced by the same amount.
lhe second step is to determine the other items under the heading Funds Provided.
lhis involves determining the inflow of cash from the sales of fixed assets (e.g., build-
ings and machinery), from the decrease in long-term receivables (e.g., collections on
ca h loans to other companies), from new share issues and other financial contribu-
tions, and from the increase in non-current (long-term) liabilities. These amounts are
added to derive the company's Funds Provided.
The Funds Utilized is then determined in a similar way. In this section, we list the
cash outflows from purchases of fixed assets (e.g., buildings and machinery), from
investments in shares and bonds, from the increase in non-current (long-term) receiv-
ables, from the decrease in long-term liabilities, and from the dividends to sharehold-
. These amounts are added to derive the company's Funds Utilized. The difference
between the Funds Provided and the Funds Utilized is the change in working capital
i,rthe year.
Finally, the change in working capital is analyzed in detail. This involves adding/
tracting the changes in various working capital accounts (e.g., inventories, current
rt-term] receivables, other liquid assets, and current [short-term] liabilities). If the
flow analysis is prepared correctly, the change in working capital will be the same
the difference between the Funds Provided and the Funds Utilized. An alternative
to organize the cash flow analysis is shown in figure 12.7.
It is important to note that a company's liquidity (i.e., cash on hand) does not nec-
rily increase with an inflow of new capital (Funds Provided). The amount of the
'd as ets also depends on how much of the cash is used (Funds Utilized) and how
other working capital accounts have changed. For example, if a company makes
, long-term investments and increases its inventories, the company's cash on hand
decrease even if it has new cash injections.

+ Operating revenues
+
Operating costs (excluding depreciation)
Financial revenues
Financial costs
} Internally
provided funds
Cash flow
from operations
-/+ Increase/Decrease of inventories
-/+ Increase/Decrease of current receivables
-/+ Increase/Decrease of liquid assets
-/+ Decrease/Increase of current liabilities
} Changes in
working capital
}
Closing Balance: fixed assets
}
+
Changes in Cash flow
+ Depreciation during the year
fixed assets from investments
Opening Balance: fixed assets
Changes in
-/+ Increase/Decrease of non-current receivables }
l
non-current receivables
-/+ Decrease/Increase of non-current liabilities and liabilities Cash flow
from financing
FIGURE 12.7
Alternative way to organize +
Dividend (to shareholders)
Additional capital (new share issue)
} Changes in
equity
t he cash flow analysis .
12.s Financial risks

All financial activities involve risks. Investors who buy shares in a company ri k lo mg
their investments if the company defaults (e.g., enters bankruptcy). A lender who has
made an interest-bearing loan to a company is at less risk if collateral has been pledged
as security, but can still lose a substantial amount of the loan. The risks associated wtth
financing a company can be classified in two types:
• operational risk
• financial risk.
A general rule is to avoid investments that combine high operational risk and higll
financial risk.
0 THE A UTHORS AND STUDENTLITTE

308
CHAPTER 12 a CORPORATE FINANCE
Operation al risk
0 erational risk, or business risk, derives from the company's operations (e.g., inno-
v?tive operations in an emerging industry, or traditional manufacturing of products
for a mature market), the character of the operations (e.g., cyclical demand, highly
competitive, or politically sensitive), and the company's cost structure and capital tied
up. An analysis of operational risk can be made on the basis of the following:
• content and character of operations
• cost structure
• capital tied up.
Key performance index for operational risk

Operational risk can be measured by the return on total capital, ROT, calculated over
several years. For a company with high operational risk, ROT may vary greatly on an
annual basis.
It is important to remember that the return on total capital is a company key perfor-
mance index. It is not an objective in itself. A company's long-term objective is always
that its operations will provide as much return on equity as possible. This objective is
applicable to the company as a whole. For different parts of the company operations,
thi measurement is less relevant. A department head, for example, has very limited
ability to influence the return on total capital or equity, even if his or her actions
uence the company performance and its return.
erational risk: the influence of company activities and character

us take the pulp and paper industry as an example of how a company's activities
dcharacter affect its operational risk. This industry is sensitive to both domestic and
rnational influence. In the last 20 years, the domestic political pressure to reduce
is ions such as sulphur dioxide has clearly influenced certain industrial investments.
reover, the pulp and paper industry, as a high-export industry, is subject to foreign
'tical influence. Fluctuations in the currency exchange rates are also important for
hinery and other purchases, and for foreign sales (some of which are marked in
dollars). In short, the operational risk in the pulp and paper industry is significant
ough this risk is compensated by a lower financial risk).
ational risk: the influence of cost structure and capital tied up

way to analyze operational risk is to study a company's cost structure and use
ital by applying the DuPont Chart (named after the U.S. chemical company du
de emours). Figure 12.8 presents the DuPont Chart, in which the return on total
I varies with the company's cost structure and capital tied up.
309
PART Ill a THE FINANCIA L SYSTEM
Financial
revenues
Turnover
} plos
Contribution Net profit/
minus
}
margin loss
Variable Profit margin
minus divided by
costs
Fixed Turnover
costs times Return on total
capital, ROT
/'
Cost structure influences
Turnover }
L. ·d Total capital's
1qu1 assets } divided by turnover rate
Accounts receivable
_ _Inventories
_ _____ Total c\apital
FIGURE 12.8
Fixed assets
The DuPont Chart. Capital tied-up influences
The DuPont Chart reveals how effectively the company's assets are used in their
entirety, and how both the capital tied up and the cost structure influence the return
on total capital. Note that no accounts from the liabilities side of the balance heet
are components in the chart. The DuPont Chart describes the company's efficiency
independently of its financial funding.
Financial risk
Financial risk focuses on how financial changes affect company operations. An analy IS
of financial risk can be made on the basis of the following:
• leverage risk
• liquidity risk
• loan duration, interest rate risk, and currency risk.
Leverage risk
Financial risk is often expressed in terms of a number of key ratios. The ratio that
typically used in financial analysis to measure leverage risk is the equity ratio or
debt/equity ratio. See Chapter 11 for the definitions.
The equity ratio, which measures the relationship between equity and total c
(i.e., total assets), is a measure of a company's ability to self-finance its operation ·
ratio can be used to express how much of the company's total capital is provided
310 10 THE A UTHORS AND STUDENTLITTE

CHAPTER 12 • CORPOR ATE FINANCE
the owners and how much is provided by other actors. A common interpretation of the
ratio is that it measures the company's ability to survive in the long term.
In English-speaking countries, instead of the equity ratio, the debt/equity ratio is
used. This ratio is essentially similar to the equity ratio, although it is calculated dif-
ferently. 1he liabilities are related to the equity (see box "Leverage equation").
Leverage equation
D
ROE= ROT+ (ROT - RL) · E
ROE= return on equity

ROT= return on total capital
Iii.= average interest rate on liabilities
D . . liabilities
_=debt/equity ratio= --.-t-
E equ1 y
The leverage equation, which is used to measure financial risk, shows the relationship
between a company's debt/equity ratio, its return on total capital and equity, and its
,verage interest rate on its liabilities. A company that has high debt/equity ratio (DIE)
according to this formula will have a high return on equity so long as the return on
total capital exceeds the average interest rate on the liabilities (in the formula: ROE
large ifD/E is large, provided that a ROT> RL). High DIE can be used as a lever to
ate a high return for the owners. At the same time, of course, the risk to the return
equity is that high DIE can quickly lead to large negative values if the return on
tal capital is less than the average interest rate on liabilities (in the formula: ROE
n negatively quickly ifD/E is large, provided that ROT < RL)- With lower leverage
higher equity ratio) the leverage effect is less noticeable, but it also reduces the risk
a negative impact on ROE (see the example).
let us take a simple example to analyze the leverage effect. Suppose a company has sales of SEK
110million, no financial revenues, variable costs of SEK 60 million, fixed costs (excluding interest
ts} of SEK 40 million, total assets of SEK 100 million, total equity of SEK 15 million (Total liabilities
Total assets - Equity = SEK 85 million). and an average debt interest rate of 7 %. In other words,
company has a relatively high debt/eq uity ratio (a low equity ratio).
We begin our analysis using the DuPont Chart, as follows:

Turnover:
}
110
Contribution
minus
} }
margin: 50
Variable Net profit:
minus
costs: 60 10
Fixed Profit margin:
costs: 40 divided by 9.1%
Turnover:
110
times
Turnover:
110 } Total capital's

d1v1ded by turnover rate:
1.1
Total capital:
FIGURE 12.9 The values
100
inserted in the DuPont Chart.
The DuPont Formula calculates:
ROE (after tax)= (100 % - tax rate) · [ROT+ (ROT - RL) · ~] =
= (100 % - 22 %) · [10 % + (10 % - 7 %) · 85 1=21,1 %

15
Now let us see what a decrease in sales of 10 % would mean in terms of a leverage effect. We
assume that the variable costs follow the decrease in sales, that is, the variable costs also decrease
by 10 %. We begin as above with the DuPont Chart:
Turnover:
99
minus } Coo<db,<ioo
}
margin: 45
Variable Net profit:
minus
}
costs: 54 5
Fixed Profit margin:
divided by 5.1 %
costs: 40
Turnover:
99
times
Turnover:
99 by
divided ~ Total capital's
turnover rate:
0.99
Total capital:
FIGURE 12.10 The new values
100
inserted in the DuPont Chart.
() THE AUTHORS AND STUDENTL

312
The DuPont Formula calculates:

85
ROE (after tax) = (100 % - 22 %) · [5 % + (5 % - 7 %) - 15]= -4.9 %
The example shows that even a relatively modest change in the company's revenues can have a
powerful leverage effect if the debt/equity ratio is high.
In summary, the leverage equation says that the relationship between liabilities and
equity influences the return on equity, but also the possibility of borrowing money.
A large amount of equity makes it more difficult to recoup capital than a smaller
amount, but at the same time it poses a lower credit risk.
Liquidity risk
Liquidity risk reflects a company's ability to pay its current liabilities in the short term
(i.e., the acid test ratio of parts of the current assets in relation to current liabilities).
See Section 11.6 for the exact definition.
A company with a poor acid test ratio may have problems in the short term with
paying its invoices, salaries, etc. Although the company may be healthy otherwise,
and have a high equity ratio, the lack ofliquidity is one of the most common causes of
Joan defaults and bankruptcies. A supplier who does not receive payment for invoices
can bring bankruptcy charges against its customer. Such a supplier will be given a
higher priority in the repayment list in relation to many other lenders if the company
in question actually enters bankruptcy.
It is essential that companies maintain control of their liquidity. For analysis of
everyday activities, of course, the liquidity ratios need to be supplemented with a
numberof other tools and techniques. Since a company's cash position can change very
quickly, payments must be scheduled, necessary new loans arranged for in advance,
and so on. In major companies, cash management is one of the most important respon-
ilities of the company's Chief Financial Officer (CFO).
aturity date, interest rate risk, and currency risk

oavoid a shortage of cash (or, on the contrary, accumulating too many non-interest
ing assets), companies need to match the maturity dates of their assets and liabili-
•By matching, we mean that when financing the acquisition of an asset, the liability
uld be due about the same time as the asset's economic life is expected to end. This
the debt-maturity principle, which is fundamental in financial risk taking.
Because loan interest rates vary over time, a company that borrows money is exposed
1 certain interest rate risk. Generally, the company has the option of choosing
een a variable rate of interest and a fixed rate of interest. If a significant amount

PART Ill a TH E FIN AN CIAL SYSTEM
of a company's liabilities (debts) carries a variable rate of interest, the company might
see its financial expenses fluctuate considerably in a short period of time.
A company is also exposed to currency risk. Currency fluctuations can influence
both the cash situation and profit. Companies can protect themselves from this risk b
buying a currency hedge, which is generally a financial instrument (a forward or futur:
contract) that allows the company to buy a specific foreign currency at an agreed-on
price at a certain time (or in a certain time period). Of course, currency fluctuations can
also be positive. For example, if a Swedish exporter sells products abroad, priced in a
foreign currency, and the value of the Swedish krona has fallen relative to that currency
when the payment is received, the Swedish exporter's profit will increase (in SEK).
12.6 Two sides of financing

In this chapter, the topic of financing has been discussed primarily as an internal matter
of the company. However, there is another side to finance. A company's financier
(investors and lenders) take an interest in how the company manages its corporate
finances. Financiers often have several investment/lending options, and can choo e
among companies. They may even choose not to invest in, or lend money to, a company.
Besides equities, other options are debt securities (e.g., bonds or certificates of depo it)
or commodities (e.g., gold, oil, or pork bellies).
For instance, a company may plan to finance a major investment with long-term
loans as well as with a new share issue. Because of the competition from other inve t·
ment options, the company must present itself as trustworthy and responsible. There
fore, the company must provide detailed information about the new share issue and
the operations. In this way, investors receive information on which they can base their
decisions. What is perceived as a way to finance the operations for the company 1
perceived as a capital investment of the actor contributing capital. In this way, the
financial market is linked to the company's need for funding. In order to protect the
investors, there are legal requirements in most countries, including Sweden, about the
presentation and distribution of this kind of information.
Thus, all corporate financing rests on two pillars: control and risk. Investors who
want control over a company take a greater investment risk than those who do not.
However, the investors who exert control are able to influence the company's operat10DI
and direction. In this position, they will achieve higher returns on their investments
if the company is successful.
314 c, THE AUTHORS AND STUDENTLITTE

CHAPTER 12 • CORPORATE Fl NANCE
summary
Most companies need financial capital to carry out their operations, since they usually
have to make large payments to enable the production of their products long before they
receive payments from customers through sales. There is a distinction between fixed
asset capital (needed to invest in assets for permanent use), working capital (needed
to finance ongoing operations), and safety capital (needed as a buffer to manage any
disruptions that may occur).
A company's capital structure shows how the company is financed and can be
divided into three parts: equity (including untaxed reserves), interest-bearing liabilities
(debts), and operational liabilities (non-interest-bearing debts). The company's equity
(including untaxed reserves) constitutes, along with parts of the interest-bearing lia-
bilities, its risk capital. It is called risk capital because it is the owners of the risk capital
who run the greatest risk oflosing their invested capital in the event of company default.
Most companies work actively with their financing, not least because all purchases
made by the company affect the liquid funds. Maintaining a reasonable level ofliquid
as ets is, therefore, a fundamental principle of financing. A second fundamental prin-
ciple is designing an appropriate structure ofliabilities for the company's operations
while still maintaining a reasonable level of equity.
Self-generated capital is the company's most important source of capital. Terms often
used to describe this method of capital creation are organic growth and self-financing.
hen the company grows without a change in the relation between its equity and its
liabilities, it is called growth under financial balance. If a company wishes to maintain
growth under financial balance, its total assets cannot grow more rapidly than its
equity. If the company intends to grow faster, without decreasing its equity ratio, the
owners must make some form of financial contribution. Cash flow analysis is a way to
analyze how the company has been financed during a certain period of time.
All forms of financing include risks. The company's operational risk depends on the
a>ntent and character of its operations, as well as its cost structure and capital tied up.
'lhe company's financial risk depends, among other things, on its debt/equity ratio,
s to liquid funds, and changes in interest rates on liabilities and currency exchange
s. An important rule for most companies is to avoid investments that combine high
rational risk and high financial risk.

References
Atrill, P. & Mclaney, E. (2014). Accounting and finance for non-specialists (9 th ed.). Prentice
Hall.
Berk, J. & DeMarzo, P. (2013). Corporate finance. Pearsons.
Brealey, R. A., Myers, S. & Allen, F. (2011). Principles of corporate finance: global edition
(10 th ed.). McGraw-Hill Irwin.
Broberg, 0., Francke, L., Furusten, K., Lindgren, H. & Petersson, T. (2014).
Foretagsfinansiering: fran sparbankslan till derivat. Studentlitteratur.
Danielsson, A. (1983). Foretagsekonomi - en oversikt. Studentlitteratur.
De Ridder, A. (2003) . Finansiell ekonomi. Norstedts juridik.
FAR:s engelska ordbok (2011). (14 th ed .)
Greve, J. (2003). Modeller for finansiell planering och analys. Studentlitteratur.
Hansson, S. (2009). Aktier, optioner, obligationer. Studentlitteratur.
Hillier, D., Ross, S., Westerfield, R., Jaffe, J. & Jordan, B. (2016). Corporate Finance: European
edition (5 th ed.). McGraw-Hill Higher Education.
Johansson, C., Marton,)., Pautsch, G. & Johansson, R. (2013). Extern redovisning- fak tabok.
Sanoma utbildning.
Johansson, S-E. & Runsten, M. (2017). The Profitability, Financing and Growth of the Firm.
Studentlitteratur.
Koller, T., Goedhart, M. & Wessels, D. (2015). Valuation: Measuring and Managing the Value
of Companies (6 th ed.). McKinsey & Company Inc & Wiley Finance.
Robinson, T., Henry, E., Pirie, W. & Broihahn, M. (2015). International Financial Sta tement
Analysis. Wiley.
Thomasson, J. (2011). Extern redovisning och finansiell analys. Liber.
,:, THE AUTHORS AND STUDENTLIT l

316
•....•.•.•..•••.••••••••••••••••••.........................•................. ~
·········· ~
MANAGEMENT ACCOUNTING
AN D FINANCIAL CONTROL
Needless to say, all types of financial operations have to be directed towards the
objectives which have been set by the owners and management. Most companies
have a number of formal systems to help them manage and control the business
efficiently. There are many methods and tools to formulate financial objectives
for the whole or for different parts of the company and to measure and analyze
how the operations are run in relation to objectives and strategies. In this chapter,
we look at the financial control of companies and some of the most common
methods for such control and for analysis and assessment of company efficiency.
u.1 Financial control

Financial control is about managing the company's operations so that the financial
objectives formulated by the company owners and management are met. There are dif-
ferent types of financial control and it can be performed by different members of staff.
An important part of financial control is, thus, to encourage all members of staff to act
such a way that their individual actions contribute towards the common objectives.
There are many different means of control and tools to use for financial control.
me are formal means of control which have been decided by the company. This
ude , for example, budgets; standardized methods for how to make product cost
ates and capital investment appraisals; principles for measuring and allocating
, revenues and performance; as well as different reporting routines. The way the
pany is structured, that is, the organizational structure which specifies how (finan-
) responsibility and powers are distributed, is another method to achieve financial
I. Less explicit tools, informal means of control, are also important, for example
al work procedures or a company culture which has been established over time
which influences the staff's behavior in a certain way.

Staff often encounter the company's financial control system indirectly. In large
companies, there are usually rules for which methods to use for product costing (Chap-
ter 8) and capital investment analysis (Chapter 9) and how these methods should be
applied in different situations. The company's choice of costing methods, allocation
bases, the size of the overhead charges and cost of capital interest rate are a few examples
of important decisions which have financial consequences and which have a bigger
influence on the staff's behavior than you might think.
Financial control
"Financial control can be defined as the process to identify, measure and communicate
valuable financial information which enables well-founded appraisals and decisions by users of
information."
SOURCE: KULLVEN 2015, TRANSLATED BY THE AUTHORS
So, how can you tell if a business is efficient or productive enough to be profitable? To
answer this question requires continuous control and follow-ups of the operations
so that it is possible to study changes over time. You also need to set up measurable
targets and take action for these targets to be met. Setting up these targets, working
out suitable numerical values and carrying out routine verifications and analyses are
important parts of the company's financial control system.
13.2Distributing responsibilities and measuring

performance
Important aspects of managing a company relate to the distribution of responsibilitie
and powers in the organization and how to measure the performance of the different
business units and departments. "You get what you measure" is a classic motto which
is frequently applied by many corporate management teams. By introducing different
financial performance targets in different units, management aims to control them
towards a desired behavior. Based on the financial responsibility of the company'
units, they can be divided into four different types:
• cost center
• revenue center
• profit center
• profitability center
A cost center is a unit which is responsible for its own costs, but which does not
any revenue. Thus, the cost unit cannot declare a profit. Production department
usually typical examples of costs centers. They can influence their own co5t b)I
C> T HE AUTH O RS AND STUDENTLITTl

318
CHAPTER 13 • MANAGEMENT ACCOU NTING AND FINANCIAL CONTROL
example, producing items more efficiently or reducing waste. The cost responsibility
can, for example, be defined as the production unit being granted to consume a certain
sum per month, usually in terms of a cost budget which the unit cannot exceed. Often
the manufacturing cost of each individual product is specified beforehand.
A revenue center is a unit which is responsible for the sales of the company's products
and for the resources required to manage sales. A typical example is a sales department,
which affects the revenue of the entire company but only answers for its own costs.
Thus, the revenue center cannot declare a profit. The responsibility of the sales unit
can include sales targets in terms of a certain level of sales per month or week. This
can then be broken down to personal intermediate targets for the different salespeople,
who often have a type of performance salary or bonus in relation to their sales volume.
A profit center is responsible for both its costs and revenue. Thus, the most important
thing is not the size of the unit's costs or revenue as such, but the difference between
the two (profit = revenue - costs). Today, profit centers are sometimes referred to as
business units, which have more free rein to run operations and might not have to
adhere to cost and revenue levels set in advance. The profit center can choose to try
to increase revenue to reach the performance target, or settle for a fixed revenue level
and try to reduce its costs.
A profitability center is an organizational unit which needs to maintain a certain
profitability. This means that the unit should create return on the capital which has
been invested in the unit in terms of machines and such like. In large companies,
divisions and subsidiaries are often examples of profitability centers. In principle, these
types of units function as "companies within the company". These units are usually
managed through targets for profitability and for return on capital as well as different
strategical business objectives set out by company management. Management does not,
however, interfere in the details of the division's or the subsidiary's operations. Often, a
profitability unit is responsible for the product and business development within their
area, as well as different types of investments.
13.3 Management accounting

In order for financial control to work, especially in big companies, a large amount of
information needs to be collected and processed. In most cases, this cannot be achieved
by the financial accounting system (see Chapter 11), which is aimed mainly at external
eholders. To be able to follow up on the company's operations, it is not enough to
Yrecord transactions between the company and its external stakeholders. It also
uires different types of data about internal affairs. For these reasons, companies
use a management accounting system, where financial accounting is supplemented
a follow-up on internal events and where it is possible to make continuous com-
ns with different goals and budgets.
AUTHORS ANO STUOENTLITTERATUR 319

For a manufacturing company it might be important, for example, to know how

many products the company has manufactured during a certain period and how much
it has cost to manufacture these specific products. Thus, in order to answer these types
of questions, the company needs to record how much has been produced of each prod-
uct and the resource consumption of each product in terms of materials, labor costs, etc.
In the same way, most large consulting firms measure their employees' "coverage
rate", that is, the number of working hours that each employee spends on client projects
which can be invoiced, and the number of hours they spend on other types of internal
work tasks within the company.
Management accounting - a reflection of the company's

operations
The basic idea of management accounting is to express the company's operations in
monetary terms, that is, translating activities into numbers. This way, the company
will get information about, for example:
• the company's costs of producing different goods or services
• the profitability of different products, products groups, and markets
• the efficiency of different departments.
Financial accounting (see Chapter 11) includes the company's external financial tran -
actions, for example, the registration of an incoming invoice. Management accounting,
however, also keeps a record of internal events in the company. Most large companie
apply, for example, some form of internal charge and transfer pricing, which mean that
you create fictive, internal trade between the different departments of the company. Thi
FIGURE 13.1
The value-added process in
a manufacturing company.
320
CHAPTER 13 • MANAGEMENT ACCOUNTING AND FINANCIAL CONTROL
wa, Y the different departments pay, for example, internal rent for their facilities to the
company's property management department and an hourly rate to the IT department
when they need IT service.
In manufacturing companies, management accounting reflects the production pro-
cess since the production costs together with the overhead charges are added gradually
to the cost of the product as it is being manufactured. To achieve this, however, you need
to record when the material is moved from the inventory, via different manufacturing
steps, to the finished goods inventory and, as a final step, to the customer (see Figure
13 _1). (It is these principles that form the basis of the arguments behind capital tied up
and working capital requirements in Chapter 6 and Chapter 12).
As long as the material has only been moved between steps in the manufacturing
process within the company, it has not been consumed, that is, no costs have been
incurred (as no resources have been consumed). In practice, the assets in the company's
raw materials inventory have reduced, while the assets of work in progress (WIP) have
increased. When the manufacturing is complete, the work in progress will consequently
reduce as well, while the assets in the finished goods inventory will increase.
A management accounting system which is organized in accordance with Figure
13,2 makes it possible to follow the flow of the resources through the company. In order
to obtain these data, each movement of the materials needs to be recorded in different
accounts. Naturally, the same recording needs to be applied to other resources as well
(e.g., labor, machines, and energy) if management accounting is to be used for fol-
low-ups. That the assets are moved between different asset accounts in the accounting
sy tern shows that they remain within the company and finally end up in an asset
account for the finished goods inventory. It is not until the asset, in this case the prod-
uct, leaves the company in connection with a sale that the actual resource consumption,
that is, the cost ofgoods sold, appears in the financial accounting system.
Asset account: Asset account:

Expenditure account: Raw materials Asset account: Finished goods Expenditure account:
Materials inventories Work in progress inventories Cost of goods sold
- I FIGURE 13.2
The value of resource
Purchased raw Moved to the asset Moved to the Moved to the
materials is an
consumption, as
account Work in asset account expenditure
asset in the progress as Finished goods account Cost of exem plified by the
Raw materials materials are put inventories when goods sold when movement of materials
Inventories into production production is the products in co nnection with the
completed are sold
manufacturing process.
f AUTHORS AND STUDENTLITTER ATUR 321

PART I ll • THE FIN ANCIAL SYSTEM
Measuring what is important

Management accounting should, thus, reflect the company's operations. In practice
this means that the management accounting system should be designed so that it i~
easy to measure and follow up on what is considered important for the company, oth-
erwise problems will arise. For example, if a department is a cost unit, the management
accounting system needs to be designed to support this and to measure performance
in a way that the department can influence. A manufacturing department can , 1or c
example, influence the consumption of materials and components, but rarely the price
for procuring these materials and components. A purchasing department which is in
charge of acquiring materials and components at a minimum price, on the other hand
usually cannot influence the consumption of the material and components. The per for~
mance of these departments therefore needs to be measured and assessed differently.
Connection to product costing

When the methods of product costing were described in Chapter 8, we looked at how
the overhead charges first are calculated and then used to make different product
cost estimates. One of the most important applications of these cost estimates is that
they allow the company to calculate the costs of a certain product in advance, using a
so-called ex-ante estimate.
In order to determine the accuracy of the ex-ante estimates, companies later create
an ex-post estimate. While the preliminary estimates are based on fixed charge and
transfer prices, the ex-post estimates show the actual costs. In order to improve future
ex-ante estimates, it is important to analyze the differences between the pre-estimated
values and the actual result. Analyses of these types of discrepancies are an important
part of financial control, particularly in manufacturing companies. One of the pu rpo es
of management accounting is precisely to provide data which enable analyses like these.
Connection to other information systems

Management accounting, thus, measures and records the performance and the resource
consumption in the company. These data can be partly collected from the accounting
system but they often need to be supplemented by data from other systems, for example
drawings, manufacturing plans and other documents that describe how different prod
ucts are designed and manufactured. In large companies today, the accounting sy tern
and the other systems are connected in enterprise resource planning systems where all
subsystems are updated automatically whenever something is recorded in any of the
systems. This of course facilitates recording, which still is a fairly comprehensive task.
So how does the recording work? We can use a manufacturing company a an
322 O THE AUTHORS AND STUDENTLITTERA

CHAPTER I 3 a MANAGEMENT ACCOUNT ING AND FINANCIAL CONTROL
example. If the company produces unique products to customer order, the operators
simply record the working hours, machine hours, materials and so on that are needed
to produce each order. In a company that mass produces standardized products, the
rocedure is a little different. In order to extract the same data, this type of company
~ ically uses manufacturing documents in the form of bills of materials and operation
c:~ds. This means that the time recorded for a manufacturing operation does not
necessarily correspond to the actual time of the operation but the time specified on
the operation card (i.e., the expected time of the operation). What is recorded in the
accounting system is, thus, a predetermined value of the use of working hours, machine
hours, etc., which is in proportion to the number of units manufactured.
The proble ms with management accounting

Management accounting, thus, aims to follow up on internal processes and this is done
by translating resource consumption and performance into monetary terms, that is,
everything is expressed in money. At the same time, this is one of the main objections
to management accounting. Since the company's internal operations are not carried out
by different units freely doing business with each other in a market, much of the data
m the management accounting system become fictive and are a fairly poor reflection
of the actual conditions. The company's actual costs of the resource consumption and
the actual performance of the company can only be measured when the transactions
involve external actors, that is, when the company pays for resources or receives pay-
ments for its performance. Even though management accounting may seem like an
exact monetary depiction of the company's operations, it is, in practice, only a rough
estimate of how the internal operations are connected to the company's result.
Another problem with management accounting is that it can be very time and
re ource consuming to create the system and use it. It is, of course, important that
the scope of management accounting is balanced against the need. Large companies
need a more comprehensive management accounting system than small companies.
Some companies manage mainly with the information available through the financial
accounting system. For many companies, however, it is difficult to manage without the
information provided by management accounting.
13.4 Balanced scorecard - a performance measurement tool

1here are many different ways to measure the company's performance. These are often
referred to as key performance indicators (KPI). Some of these are financial ratios, for
aample, profitability, return on equity, equity ratio, and acid test ratio (described
Chapter 11), while others are non-financial, for example, customer satisfaction,
employee satisfaction, and the number of invoiced consulting hours.
HE AUTHORS AND STUDENT LI TTERATUR 323

How are we perceived by our stakeholders?
Financial
Measurable value/
Goal
Key performance indicator Past
/
How are we perceived by our customers? How efficient are we?
Goal
Customer
Measurable value/
Key perfomance indicator
! Goal
Internal processes
Today VISION&
(externally) ....... STRATEGY .......
!
\Future
Goal
Innovation/development
Measurable value/
Key perfomance indicator
Goal
Employees
Measurable value/
Key perfomance indicator I
Futurt
FIGURE 13.3
Balanced scorecard
- an example. What needs to be improved? Satisfied employees
Balanced scorecard is a method that has been developed to compensate for the fact
that traditional management control and performance measurement put too much
emphasis on financial relationships. In order to include other aspects of the operations,
the financial data are, thus, balanced against other data, for example, customer atlS-
. faction, throughput time, or the number of new products on the market. A balanced
scorecard is always designed in accordance with the needs of the company in question.
The original version of the method included four different perspectives to provide•
relevant basis for decisions at different levels in the company. Figure 13.3 illu trates 1
balanced scorecard with five perspectives.
• Financial perspective (financial position, profitability)
"How are we perceived by our owners and other stakeholders?"
C THE AUTHORS AND STUDENTLITTERA

324
• Customer perspective (customer satisfaction, market shares)

"How are we perceived by our customers?"
• Internal processes (lead time, quality levels, resource consumption)
"What do we need to improve and how efficient are we?"
• Innovation and development perspective (innovation intensity, number of new
products)
"How can we continue to improve our operations, create value, and become more
innovative?"
• Staff (number of training days per year, staff turnover)
"How do we act to keep our staff and develop their skills, and how do we recruit
staff with the right skills?"
for each one of these perspectives, clear and measurable targets and numerical values
are formulated. Finally, concrete action plans are drawn up to reach the targets of the
five perspectives.
Thus, the purpose of the balanced scorecard method is, as the name implies, to
aeate balanced management control that includes more than the financial aspect. The
mo t important targets have to be formulated so that they are not only relevant for the
company but measurable as well. In addition, they need to be followed up continuously.
The method also emphasizes the importance of focusing on the strategic objectives of
the company by connecting them to different numerical values and, thus, bringing the
strategy and the day-to-day operations closer together.
budget is aforecast of future financial events, and when it comes to budgets in compa-
Die , it is also a plan: What can we afford? What can we allow things to cost? In financial
and management control, budgeting is usually described as a process which aims to
collect and compile information about the company's operations that can form the basis
the financial planning. Budgeting is mainly about balancing and setting up financial
ets for different activities, organizational units, projects, and investments. A lot of
data used in budgeting are therefore collected from the company's management
financial accounting systems.
should consist of a financial forecast for future periods.

should consist of a financial plan for future periods.
should control (guide) the behavior of the staff.
I AUTHORS AND STUDENTLITTER A TUR 325

Different types of budgets

There are many different types of budgets. There are, for example, budgets for organi-
zational units (departments, divisions, business areas, companies),functions (develop-
ment, marketing, manufacturing, delivery), projects, products, markets, sales activities,
and investments. How and what an organization decides to budget is governed by its
operations and objectives. All budgets have to have a budget period. Does the budget
apply to the next fiscal year, next quarter, or perhaps the next month?
Budgeting, which is a cyclical activity which usually follows the fiscal year of the
company, includes creating budgets at several levels. There are high-level budgets or
master budgets (i.e., budgets at the highest level in the company) and sub-budgets (i.e.,
budgets at lower levels). The sub-budgets have two purposes - to govern the unit or
function which the sub-budget concerns, and to provide a basis for the main budget.
In large companies, budgeting involves many people with different roles. Heads of
departments, project managers, salespeople, and product managers who lead activi-
ties that consume resources and create value naturally have to participate and asses
future outcomes. In many companies, the budget process is managed by a person or a
group with a central position in the company. The main responsibility often lies with
a controller, a person who is responsible for the financial control in the company.
Budgeted income statement

The budgeted income statement is a forecast of the company's future financial result and
therefore entails information about expected revenue and costs for a coming period,
usually a year. In other words, the budgeted income statement consists of a revenue
budget and a cost budget.
A revenue budget is an estimate of the expected revenues (e.g., operating revenue
and financial revenues) for the coming period. Revenue budgets are usually based on
information from a number of other revenue budgets at a lower level. Sales budget for
the marketing department, the domestic market, a specific customer group, or a budget
for expected financial revenue are a few examples of revenue budgets.
In the same way, the cost budget is an estimate of the expected costs for the coming
period. A few examples of common cost budgets are staff budgets, material budget
. purchase budgets, investment budgets, and project budgets.
Figure 13.4 illustrates an example of a budgeted income statement (which in turn
consists of a revenue and a cost budget) for a coming fiscal year. Naturally, the budsd
needs to be adapted to the company's operations. In the example, we use a fict
company, Stadutrustning AB, which purchases cleaning machines and other types
cleaning equipment which it sells to property owners, real estate service compa
and, to a some extent, private customers. The company also sells cleaning prod
326 <> THE AUTHORS AND STUDENTLITTE

PROFIT AND Whole

LOSS BUDGET 2017 (TSEK) Quarter 1 Quarter 2 Quarter 3 Quarter4 year
Reven ues
Sales
Property owners 2,000 2,200 2,200 2,200 8,600
Service companies 2,500 2,600 2,600 2,400 10,100
Private customers 400 350 300 300 1,350
Spare parts 300 300 300 300 1,200
financial revenues 10 10 10 10 40
Total reve nues 5,210 5,460 5,410 5,210 21,290
Costs
Cost purchased goods
Cleaning machines, large -1,000 -1,100 -1,200 -1,300 -4,600
Cleaning machines, small -1,200 -1,250 -1,300 -1,350 -5,100
Spare parts -100 -100 -100 -100 -400
Consumer goods -so -so -50 -50 -200
Total -2,350 -2,500 -2,650 -2,800 -70,300
Staff costs
Corporate management -300 -300 -300 -300 -1,200
Employees, sales staff -800 -800 -800 -1,000 -3,400
-600 -600 -600 -600 -2,400
Employees under collective agreement -200 -200 -200 -200 -800
Total -7,900 -7,900 -7,900 -2,700 -7,800
-50 -50 -50 -50 -200

-80 -80 -80 -80 -320
-10 -10 -10 -10 -40
-30 -30 -30 -30 -120
-20 -20 -20 -20 -80
-60 -60 -60 -60 -240
-35 -35 -35 -35 -140
-45 -45 -45 -45 -180
-20 -20 -20 -20 -80
-350 -330 -330 -330 -7,350
-4,600 -4,730 -4,880 -5,230 -19,420 FIGURE 13.4

Example of a budgeted
(before tax) 610 730 530 -20 1,870 income statement:
Stadutrustning AB.

327
PART Ill • THE FINANC IAL SYSTEM
and spare parts for the machines. Stadutrustning AB has chosen quarterly budgetin
summing it up for a whole fiscal year. g,
Cash budget
It is also important to assess the future receipts (cash in) and payments (cash out) to
and from the company to plan the financing of the company. This is the purpose of
the cash budget, which is an estimate of the cash flow for a coming period. To create a
cash budget, it is common to start with the balance sheet at the beginning of the budget
period and then adjust this with data from the revenue and cost budgets on which the
budgeted income statement is based. Basically, you are trying to estimate the ca h
receipts and cash payments that the operations will bring and then calculate how the
different items in the balance sheet will be affected.
It is not uncommon to have big variations in cash flow during a period of time,
for example, because of variations in sales and new investments made. An important
purpose of the cash budget is, therefore, to enable the company to plan its cash flow,
ensuring that the company has enough available cash to pay future invoices. Another
purpose is, of course, to provide information for the financial planning, that is, deci-
sions about how and when operations should be financed.
Creating a cash budget for a company is similar to a cash flow analysis, as de cribed
in Chapter 12.4. The main difference is that a cash flow analysis is made afterwards,
while the cash budget is made in advance. Figure 13.5 shows an example of what a ca h
budget might look like for the fictive company in our example, Stadutrustning AB. A
the budget illustrates, the company is planning to invest in new inventory equipment
and new vehicles during the coming fiscal year. The cash budget indicates that the
company will have enough available cash during all four quarters, even if it d rap close
to zero in quarter 3.
Budget work
The budget work in a company never ends. Budgets are set at the start of a period and
are then used to make decisions and manage operations throughout that period. When
the period ends, the budgets are followed up and discrepancies are analyzed. Before
a budget period ends, the company has to set a new budget for the following period
An interesting aspect is how the company responds to unexpected changes dunng
the budget period. Some companies follow the principle "what is done cannot be
undone", that is, regardless of whether the conditions have radically changed,
budget remains the same. Other companies choose to work with revised budgets.
regular intervals, for example every quarter or every four months, the budget is r
to take into account changed conditions.
c, THE AUTH OR S AND STUDENTLITTUA

328
CASH FLOW Whole

BUDGET 2017 (TSEK) Quarter 1 Quarter2 Quarter 3 Quarter4 year
Receipts
Customer receipts 4,500 4,900 5,000 5,400 19,800
Financial receipts 10 10 10 10 40
Bank Joans 3,000 3,000

Total rece ipts 7,S10 4,910 5,010 5,410 22,840
-3,050 -2,100 -2,400 -2,900 -10,450

-1,900 -1,900 -1,900 -2,100 -7,800
260 260 520
-10 -10 -10 -10 -40
-30 -30 -30 -30 -120
-40 -40 -80
-100 -100 -100 -100 -400
-4,000 -4,000
-2,000 -2,000
-8,870 -4,140 -6,180 -5,180 -24,370
1,850 490 1,260 90 1,850
-1,360 770 -1,170 230 -1,530
490 1,260 90 320 320 FIGURE 13.5
of quarter and year) Example of a cash budget:

Stadutrustning AB.
1he majority of all companies, at least large companies, work actively and systematically
th fi nancial control. Most companies use budgeting as a tool, even though traditional
budgeting has been subject to criticism. There are experts who argue that the approach
serious flaws. One argument is that budgeting involves an exaggerated focus on
measurable values, at the cost of more important issues. It is also argued that budgeting
s to the main emphasis being placed on financial aspects. In addition, imbalance
n occurs, that is, the financial conditions and targets for a specific unit may change
siderably at the start of a new budget period. Others claim that the budget process
urages power games between different units in the company, where separate units
try to get the "best" budget at the expense of the company as a whole. There is no
t, however, that the budget process requires considerable staff resources. It is,
329
thus, important to find a good balance between the usefulness of budgeting and the
resources required to carry out the budget process.
The scope and level of detail required vary from company to company. Some com-
panies are very ambitious and create detailed budgets of many different types and
at different levels and have a very structured and transparent budget process. Other
companies focus less on traditional budgeting and have instead developed other forms
of financial control.
EXAMPLE
Handelsbanken - a company without budgets

One example of a Swedish company that, for many years, has worked without budgeting in the
traditional sense is the bank Handelsbanken. Instead, they have developed other methods and
routines to manage operations. Every fall, the bank makes an overall plan for the operations of the
entire company. Once the plan has been drawn up, the different units of the bank develop their
operational plans, which are based on the overall plan. When it comes to cost assessment, the
bank has created a special committee to calculate transfer prices for "trading" between internal
units. According to Handelsbanken, this method means that there is more focus on the operations
and the targets of the bank and less on different types of detailed budgets. In addition, the bank
saves time and resources as budgeting can sometimes be time-consuming. It is important to point
out, however, that Handelsbanken of course uses financial control. The company has, however,
chosen not to use one of the most common tools, budgeting, at least not in the traditional sense.
13.6 The effects of financial control

Systematic and well-structured financial control is important for most companie .
Management tools in the form of budgets, balanced scorecards, methods for product
costing and investment calculation, and organizational structure must be used wi ely.
The methods and tools which have been discussed in this chapter have in many respect
a direct effect on the way the staff act.
The way product costing is carried out, for example the choice of allocation ba
and allocation rates, controls how the indirect costs of the operations are distributed
between departments and products, which in turn controls the estimated cost of•
certain product. This can in turn affect important decisions regarding, for example.
the pricing of a product or whether product components should be manufactured
the company itself or a subcontractor. It may also affect decisions about which pa
of the company should be rationalized.
It is also common for different departments of a large company to have a bu<lld
for the purchase of equipment. If there is a surplus in the budget when the fiscal
draws to a close, there is a tendency, sometimes close to a state of panic, to buy
330 ro THE AU THORS AND STUDENTLITTER

equipment to "spend" the budget. The argument is that if you do not do so, you might
risk budget cuts the following year. This is an example of an imbalanced-management
effect that may occur if the budget process is not designed wisely.
An important tool, which has only been mentioned briefly in this chapter, is how
the wage system is designed. In many companies, it is common for the wage of, for
example, the salespeople to consist of a fixed wage and a bonus (incentive), which means
that salespeople tend to spend more time and effort on selling goods or services that
will increase their bonus compared to those that will give them a smaller bonus. While
a well-planned bonus system will encourage the staff to act in line with the compa-
ny's objectives, a badly planned system can, for example, create negative competition
between the staff and the departments.
Sum mary
Financial control is about controlling the company's operations so that the financial
objectives formulated by the company's owners and management are met. There are
for mal means of control, for example, budgets; methods for product cost estimates and
capital investment appraisals; principles for measuring and allocating costs, revenues,
and performance; as well as different reporting routines. Other means of control are
informal, for example, different work procedures or a company culture which has been
e tablished over time and which influences the staff's behavior.
Budgeting is a process which aims to collect and compile information that can form
the basis for the company's financial planning. Budgeting is about finding a balance
and setting up financial targets. There are many types of budgets, for example, sales
budgets, revenue and cost budgets, budgeted income statements, and cash budgets.
Some of the data used in budgeting can be gathered from the company's financial
accounting system but this often needs to be supplemented with data from the man-
agement accounting system.
Another important way to manage a company is to distribute responsibilities and
power in the organization and decide how to measure the performance of the different
:anit . This includes cost centers, revenue centers, profit centers, and profitability centers.
Moreover, there are many different ways to measure the company's performance.
rlhese are usually referred to as key performance indicators. Some are financial, for
mple, profitability, return on equity, equity ratio, and acid test ratio, while others
non-financial, for example, customer satisfaction, employee satisfaction, or the
ber of invoiced consulting hours.
It is important that financial control is designed to measure what is actually impor-
for the company and that it directs the staff in the desired direction. The old saying
t is measured will be performed" still applies.

References
Almqvist, R., Graaf, J. & Parment, A. (2016). Boken om ekonomistyrning. Studentlitteratur.
Anthony, R. (2014). Management Control Systems. McGraw Hill Higher Education.
Ax, C., Johansson, C. & Kullven, H. (2011) . Den nya ekonomistyrningen med eLabb. Liber.
Bergstrand, J. (2010). Ekonomisk analys och styrning. Studentlitteratur.
Kaplan, R. S. & Norton, D. P. (1996). Using the Balanced Scorecard as a Strategic
Management System. Harvard Business Review January-February, 74(1), 75-8 5.
Kullven, H. (2015). Budget och budgetering. Liber.
Olve, N.-G., Roy, J. & Wetter, M. (1999). Balanced Scorecard: I svensk praktik. Liber.
332 c, THE AUTHORS AND STUDENTLITTE

·········............................................................................ A
~
BUSINESS STRATEGY AND

STRATEGY MODELS
Abusiness strategy is a long-term plan for how the company should achieve
Its business objectives. In practice, however, thinking long-term is often very
ifficult. Everyday issues often take priority and management easily ends up
~nding extensive time putting out fires to solve short-term problems. More-
over, the market and the world around us are often both difficult to interpret and
uncertain, and it is easy to make the wrong assessments about the future. This
apter looks at the basic concepts and some of the most well-known analysis
odels to discuss and develop a company's business strategy.
•1 There needs to be a business idea

ry company has to have a business idea, that is, an overall, long-term aim. The
siness idea should say something about why the company exists and express the
that the owners have for the business. A good business idea is short, clear, and
I anchored in the company. This way, it can set the direction for the business and
wer what the company's employees should, and should not, do. A business idea for
private company, thus, connects the company's function on the market with its value
positions and how this should be achieved by utilizing the company's capabilities
resources in the right way (see Figure 14.1 on the next page). In other words, a good
ine s idea answers questions like: Why does the company exist? Within which areas
uld the company operate? What is the orientation and philosophy of the company?
One part of the business idea is commonly formulated in terms of a mission state-
t for the company. The car rental company Avis, for example, states its mission in
We wil l en sure a stress-free car ren tal experience by providing superior services that
cater to ou r customers' individual needs.
( AUTHORS AND STUDENTL ITTERATUR 335

PART IV • MANAGEMENT AND ORGANIZING
Our market is ...

Our function is to ...
Effect;~"'" ,,,.,m,1) {
FIGURE 14.1 We offer ...

A good business idea
ill ustra tes the connections
between the company's
market position, value
"''''"'' """'"'" { Resources/
competencies
We do so by .. .
Our most important resources ...
proposition, and resources.
An eloquent mission statement answers who the company's key customer group is, what
the company offers, and how the company differs from its competitors. The mission can
then be connected to a slogan or a motto which can communicate something essential
about the company in a brief and effective way, in the case of Avis, the well-known
motto: "We try harder." Google state in their mission that they want to "organize the
world's information and make it universally accessible and useful" at the same time
as the information should not be used in a negative way, that is, "don't be evil". Other
famous slogans are Audi's "Vorsprung <lurch Technik" (progress through technology)
and Carlsberg's "probably the best beer in the world". With a well-formulated slogan
the company can emphasize important aspects of its culture, the company's core values.
The mission can be connected to a vision, that is, the position that the company
is aspiring to or what the company wishes to achieve in the future . One of the most
famous examples is probably the American business executive Henry Ford and h
vision for the company to manufacture cars that did not cost more than the general
public could afford. Nowadays, Ford Motor Company formulates its vision a "people
working together as a lean, global enterprise for automotive leadership." In many wa
Henry Ford's original vision overlaps with Ingvar Kamprad's (Ikea) vision of"furniture
for the masses" or Bill Gate's vision for Microsoft about a "PC on every desk".
The mission and the vision are then connected to a strategy in the form of a formu
lated direction for the company and a long-term plan for the different measure to be
· taken in order for the mission, the vision and, thus, the business idea to be fulfilled. I
addition to this, the company will then set up interim objectives which will make the
plans and the direction more concrete for the staff. The idea is then for management
to follow up on these objectives in order to determine whether the business idea and
the strategy are being implemented.
336 0 THE A UTHORS AND STUDENTLITTERA

CHAPTER 14 • BUSINESS STRATEGY AND STRATEGY MODELS
Business idea - strategy - implementation
Mission: the company's task and the purpose of the operations
Vision: a fut ure state to which the company aspires
Strategy: the measures to reach that state

Objectives: numerical values to mo nitor that the strategy is being implemented correctly
14•2 The strategy realizes the business idea

In order for the business idea to be concrete, the company has to formulate a strategy,
that is, a direction for the business operations and an overall plan which outlines the
measures that need to be taken to implement the business idea. The term "strategy"
originates from the military, where the Greek origin strategos referred to the one who
planned the war at large - the strategist. Later, via the influential Prussian military
general and thinker Carl von Clausewitz (1780-1831), it came to refer more to the "art
of using battles to win the war" as opposed to tactics which were about "using the
troops in battle". In line with von Clausewitz's ideas, strategy is thus about choosing
when, where, and how it is appropriate to take measures to achieve your goals. Instead
of fig hting every battle, it might sometimes be a better idea to step aside and try to
reach your goals in a different way. Nowadays, we talk about strategies in all sorts of
contexts. However, the common denominator is that strategies are long-term plans
that are aimed at realizing an intention or a business idea.
Different types of strategies

What constitutes a good strategy naturally depends on what the company's owners
want to achieve, but what is seen as strategic is also, in many cases, heavily based on
the situation, that is, what the company is able to achieve in relation to customers, com-
petitors, resources, and in-house expertise. One of the earliest authors to write about
rategic management, Igor Ansoff (1957), developed the now classic product/ market
matrix (th e AnsoffMatrix) to describe four different growth strategies that a company
can choose between (see Figure 14.2). These strategies can often be recognized by the
way di fferent companies act, even though some companies combine them. According
to the model, there are four different ways for a company to achieve growth, starting
With its current products and current markets.
HE AUTHORS AND STUDENTLITTER ATU R 33 7

PART IV • MANAGEMENT AND ORGANIZ ING
Products
Current
Market penetration Product development
Market development Diversification

FIGURE 14.2
The product/market matrix
(based on Ansoff, 1957).
1 Growth can be achieved through market penetration, that is, using different
methods, for example advertising and aggressive marketing, to increase the
company's market shares for existing products and taking customers away from
the competitors.
2 Growth can be achieved through product development, that is, by investing
in the development and launch of new products for customers in the already
existing markets.
3 Growth can be achieved through market development, that is, the company
invests in the launch of its already existing product in new markets, for example,
by opening sales offices in parts of the world where the company has not had
representation before.
4 Finally, growth can be achieved through diversification, that is, the company
invests in the development of new products and enters new markets at the same
time. Diversification can often be a difficult step, which is why most companie
usually start with one of the other steps.
The four growth strategies aim to create competitive excellence in relation to the com-
pany's competitors. In order to achieve this, the most important decision is thu iD
which markets the company wants to operate and what the company's value propo itiOD
should look like.
338 i:> THE AUTHORS AND STUDENTLITTERA

CHAPTER 14 a BUSINESS STRATEGY AND STRATEGY MODELS
Strategic advantage
Uniqueness perceived
Low cost position
by customers
Overall cost
Differentiation
leadership
Focus
FIGURE 14.3
Generic business strategies
(based on Porter, 1980).
Another example of a well-known strategy model identifies four so-called generic

business strategies. The model has been developed by Michael Porter (1947-) and is
ba ed on the idea that there are two fundamental ways in which a company can gain
advantages in relation to its competitors: by having low costs or by offering differentiated
products (i.e., products that are different from the products offered by the competitors).
The low-cost producer uses less resources than the competitors to produce its goods
and services and can therefore sell them at a lower price, while a company with dif-
ferentiated products can drive its competitors out of the market thanks to the unique
advantages of the products.
These two competitive advantages can either be achieved in a mass market or in a
smaller niche market, which means that there are, according to the model, three generic
competition strategies that a company can apply: to compete with low prices, to compete
with differentiated products, or to focus on one part of the market (see Figure 14.3). There
are, however, two versions of the latter strategy; either keeping lower costs (cost focus)
or offering unique products (differentiation focus) in relation to the competitors in a
lpeeific market niche.
In ection 3.1, we looked at a model (created by Michael Treacy and Fred Wiersema)
ribing three principal ways to create competitive excellence: by product leadership,
operational excellence, or by customer intimacy. There are clear similarities with
er's model above, as well as with Ansoff's growth strategies.
339
PART IV a MANAGEMENT AND ORGANIZING
Competitiveness by product leadership means that the company's value proposition

- and thus its products - is perceived as superior to the competitors' value proposition.
The strategic positioning according to the product/market matrix in Figure 14.2 could
mean that the company focuses on product development, and according to Porter's
model in Figure 14.3, that the company focuses on a product differentiation strateg
where it tries to reach new customer groups through its product development. On:
example is the Japanese car company Toyota which in the end of the 1980s launched
the luxury car brand Lexus with the aim of competing in the same market segment
as, for example, Mercedes-Benz.
If the company instead chooses to create competitiveness by operational excellence
it means that the company's strategic positioning is about focusing on what Porte;
refers to as overall cost leadership (cf. Figure 14.3). In the product/market matrix, this
is usually associated with the term "market penetration", that is, aggressive efforts to
increase sales, targeting the entire, or parts of, the market. There are many examples
of companies that have entered established markets through low-cost strategies and
then developed other more differentiated value propositions. For example, in the con-
sumer electronics market, Japanese and then both Korean and Chinese companies have
entered the market by offering decent products at low prices, to then gradually begin
to compete through product development and quality. The Korean company Samsung
is the world's largest television manufacturer today.
Competitiveness by customer intimacy means that the company has the ability to
customize its offers according to the needs of some specific customers or small customer
groups. This can be described as a strategy based on differentiation (Figure 14.3). Many
companies that deliver systems and installations and different types of complex services
belong to this category where close customer relationships are absolutely essential. For
suppliers of telecommunication systems (mainly Swedish Ericsson, Finnish okia,
and Chinese Huawei), it is important to maintain long-term relationships with, and
customize systems for, the world's telecommunication operators (in Sweden, e.g., Telia,
Telenor, Tele2, and Hi3G).
According to this way of thinking, it is essential that a company actively chooses
its strategic position, otherwise it risks becoming "almost as cheap", or offering prod
ucts that are "almost as good" as the competitors' products, a situation which i often
described as being stuck in the middle (see Figure 14.3). One example is the Swedish
· car manufacturer Saab, which was founded in the 1940s and, for a long time, was
considered one of the most innovative car companies in the world, with high technical
quality and several important innovations. In Sweden, Saab was a people's car, but the
company constantly struggled to compete in terms of price. From the 1980s onwards,
Saab was marketed internationally as a sportier premium car within the same segment
as, for example, BMW and Audi. At the start of the 1990s, Saab was sold to the U
company General Motors. In the long term, however, Saab did not manage to develop
340 c, T HE A UTHORS AND STUDENTLITTUA

CHAPTER 14 • BUSINESS STRATEGY AND STR ATEGY MODE LS
cars within the premium segment and during the 21st century, it drifted further and
further away from the competitors in terms of design and technology. At the same
time, Saab was too small to be able to create economies of scale in production and tech-
nological development. Instead, the company began to use more and more technical
components from General Motors, which in turn meant that the company lost parts
of the special character that many customers associated with a Saab car. After several
years of economic str~ggl_es, large losses, and changes of ownership, Saab Automobile
ABclosed its product10n m 2011.
Blue Ocean Strategies

lhe generic strategies represented by, for example, Ansoff and Porter, have been criti-
cized for putting too much emphasis on the current business conditions, that is, they
describe strategy development as revolving around a stable competitive situation with
well-defined markets and products, where a company freely can choose its strategies
and position itself in relation to other companies within a predictable framework. The
situation has sometimes been described as companies behaving like battle ships in an
EXAMPLE
Strategy and priorities in practice: the example of Atlas Copco

Apractical example of how a business idea and a strategy can be expressed in concrete terms is
the Swedish industrial company Atlas Copco:
Atlas Copco's vision is to become and remain First in Mind - First in Choice®with our
employees, customers and other stakeholders. This means being the first company you think of
and the one that you choose.
Atlas Copco's mission is to deliver sustainable profitable growth. That means we protect and
grow our business, including our resources and people, in a way that is economically, environmen-
tally and socially responsible.
Our strategy for achieving sustainable profitable growth makes us stay competitive and inno-
vative and ensures we continue to conduct business ethically. This strategy consists of five pillars
underl ining all our activities and they are complemented by our priorities.
Each one of our strategic pillars addresses our main sustainability priorities. The strategy and
prioritiescomplement each other. The strategy is what we do. The priorities are how we do it. And
the priorities ensure that we do this today, tomorrow and in the long term. They ensure that our
Strategies are truly sustainable and that as we grow, we do so ethically, and we build an organiza-
tion that will deliver results far into the future.
SOURCE: ATLAS COPCO, 2017 (ITALICS ADDED BY THE AUTHORS)
HE AUTHORS AND STU DENTLITTERA TUR 341

ongoing naval battle where they are constantly fighting over the exact same part of the
ocean, which turns red with blood from the battles.
A strategic alternative, according to this perspective, is to metaphorically move to
a different part of the ocean where there are no competitors and the water is still blue:
the blue ocean. One example of a company that has succeeded with this is the Canadian
contemporary circus Cirque de Solei, which changed the circus concept by creatin
a modern circus with focus on theater and dance, excluding the traditional elemen~
of performing animals. Other examples of companies that have changed the rules of
competition are Ikea, which in the 1960s began selling furniture at reasonable prices
in large stores with showrooms; the airlines South West Airlines and Ryanair, which
challenged the large, traditional airlines by introducing low-cost flights in America
and Europe; Uber and AirBnB, which changed the rules for taxi services and room
rentals by acting as intermediaries for these services, performed by private individuals,
via the Internet; and the Swiss company Nestle's launch of espresso machines with
pre-apportioned coffee capsules under the brand Nespresso. Thus, the idea behind
the Blue Ocean Strategy is to change the rules of competition by redefining the value
proposition, and thereby the market, by creating other types of products and service
than those offered by the competitors.
Strategy from the inside: the company's strategic capabilities

The traditional description of how strategies are developed has been criticized. One crit-
icism is that the strategy discussion focuses on market strategies and the organization of
the industry and the market, that is, applying an outside perspective on the company. The
company's positioning in the market, the competitors' actions, and the substitutes of the
products are in these models described as given, or easily predictable, and the company
can by a decision made by corporate management simply choose to follow one of these
generic strategies. A contrary approach would argue that the company has a number of
limitations to take into consideration. The key limitations - but also opportunitie - are
based on the company's specific resources and skills, that is, the company's capabilities
which enable the company to generate one or several competitive value proposition/
According to this resource-based view, strategy development is really about building and
developing the company's different resources from a long-term perspective, for example,
· the employees' skills, the company's technology, trademarks, patents, financial resourc
access to raw material, production efficiency, and the company's market position. lheaun
should be for the company's resources to be unique (or at least rare and special), embedded
in the organization, difficult to copy, and preferably not exchangeable.
Based on such company-specific resources, the company can then organize th
to a number of capabilities which are manifested in different products. Done cor
reedy, this will create a competitive advantage in relation to other companies on
342 c, THE AUTHORS AND STUDENTLITTEIA

market. Successful companies have also, according to this approach, organized their
capabilities so that they are dynamic and thus are able to adapt to the surroundings
and to any changes in the company's resource base in order to gradually renew their
value propositions (cf. the discussion on the core competencies behind the company's
innovation strategy in Chapter 7).
The strategic planning process and the role of management

The work to formulate and implement a strategy is called the strategic planning process.
Asimplified illustration of a strategic planning process is presented in Figure 14.4. In
the model, the process starts by developing a business idea and analyzing the com-
pany and its external environment (to the left in the figure). Next, a goal is formulated
that explains how the company should develop and a strategy for how to achieve it.
The formulated strategy is then translated into concrete action plans, with clear and
measurable interim goals, which are executed and evaluated.
However, the strategic planning process is rarely this linear in practice. Often, there
are a number of iterations and start-overs between the different steps. Moreover, the
most difficult part of the strategic planning process is not the analytical stage, but the
later steps "formulation", "planning", and "execution". Even if the strategic analysis
can be both comprehensive and difficult, the biggest challenges usually relate to the
concrete implementation of the strategy.
So far, strategies and strategy formulation have been described as something that
happens in companies. It has also been said that every company has a strategy, explicitly
or not. In concrete terms, however, strategies have to be formulated by an individual or
agroup of people, and the strategic planning process above is a description of activities
carried out by a number of individuals. Usually, it is the company's board of directors that
formulates the strategies, but the documentation behind these strategic decisions is often
FIGURE 14.4
The strategic planning
process according to Philip
Kotler (from Bengtsson &
Skarvad, 1988).

PART IV • MANAGEMENT AND OR GAN IZIN G
- i
.
FIGURE 14.S The ma,ke,- The'""""''"

The corporate business strategy strategy
strategy and functional The production
strategy
strategies.
based on work by the company employees. The task of the Board and top management is
then about ensuring that the company's operations and, above all, its business model and
value proposition are matched against the demands and opportunities of the market and
the formulation of the strategy. This way, the functional strategies of the value creation
processes should be linked to the company's overall business strategy (see Figure 14.5).
Moreover, different issues might emerge during the strategic planning process that
affect the outcome. Thus, all strategies and plans are not implemented exactly the way
it was originally intended. In order to capture the uncertainty of the strategic planning
process in practice, terms like "planned strategies" are sometimes used, which later,
if nothing happens, turn into "intended" and "realized strategies". However, if thing
change during the implementation of the strategy, some parts of the planned strategie
turn into "non-implemented strategies", at the same time as the plans are reinterpreted
and new situations arise which mean that emergent strategies gradually develop during
the implementation. The strategy which is finally realized is, thus, more or less a combina-
tion of the planned strategy and the strategy which emerges during the implementation.
The relationships between the different types are presented in Figure 14.6.
FIGURE 14.6
The strategic planning
process from planned
strategy to realized st rategy
(based on Mintzberg, 1994).
c, T H E A UT H OR S AND STUDENTLITTERA
344
CHAPTER 14 • BUSINESS STR ATEGY AND STR ATEGY MODELS
Thus, the company's overall strategy has to both include and adapt to the functional
strategies that have been described in the previous chapters on marketing, production,
and product development. Assessing the company's capabilities is part of the respon-
sibility of top management. This is partly expressed through the company's overall
strategy, and partly through the defined points of departure for the development of
the functional strategies.
14.3 Models for strategic analysis

A good strategy, thus, includes a good overall action plan for how the employees can
work together to fulfill the business idea. However, creating a strategy requires very
comprehensive analysis and there are many methods and models for how to carry out
these types of strategic analyses. Even though these models are intended for developing
business strategies, they are often applied in many other contexts and at different
organizational levels.
We will describe some of the most common and well-known analysis models that
are used as a basis for strategic decisions. The models can be said to have two purposes.
Firstly, to analyze the company's current operations: what does the company's situa-
tion look like? Secondly, to analyze the company's external environment, for example,
the company's competitive situation, its customers, the development in the markets
where the company operates, the technological development, and the likely actions of
its competitors.
SWOT analysis
A common method for internal and external environmental scanning is the SWOT
analysis. The method is simple, which is also the reason why it has become so popular.
WOT stands for: Strengths, Weaknesses, Opportunities, and Threats. The first two are
mternal factors (strengths and weaknesses), while the two latter (opportunities and
threats) are external factors (see Figure 14.7). Examples of strengths (S) may include
having production processes that are more efficient than those of the competitors, a
Illes organization that reaches more customers than the competitors, or technical
expertise that is more advanced than that of the competitors. Weaknesses (W) are
the opposite: the company may have problems with staff recruitment, may have lost
customers because of a weak service organization, or not had time to develop the
s organization in a region as planned. In these situations, it is important to not
restimate your own strengths and underestimate your own weaknesses. Opportu-
·es (0) mean that you can identify possible circumstances (current and future) that
be utilized to benefit the company. Threats (T) mean that you identify possible
mstances that could cause problems.
I AUTHO RS AND STUDENTLITTERATUR 345

Strengths Weaknesses
Opportunities Threats
FIGURE 14.7
SWOT analysis (based on
And rews, 1971).
It can sometimes be difficult to differentiate between a strength or a weakness, oppor-

tunity or threat. A unique competence is a strength but if it becomes obsolete it will
become a disadvantage and thus a weakness. The same applies to threats and opportu-
nities. Thus, a good SWOT analysis requires that the company takes into account the
development over time (e.g., that the company's expertise does not become obsolete)
and defines specific limitations for the analysis to generate useful results. The mo t
important conclusions from a SWOT analysis include identifying different mea ure
to turn the weaknesses into strengths, making use of identified opportunitie , and
avoiding potential threats.
The SWOT model is relatively unsophisticated but at the same time very easy to
remember, which has made it one of the most common strategic analysis model .
A SWOT analysis is often performed as a group activity or a workshop covering perhaps
a day. Moreover, it is not always the formal final result of the SWOT analysis that i
the most important outcome, but the knowledge that the participants acquire during
the discussions.
Lifecycle and portfolio analyses

In technology-based companies, the sales of the company's products usually develop lD
accordance with different product lifecycles (see Chapter 7). Thus, it is usually important
to management that the company's product portfolio consists of products in differeal
stages of their respective lifecycle. One of the most common strategy models for tlrll
type of portfolio analysis is the Boston Matrix (named after the company behind
matrix, the U.S. consulting firm Boston Consulting Group). The basic idea is to an
346
Market share
High
Stars Question marks
Cash cows Dogs
FIGURE 14.8
The Boston Matrix.
a company's product portfolio according to the dimensions growth rate and market
share (see Figure 14.8).
The vertical axis of the Boston Matrix marks the growth rate of the product's sales on
aspecific market. The horizontal axis marks the market share of the product compared
to the market share of the biggest competitor, with increasing shares to the left (!) in
the figure. If the company's market share is equal to that of the biggest competitor, this
i marked in the middle. If the company has the largest market share, this is marked
to the left and the company is then compared to the second biggest company in the
market. This way, the products can be divided into four categories: cash cows, dogs,
question marks, and stars.
The basic idea of the model is that the greater the market growth of a product, the
more liquid assets it tends to require, for example, in terms of new production plants,
inventories, and marketing channels. At the same time, the greater the relative market
lhare of a product, the more liquid assets it tends to generate. Mature products which
often have a slow growth rate, but a relatively large market share, can thus be very
profitable. They are called cash cows since they generate more liquid assets than they
require. The opposite, that is, products with a low market share but with a high growth
nte can, however, create a problem as they have low profitability at the same time as
require more liquid assets than they generate. They are called question marks, since
company does not know how they will develop. Products with slow market growth
low market share (dogs) often have low profitability even though there may be a
nee between the assets they generate and the assets they require. The same applies
£ AUTHORS AND ST U DENTLITTERATU R 347

to products with high market share and fast growth rate (stars); even though they are
profitable, the growth often requires extensive liquid assets.
Thus, the idea is that the products move through the matrix during the different stages
of the product lifecycle. New products are question marks, fast-growing products are
stars, while products with a high sales volume make up the cash cows. Older products,
dogs, are products that reduce the company's profitability: the cost of keeping them in
the product portfolio is higher than their contribution. To stay profitable in the long
term, the company always has to make sure to have a product portfolio with products in
different stages (squares) of the matrix. One example is AstraZeneca's ulcer medication
Losee, which initially was a large cost item, but which over time after its launch in 1992
became the company's biggest cash cow (in 1996, Losee stood for no less than 45 percent
of the company's total sales). The revenue that flooded into AstraZeneca thanks to Losee
financed the development of new products, among them, Nexium and Crestor.
Another model for portfolio analysis is the GE-McKinsey Matrix, first developed by
the U.S. consulting firm McKinsey for the multinational corporation General Electric
(GE). See figure 14.9. It has the same basic idea as the Boston Matrix, with business
position on one axis and market attractiveness on the other, but it includes more seg-
ments and also indicates measures for the different segments.
Both of these models are, thus, based on the idea that the products' position changes
over time. The lifecycle analysis can also be applied to more general shifts in technology
and markets. Staying informed about the development in the technical fields where
the company operates is important from a strategic perspective, both in terms of the
company's market organization and its product portfolio investments.
Business unit strength
High Medium
Invest: Selective investment: Hold:

focus on growth improve the business posi- develop the business
tion to generate revenue
Selective investment: Hold: Harvest or divest

build on the company's develop the business posi-
strengths tion selectively to generate
revenue
Hold: Harvest: Divest

develop the business reap the profits
FIGURE 14.9
position selectively and build
The GE-McKinsey Matrix on the company's strength
(source: McKinsey).
348 c, THE AUTHORS AND STUDENTLITTERA

CHAPTER 14 • BUS INESS STRATEGY AND STRATEGY MODELS
External environmental scanning: the company's competitiveness

It is important to be informed about the competitors on the market. Otherwise, there
is a risk that you overestimate your own strengths and opportunities, while under-
estimating your own weaknesses and external threats (cf. the SWOT model). One way
to analyze a company's competitive situation is thus to look at the competitive forces to
which the company is exposed. The most well-known model for this type of analysis
is often referred to as Porter's Five Forces, named after the man behind the model,
strategy professor Michael Porter. The model was developed as a counter-reaction to the
popular SWOT analysis and is illustrated in Figure 14.10. According to Porter's model,
a company is always exposed to five competitive forces. The first, and most apparent
force, is that a company is always exposed to competition from existing companies in
the industry, that is, the company's current competitors. Most companies have fairly
good knowledge about their fellow competitors, their products and sales, which is why
this is the easiest analysis.
In addition, a company is exposed to competition through the bargaining power of
its customers and suppliers. If the customers are powerful and have a strong bargaining
power, they can force down prices or change the bargaining conditions to the extent
that the company's profitability decreases. It can, for example, be risky for a small com-
pany to become too dependent on one single big customer. In the same way, powerful
suppliers can, for example, raise their prices or prioritize other customers that they
perceive as more important, which may also pose a threat to the company.
Moreover, there are also the threat of new entrants, that is, potential competitors,
who may enter and establish themselves on the market in the future. This applies
~ ' of oew'""'""
Bargaining power C . Bargaining power
of suppliers ompanies ~
in the industry of customers ' .
Rivalry among
existing competitors
Threat of substitute
FIGURE 14.10
Porter's five forces
(based on Porter, 1985).
HE AUTHORS AND STUDE NTL I TTERATUR 349

PART IV • MANA GEMENT AND OR GANIZI NG
especially to markets with high profitability and low barriers to entry, that is, where
new entrants can establish themselves relatively easily and without large investments.
Finally, there are also threats coming from potential substitutes for the company's
products, for example, new technical solutions that can change the market in one
swoop. One example is how the introduction of the taxi service Uber has changed
the conditions for the old taxi companies. There are, however, several other examples
of substitutes for taxi services, like the increased use of private cars, the expansion
of public transportation, increased biking, or that the use of video conferences and
telephone meetings completely replaces the need for taxi services.
The company's stakeholders

Another type of analysis is about identifying the company's stakeholders and analyzing
the interests of each stakeholder. The classic stakeholder model describes the company
as an arena where different actors ("stakeholders") with different interests meet and
negotiate (see Figure 14.11). According to the model, a stakeholder contributes to the
company's operations, for example in the form of financial capital, hours worked, or
products delivered, in proportion to a reward, for example in the form of intere t,
payment, or a non-monetary reward. If there is an imbalance between a stakeholder'
contribution and reward, this will affect the stakeholder's willingness to contribute
to the company, which may have serious consequences for the company's operations.
The stakeholder model was originally developed by the Swedish professor Eric
Rhenman (1932-1993) with the aim of understanding and analyzing the organi zation
FIGURE 14.11
The stakeholder model
(based on Rhenman, 1964).
350 © TH E AU THORS AND STUDENTLITTERA

Power
Keep satisfied Manage closely

• Moderate priority • Highest priority
• Sufficient • Engage actively
involvement
Monitor only Keep informed

• Lowest priority • Moderate priority FIGURE 14.12
• Do not overload • Sustain interest The strategies of stake-
holder management
(based on Donaldson
Interest & Preston, 1995).
and strategic management of different companies. Today, the stakeholder model is

also often used when companies formulate communication strategies and plan their
communication efforts, for example, in relation to a product launch, a construction
project, or when they wish to influence the outcome of a decision.
Toe stakeholder model can also be taken one step further by developing different
trategies to manage different types of stakeholders in a specific situation, for example,
a project (see Figure 14.12). Stakeholders with strong interests and big influence should
be "managed closely", that is, they should be prioritized in terms of information and be
invited to actively participate in the project (as opponents they can cause great damage).
When it comes to powerful stakeholders with weak interests, it is enough to keep them
satisfied: they should be involved with moderation. Stakeholders with strong interests
but less power should, according to the model, be kept informed, while stakeholders
with less power and weak interests in the business should not be overloaded with
information and requirements to actively participate. It is enough to monitor them.
PESTLE analysis
Thus far, the analysis has essentially revolved around the company's own operations
and stakeholders. Sometimes, however, we need to widen the perspective and try to
analyze how the world around us will change independently of the company's own
operations (i.e., the external environment that generates the opportunities and threats
m the SWOT analysis). One model to make this type of analysis of major trends is the
so-called PESTLE model. PESTLE stands for political, economic, social, technological,
legal, and environmental changes (see figure 14.13). However, to apply this type of model
requires fairly detailed knowledge about the different fields, and it often requires the
help of experts to get a good idea of the six trends (PESTLE) in, for example, a country
or region. Used correctly, a PESTLE analysis can, however, give a very good idea of

Political Economic Social
Tax policies Inflation rate Cultural trends

Fiscal policy Interest rates Demographics
Trade tariffs Foreign exchange rates Employee expectations
Change of government Economic growth patterns Population analytics
Local government policy Buying trends
(e.g., planning consents) Seasonal behaviors
Technological Legal Environmental
Automation Consumer laws Geographical location

Research and development Health and safety standards Climate change
Technical awareness in Labour laws etc. Environmental offsets
the market Trade barriers Emissions legislation
FIGURE 14.13 Impact of new media Green agenda
The PESTLE model.
the institutional development in the world and the current and future conditions, for
example in relation to a large investment.
Scenario technique
Another, more sophisticated, analytical method is the scenario technique. The idea of
using scenarios for strategic planning originates from the military. By creating scenar-
ios of future conflict situations, the military has, for a long time, both simulated and
practiced strategic planning and decision-making in emergency situations. Among
companies, the method gained wide recognition when the strategic planning depart-
ment of the Dutch-British oil company Shell Oil managed to predict the dramatic ri e
in oil prices following the Yorn Kippur War (the October War) in the Middle East in
1973, sometimes referred to as the "first oil crisis". Since then, Shell has used the scenario
technique as a strategic planning tool and asserts that it has been successful.
Companies that wish to use the scenario technique should follow a work proce
.similar to the one described in the square "Work process for scenario techniques". In
principle, however, the scenario technique is based on the use of a number of pecific
assumptions and known facts to create a number of scenarios for possible future situ
ations, which can then be used for strategic planning.
352 <> THE AUTHORS AND STUDENTLITTERA

CHAPTER 14 • BUS INESS STRATEGY AND STRATEGY MODELS
work process in scenario techniques
1 Decide on the question to be answered by the analysis and which goal/s should be achieved.
2 Set the scope and time of the analysis, taking into consideration how quickly changes have
taken place in the past and try to assess to what extent it is possible to predict, for example,
demographic changes and product lifecycles. A normal time horizon is 10 years.
3 Identify the most important stakeholders, try to identify their interests in the company and if
these interests have changed over time.
4 Map basic trends and driving forces, for example, by using a PESTLE analysis, and assess to
what extent they will affect the posed question and the company's operations. Categorize the
trends if possible.
5 Map important uncertainties and try to mark key driving forces on two axes; discard all driving
forces that are unimportant.
6 Try to group influencing forces/uncertainties along these axes, until two main focuses remain,
present these in a four-square chart, which will result in four basic scenarios.
7 Identify extremes and possible outcomes and check whether the dimensions are consistent
and plausible. Check three key points: is the time frame plausible, does the scenario have
internal consistency (i.e., could the different influencing forces/uncertainties happen
simultaneously) and are there stakeholders which are important but which will not be affected
by the scenario?
8 Name and define the scenarios. Avoid dividing them into pure "best-case" and "worst-case"
scenarios which may easily become predictable. Write out the scenarios with an in-depth
analysis and assess whether they are relevant to achieve the goal/s. Do the scenarios represent
stable situations?
9 Identify whether there is a need for further research, whether more information is needed and,
if so, where it can be obtained.
10 Formulate a decision based on each scenario. The critique against scenario planning is mainly
about the difficulties in reducing a complex world to two dimensions, without these dimensions
becoming trivial and obvious. Correctly executed, however, the scenario technique can be of
great use in developing a preparedness plan should a crisis, or something unexpected, occur.
The Business Model Canvas

Apopular strategy model today is to analyze a company's activities using the Business
Model Canvas, which was developed by the Swiss researcher and consultant Alexan-
derOsterwalder. This strategy model divides the company's business model into nine
elements: key partners, key activities, key resources, value propositions, customer rela-
tionships, channels, customer segments, cost structure, and revenue streams (see Figure
l4.i4). This way, the Business Model Canvas is intended to connect the company's
ltrategy with its concrete activities and clarify the connections between the company's
Hf AUTHORS AND STUDENTLITTERA TUR 353

internal processes and resources, on the one hand, and the stakeholders and structures
in the company's external environment, on the other. The idea is to create a big canvas
of the model (thus the name Business Model Canvas) that the employees then can use
in a strategy workshop to describe the content of the nine different elements and thus
gain a better understanding of how the company works and how it and its different
elements can (should) develop in the future .
One of the most well-known examples of the use of the Business Model Canvas is
when the world's largest food and drink company, the Swiss company Nestle, developed
and promoted the concept and brand Nespresso. The basic idea, the value proposition (at
the center of the canvas) was to enable customers to make the perfect espresso in their
own home. The customer relationship (in the middle of the right half of the figure) was
created by launching Nespresso Club and sales channels via the Internet, the website
www.nespresso.com, and via special, exclusively designed Nespresso stores. It was only
the machines that were sold in traditional stores for home appliances. As a next step,
FIGURE 14.14 the American actor George Clooney was introduced as the brand's spokesperson and
The Business Model Canvas "Nespresso - what else" became the slogan.
(based on Osterwalder &
Pigneur, 2010).
Key partners
~
Key activities
~
Valueproposition ~
t
Customer
relationships
Q Customersegments l
~ ~
Key resources Channels
Cost structure
!!:,
.
.
Revenue strea1ns
354 <!:> THE AUTHOR S AND STUDENTLITTEAAT

To the left in the Business Model Canvas, the key activities were defined as mar-
keting, production, and logistics, and the key partners were defined as the machine
manufacturers (Nestle did not manufacture the machines themselves). The cost struc-
ture mainly consisted of manufacturing, marketing, distribution, and costs for sales
channels. The key resources were defined as the distribution channels, the patents, the
brands of the system, and the production sites. The most important revenue streams
were identified as the sales of coffee capsules, even though the sales of machines and
accessories could generate some incidental revenue.
After the development of the strategy: the

14 .4
implementation
Strategy development - difficult but necessary
Developing a strategy is difficult. For recently established companies, it can be very
problematic to formulate a business idea which is competitive and a strategy which
will lead to the desired results. In established companies, the strategy is often closely
associated with the values of the company's organization and the products which the
company offers. Thus, a change in strategy often requires major adjustments, for exam-
ple, reorganizations, new products, and even hiring of new employees. The larger the
organization and the more successful it seems to be, the more difficult it is to change
trategy. Changing strategy is like changing course of a large oil tanker: once the tanker
is moving in a certain direction it will take a long time and effort to turn it around.
In this lies the strength as well as the weakness of a strategy. If it is well-anchored
within an organization, it runs automatically. The task of management will be to keep
the course and make sure that no major changes are implemented that will bring the
company off that course, while the board of directors and top management, together,
have to monitor that the strategy is actually working. Thus, one of most important
contributions of the board of directors is to determine when a strategy needs to be
changed and making sure that the necessary strategic change is implemented.
However, a fundamental problem in all forms of strategy development, is that the
future is always more or less uncertain. Both internal and external environmental
analyses are based on known situations and facts, which makes it difficult to free
oneself from current circumstances. It is also easy to exaggerate current trends and
the consequences thereof in the short term, at the same time as there is tendency to
underestimate trends and changes in the long term. As such, strategy development
always includes a certain level of genuine uncertainty. This dilemma was effectively
described by Donald Rumsfeld (the United States Secretary of Defense 1975-1985 and
20 0 1-2006) when during a press conference in 2002 he coined the phrase "unknown
unknowns" to explain the lack of evidence to prove the presence of nuclear weapons in

Iraq, at the same time as the U.S. used this precise accusation as the main argument to
invade the country (which they also did in 2003). There are, to use Rumsfeld's choice
of words, situations where "we know what we know" and "what we do not know", but
sometimes there are also situations where we "do not know what we know" or, even
worse, "do not know what we do not know". The latter is a typical example of what is
usually referred to as genuine uncertainty.
Re ports that say that something hasn't happened are al ways interest ing to me,
because as we know, there are known knowns; there are things we know we know.
We also know there are known unknowns; that is to say we know there are some
things we do not know. But there are also un known unknowns - the ones we don't
know we don't know. And if one looks t hroughout the history of our country and
other free countries, it is the lat ter category t hat tend to be the difficult ones.
DO N ALD RUMSFELD , DEPARTM EN T OF DE FEN SE N EWS BRIEFI NG, F E B . 12 , 2002
After the development of the strategy

Strategy is, thus, about deciding on a direction for the company's operations and to take
the necessary measures for the company to move in that direction. This often includes
setting a number of strategic objectives, which then form the basis for a strategic plan
where the necessary measures are specified. Strategic initiatives may have consequences
in the short term, for example acquisitions or sales, closing down of units, or setting up
new operations, but usually the consequences of the strategic decisions will not show
until some time has passed. When a company's strategic decisions have been made by
the board of directors, it falls upon management to develop the strategic plan and take
the necessary measures to achieve the set goals. However, in most situations, it is the
management that has compiled the information behind the strategic decisions and ha
written the strategic plan.
The U.S . business historian Alfred D. Chandler (1918-2007) formulated the the i
that a company's structure follows its strategy (structure follows strategy), but contem-
porary strategic thinkers are also aware that the company's structure, in many way ,
forms its strategy (i.e., structure forms strategy). Another saying is culture beats strategy,
that is, it does not matter how fantastic the new plans and strategies of top management
are; if they are not anchored in the organization, the plans will face resistance that can
be strong enough for them never to be implemented. In practice, strategy development
is thus an interactive process which includes several stakeholders and iterations. Thus,
the resource-based strategic school and the idea of the strategic planning proces as
consisting of planned, emergent, and realized strategies are probably the best de crip-
tions of reality.
Once the decisions have been made, it is the responsibility of management to prior
356 C> THE AUTHORS AND STUDENTLITTERAT

itize and allocate the company's resources as well as to create or change the resources
and competencies needed to implement the strategy. Management becomes a matter of
facilitating activities with the aim being to create, organize and use valuable resources
(such as raw materials, technology, competence, distribution channels, and brands) that
can contribute to the company's competitiveness and its ability to generate a surplus.
The corporate management has a number of tools at its disposal, partly its own deci-
sions (like investments and other forms of resource allocation), and partly measures of
a different character, for example, political lobbying and attempting to coincide with
events outside of management's control.
Setting objectives
One of the most powerful ways to manage an organization is to set objectives. The
corporate strategic objectives are broken down into functional objectives for the three
value creation processes as well as sales objectives, production objectives, objectives
for renewal of the product portfolio, or objectives for competence development. These
functional objectives can then gradually be broken down into concrete goals for
the next organizational level, sometimes all the way down to the individual. Thus,
objectives at one level become means at a higher level. This is often referred to as an
objective-means hierarchy.
It is commonly argued that objectives should be "SMART", that is, Specific, Meas-
urable, Approved, Realistic and Time-bound (see Table 14.1). In other words, the objec-
tives should be clear and easy to measure and follow up.
TABLE 14.1 SMART or VACT objectives.
SMART VACT
Specific Visionary
M•·asurable Approved
Approved Common
Rea listic Time-bound
T"le-bound
However, given this strong emphasis on exact goals, some have argued that the impor-
tant thing for strategic development projects is rather to have a goal which is Visionary,
Approved, Common, and Time-bound (VACT; in Swedish VAGT), rather than meas-
urable. A famous example of a visionary, explicit objective was when the American
president John F. Kennedy announced in 1961 that USA with its investments in space

PART IV • MANAGEMENT ANO ORGAN IZING
would "put a man on the Moon before the end of this decade". Whether it was a SMART
or VACT objective is debatable, but evidently it was possible: on July 20, 196 9, the
astronaut Neil Armstrong landed on the Moon.
I believe that this nation should commit itself to achieving the goa l, before this
decade is out, of landing a man on the moon and returning him safely to the earth.
No single space project in this period will be more impressive to mankind, or more
important for the long-range exploration of space.
PRESIDENT KENNEDY, ADDRESS TO CONGRESS
ON URGENT NATIONAL NEEDS, MAY 25 , 1961
The necessary compromises

Since it is not possible to execute every single activity, all measures taken by corporate
management include weighing different options. Every measure also has financial
consequences. Measures taken by corporate management are often aimed at affecting
the value creation processes, for example, through investments in product development
by increasing the budget of the R&D department, through investments in marketing by
attending fairs, or through investments in the production process by introducing new
technology. A decision to invest in, for example, new production technology, will ini-
tially affect the cash flow and the balance sheet, but in the long term it will - hopefully
- lead to increased revenue and/or reduced costs. Thus, the different measures which
management takes must be weighed against each other. In assessing this prioritization
the value creation processes are also linked to the company's financial accounting and
its annual financial statements. A measure will, thus, affect the company's revenue or
costs, the active or passive side of the balance sheet, and the company's cash flow. In
every situation, management also has to make sure that there are enough resource
to match the market demand with the company's internal capabilities, today as well
as in the future.
0 THE AUTHORS AND STUDENTLITTERAT

358
su mmary
Every company should be based on a business idea that explains why the company exists
and expresses the owners' idea for the business. A good business idea is short, clear,
and well-known in the company. The business idea includes the company's mission,
which defines the company's key customer groups, what the company intends to offer,
and how the company differs from its competitors. The mission is often connected to
a vision, that is, the position which the company aspires to or what the company wants
to achieve in the future.
In order for the business idea to be concrete, the company needs to formulate a
strategy, that is, a long-term, overall plan that outlines the necessary measures to realize
the business idea. What constitutes a good strategy depends on what the company's
owners want to achieve, but also what the company is able to achieve in relation to
customers, competitors, resources, and in-house expertise. There are several models
that a company can apply to create a strategy, for example the product/market matrix
(the Ansoff Matrix), which describes four different growth strategies, and Porter's
three generic business strategies to create competitive advantages: low price, product
differentiation, or focus on a specific part of the market. Another example is "Blue
Ocean", which means that the company creates a strong position by redefining the value
proposition, and thus the market, by creating other types of products and services than
the ones offered by the competitors.
Creating an effective strategy requires comprehensive analysis. There are several
methods to perform this type of analysis, for example, SWOT, lifecycle analysis,
portfolio analysis, environmental scanning, stakeholder analysis, PESTLE analysis,
cenario technique, and the business model canvas. Most of these methods are about
analyzing the company's current operations and its external environment in order to
identify future opportunities and threats.
Strategy is, thus, about deciding on a direction for the business and taking the
necessary measures in order for the company to move in that direction. Once the
decisions have been made, it falls upon management to take the necessary measures
for the strategy to be implemented. A fundamental problem in all forms of strategy
development is, of course, that the future is always uncertain. Business analysis and
environmental scanning are based on the knowledge that we have today and more or
le swell-founded assumptions about the future.

PART IV a MANAGEME NT AND ORGANIZING
References
Andrews, K. (1971). The Concept of Corporate Strategy. R.D. Irwin.
Ansoff, I. (1957). Strategies for Diversification. Harvard Business Review, 35(5), Sep-Oct,
113-124.
Atlas Copco (2017). www.atlascopcogroup.com/se/investor-relations/
atlas-copco-for-investors/how-we-do-business
Bengtsson, L. & Skarvad, P-H. (1988). Foretagsstrategiska perspektiv. Studentlitteratur.
Chandler, Jr., A.D. (1962). Strategy and Structure: Chapters in the History of the American
Industrial Enterprise. MIT Press.
Donaldson, T. & Preston, L. E. (1995). The stakeholder theory of the corporation: Concepts,
evidence, and implications. Academy of Management Review, 20(1), 65-91.
Hill, T. & Westbrook, R. (1997). SWOT analysis: it's time for a product recall. Long Range
Planning, 30(1), 46-52.
Kim, W. C. & Mauborgne, R. (2005). Blue ocean strategy: From theory to practice. Ca lifornia
Management Review, 47(3), 105-121.
Mintzberg, H. (1978). Patterns in strategy formation. Management Science, 24(9), 934- 948.
Mintzberg, H. (1994). The Rise and Fall of Strategic Planning. Prentice Hall.
Mintzberg, H., Ahlstrand, B. & Lampel, J. (2005). Strategy Safari: A Guided Tour Throug/r tire
Wilds of Strategic Management. Simon and Schuster.
Osterwalder, A. & Pigneur, Y. (2010). Business Model Generation: A Handbook for
Visionaries, Game Changers, and Challengers. John Wiley & Sons.
Porter, M. E. (1980). Competitive Strategy: Techniques of Analyzing Industries and
Competitors. Free Press.
Porter, M. E. (1985). Competitive Advantage: Creating and Sustaining Superior Performance.
Free Press.
Rhenman, E. (1964). Foretagsdemokrati och foretagsorganisation. SAF Norstedt.
Wernerfelt, B. (1984). A resource-based view of the firm. Strategic Management Journal, 5(2),
171-180.
0 THE AUTHORS AND STUDENTLITTEAA

360
········.•....•...•......................................•..........•................... ~ ...,.
LEADERSHIP AND HUMAN
RESOURCE MANAGEMENT
(H RM)
Employees are essential to the success of a company. A company's employees

provide the customers with quality products, devise new ways of doing busi-
ness, generate ideas for new products and develop methods for working more
efficiently and creating more value. Technology, machines, and equipment only
create the basic conditions for efficiency and innovation. Ultimately, it is always
how the staff perform their tasks that determines whether an operation will be
successful. Therefore this chapter discusses staff management and leadership in
acompany. This area is called Human Resource Management (HRM) and includes
a number of different areas, for instance employer liability to its employees,
talent management, labor organization, and staff leadership.
1s.1 A company and its employees

"Our employees are our primary asset." This is a common statement by executives and
managers. However, the statement is actually incorrect in the strictly financial sense:
formally employees do not represent assets in the company as they cannot be sold in the
ame way as machines, equipment, and inventories. But, companies consist of people.
People are social beings and tend to form groups. People also have feelings, which
managers and leaders must always take into account. Staff-related issues are therefore
essential to the functioning of an operation. As all experienced managers and leaders
know well, personal leadership is one of the hardest skills to master.
A company's relations with its employees are governed by a number of labor laws,
the prime purpose of which is to protect the position of employees in relation to their
employers and to prevent various forms of discrimination or abuse of power in the
Workplace. Some of the most important laws in this area in Sweden are the Employ-
ment Protection Act (lagen om anstiillningsskydd (LAS)), the Work Environment Act

PART IV • MANAGEMENT AND ORGA NIZI NG
(arbetsmiljolagen), the Annual Leave Act (semesterlagen), the Employment (Codetermi-

nation in the Workplace) Act (medbestiimmandelagen (MBL)), and the Discrimination
Act (diskrimineringslagen).
Much of the labor law in Sweden is based on the existence of a collective agreement
between the employer (company) and the employee's trade union. This collective agree-
ment may contain provisions on the amount of pay, length of working hours and how
working hours are organized, various pension conditions, and how the Annual Leave
Act should be applied. It is also common for employees to have agreed certain special
conditions with their employers that will apply only to them. An employee may have
an individual salary, the right to a company car and an extra week of leave, but no
right to overtime payment. A collective agreement is therefore a framework agreement
that determines the conditions for individual employment contracts. However, it also
imposes on the parties (the employers' organization and the trade union) and their
members an obligation to maintain peaceful industrial relations, i.e., they may not
take industrial action, for example strike or lockout, during the term of the agreement.
Different forms of employment

An employer is subject to a number of requirements when it employs employees: it mu t
pay social security contributions and its employees' preliminary income tax, grant
employees statutory annual leave, and comply with laws and regulations concerning
the work environment and worker safety. Sweden also has a number of rules on how
employment contracts may be terminated and employees may be dismissed.
If an employee is employed without anything specific being said about the employ-
ment conditions, the employee generally has a permanent job or position. Consequently,
an employer may not, on the day after the employee was employed, say that they actually
imagined shorter, limited-time employment, a temporary position, or trial employ-
ment. Permanent employment gives a Swedish employee relatively strong employment
protection. In Sweden, an employer can only terminate permanent employment by
giving notice of termination, which must, by law, be "objectively justified", or by mean
of dismissal because the employee has been guilty of gross breach of contract.
In most cases, notice of termination is due to shortage of work, i.e., the company i
performing poorly so that a unit needs to be closed or operations have been changed
in such a way that there are no longer tasks for all employees. An employee may also
be given notice of termination for personal reasons. However, these must be so strong
that it is not reasonable to demand that the employee remain with the employer. Con-
sequently, the intention is that it should not be possible to give notice of termination
on account of trivial oversights, occasional mistakes, or the personal opinion of the
employer. Moreover, an employer may not give an employee notice of termination ifit
is possible to redeploy them to other tasks within the company.
362 © THE AUTHORS AND STUDENTLiTTERAT

CHAPTER 15 • LEADERSHIP AND HUMAN RESOURCE MANAGEMENT (HRM)
However, if an employee commits a serious offence at work, for example a criminal

act, or refuses to obey the employer's orders, the employer is entitled to dismiss the
employee from the job without notice. Assault and theft are examples of criminal acts
that lead to immediate dismissal.
An employee may also have a time-limited position. However, the Employment Protec-
tion Act only permits certain forms of such employment so, even if the parties have made
an agreement on time-limited employment, it is not certain that it will apply. However, an
employer is always entitled to employ an employee for a trial period of up to six months.
If the employer does not want to retain the employee after the trial employment, they
must notify the employee before the end of the trial period. Otherwise, the trial employ-
ment automatically becomes a permanent employment. Other permitted time-limited
employment types may be a temporary replacement position, work experience, holiday
work, seasonal work, or work occasioned by a temporary large volume of work. In all of
these cases, there is specific legislation that aims to prevent an employer from making
use of time-limited employment instead of employing staff on a permanent basis.
Rights and obligations

Once employed by a Swedish company, an employee has a number of rights. For exam-
ple, they are entitled to receive pay, five weeks of paid annual leave every year, leave in
connection with illness, paid parental leave and leave to care for a sick child, and leave
of absence to study. Under the Gender Equality Act (jiimstiilldhetslagen), an employer
may not disadvantage an employee (or job seeker) on account of their gender.
The employer has a statutory right to manage and distribute work. Within certain
li mits, therefore, the employer determines what is done, when it is done, who will
perform the tasks, and how the work will be organized. To do this in practice, large
employers appoint managers who are expected to function as leaders and represent
the employer in relation to the staff. Via these managers, the employer has the formal
re ponsibility for ensuring that work is performed correctly. For important decisions
and decisions that affect the content of their work, employees are entitled, under the
Employment Act (lagen om medbestiimmande, MBL), to information from and consul-
tation with the employer (but are not entitled to be formally involved in decision-mak-
ing). In large companies, the employees are also entitled to be represented on the Board
of Directors via their trade unions.
The employer also has a statutory right to the results of its employees' work. This
means that, in principle, the employer owns all goods, services, design drawings, sam-
ples, texts, ideas, and innovations that are the result of activities performed as part
of the employment. An employee may not compete with their employer or, without
permission, carry on their own business operations in parallel if the operations may
be regarded as part of their ordinary employment.

Work environment
Under the legislation, an employer is responsible for its employees' work environ-
ment. Although every single employee is under an obligation to use prescribed safety
equipment, for example, and follow safety instructions, the employer has the principal
responsibility for the company's working conditions being such that employees do
not risk exposure to physical injury or ill-health. In Sweden, this applies in principle
to all employees in a workplace, i.e., both a company's own staff and external staff,
consultants and contractors who may be working in the same workplace.
The employer's responsibility originally mainly concerned the physical work
environment, i.e., issues relating to load, ergonomics, noise, vibration, and chemical
health risks. Responsibility for the work environment now also includes employees'
mental health and well-being, i.e., the psychosocial work environment. Consequently,
an employer's responsibility nowadays concerns everything that affects its employ-
ees' health in their work: air, sound, chemicals, machinery, equipment, IT systems,
workload, work content, work organization, stress, and opportunities for recovery.
Social needs are also considered part of the work environment. Any problems related
to discomfort, social interaction, harassment, bullying, and infringements of rights
are also issues that come under the employer's responsibility.
In Sweden, all employers are under an obligation to carry out systematic work
environment work, and this must be a regular part of operations. This means that
matters relating to physical and psychosocial work conditions must always be taken
into account when making decisions about operational leadership and organization. In
addition, all workplaces in Sweden with at least five employees must have a designated
safety officer whose task is to monitor the work environment and report any shortcom-
ings. The safety officer is appointed by the employees (in practice the trade union) and
has the right to stop operations. This statutory right may be applied if the safety officer
discovers work conditions that represent a serious, immediate risk to the employees and
are not immediately remedied by the employer when their attention is drawn to them.
The work environment is often discussed as a problem. Work environment i sue
are often associated with issues of ill-health, occupational health services, and rehabil-
itation instead of with issues of business, innovation, and efficiency. Investments in the
work environment of course cost employers money, but there is actually no contradic-
tion between the work environment and profitability. In fact, often the opposite is the
case. Successful operations tend to have better work environments than less succe ful
operations. While a poor work environment and poor work organization may cause
accidents, discomfort, and inefficiency, a good work environment may instead con
tribute to creativity and encourage employees to do their best for the operation · An
employer that shows that they care about their employees naturally has more loyal
committed employees than an employer that does not care.
© THE AUTHORS AND STUDENTLiTTERA

364
In the same way, the content of the work and the organization of operations cannot
be separated from the work environment. While the work environment affects the
quality of work, the tasks also affect employees' experience of the work environment.
The biggest work environment problems in Sweden today are rarely related to physical
health risks. Instead, they concern feelings of frustration and hopelessness as a result
of inability to perform tasks correctly.
Although Swedish workplaces are among the safest and best material workplaces
in the world, absence due to sickness is high compared with most other countries.
Since the end of the 1990s, absence due to sickness has also increased. According to
most analysts, the reasons seem to be increased efficiency requirements, lack of good
work organization, lack of administrative support, unclear work structures, stress as
a result of a need to make rapid changes, and poor adaptation of IT systems and new
technology. Today, the boundaries between work and leisure are becoming less well
defined and people need to be constantly available and flexible, at the same time as they
work in different projects. Thus, it is even more important to create a work environment
in which employees have adequate support from their managers, have a basic sense
of security, and can do good work. It is therefore essential to create an organizational
structure that supports operations (see also Section 16.3).
Equal treatment, diversity, and gender equality

It is a human right not to be subject to discrimination or harassment. Consequently,
the Discrimination Act stipulates that all workplaces in Sweden must work actively to
counter discrimination and ensure that everyone is treated equally. It is not enough
to tackle discrimination if it occurs. An employer is under an obligation to work pre-
ventively at all times.
Equal treatment at work means that everyone must have the same opportunities,
regardless of gender, age, origin, religion, sexual orientation, or disability. Addressing
equal treatment issues at work is positive in many ways . It makes an employer more
attractive and creates a workplace that makes use of everyone's knowledge, where differ-
ences are considered to be an advantage rather than an obstacle. A good mix of people
with a variety of experience can enhance both the efficiency and quality of operations.
On the other hand, poor social cohesion, bullying, and harassment often exist side by
ide with discrimination and prejudice. A person who is prejudiced often finds it hard
to adapt and to accept new ideas and solutions. A prejudiced, discriminatory workplace
may also find it difficult to recruit staff.
However, it is not always easy to achieve a diversity-oriented workplace. It is common
for an employer to appoint new employees in whom they recognize themselves, i.e.,
people with the same experience, background, and gender as the employees who are
already in the workplace. This phenomenon is sometimes called homosociality, for
THE AUTHORS AND STUDENTLIT TE RATUR 365

PART IV • MANAGEME NT AND ORGANIZING
example men identify with and seek out other men, while women are typically exclud
from sueh contexts, 1or
C •
mstance •
m •
connection "h recrmtment
wit . or promotion. How- ed
ever, this type of exclusion need not only be based on gender. It may also be based 0
factors such as social class, ethnicity, or sexual orientation. n
The concept ofgender equality is closely associated with equal treatment and em ha-
sizes equality between the genders. Gender equality is usually defined to mean ~hat
women and men should have the same opportunities, rights, and obligations in all area
oflife. In a company, the employer is under an obligation to promote gender equality
as part of the work to promote equal treatment. All companies with more than 10
employees in Sweden have to prepare a gender equality plan.
The gender equality work in a workplace may focus on different aspects. Its aim may
be quantitative, to achieve an even distribution of women and men, or it might involve
measures to change the power relations between the genders. Working on gender equal-
ity from a quantitative perspective means striving for an even gender distribution in a
workplace and in various positions and power situations. An even gender distribution
is usually considered to exist when the ratio of women to men in a group is 4o-6o %
(or more even).
In qualitative gender equality work, the conditions of women and men are in focus. It
involves highlighting standards and values that affect the opportunities and condition
of women and men. In qualitative gender equality work, the aim is therefore to change
the norms and structures that are not necessarily changed just because an even gender
distribution has been achieved. However, it is not always possible to make a clear di .
tinction between quantitative and qualitative work. Quantitative measurement often
needs to be followed by qualitative analysis to find the underlying causes of the lack
of gender equality, for example which norms cause most managers to be men, even in
workplaces that are dominated by women, or cause female managers to tend to receive
less administrative support than their male colleagues.
However, it is important to remember that neither women nor men are homogeneou
as groups. Not all women have the same life experience or living conditions, and nor
do all men. Consequently, it is important to be aware, in all work on gender equality,
diversity, and equal treatment, that there are different power structures and how these
power structures interact.
Recruitment and talent management

As stated above, being an employer entails a great deal of responsibility. Legislators have
tried in various ways to protect employees from potentially irresponsible employer · At
the same time, the decision to hire a new employee is also one of the most important
business and operational decisions a company makes. Recruiting the wrong per on
to a position can be very expensive. Firstly, it can be expensive for the company if it
c, THE AUTHO RS AND STUDENTLITTERATUI

366
has to terminate the employment prematurely. In Sweden, it is difficult to dismiss an

employee, for which reason an agreement is usually reached with the employee that he
or she will receive financial compensation for leaving, a severance payment. Secondly,
the processes related to notices of termination and dismissals are rarely much fun
for either party, which can easily have negative effects on operations and the other
employees. Thirdly, and most importantly, poor recruitment may have major effects
on all aspects of operations. An employee may not make any obvious mistakes in
their work, but a lack of skill, lack of commitment, or lack of social skills may lead to
a wide range of problems in operations, for example quality deficiencies in products,
tasks not being performed, poor customer service, and negative tension and conflict
within the team.
Recruiting employees is a central part of a company's talent management, i.e., its
work to ensure that it has access to the necessary skills for operations, both now and in
the future. Talent management is therefore about recruiting new staff and also about
ensuring and developing the skills of existing staff in technologies and work meth-
ods. Talent management is also about creating a balance between older, experienced
employees and younger, less experienced employees so that the company has access
to possible replacements when an employee retires or leaves for some other reason. At
the same time, a company cannot just employ younger, inexperienced employees to
keep payroll costs down. It also needs older employees with more experience and skill.
Operations that are to be sustainable in the long term must not be too dependent on
key individuals. There must be overlapping skills.
This is particularly important in relation to managers and experts who possess key
kills. Many companies therefore try to identify and deliberately develop potential
uccessors for this type of key position. This may involve formal training and courses,
as well as on the job training, in which employees develop in their occupations by
gradually assuming increasingly qualified tasks. Today this means that many employ-
ees pursue their careers not by traditionally climbing the managerial ladder, but by
gradually working on increasingly complicated and complex projects.
Strategically, therefore, a company's talent management is about both recruiting
employees and developing existing employees. Sometimes it is not necessary to employ
staff to gain access to skills. Flexibility is often enhanced if a company can make use
of the skills of external actors instead. Many companies now operate in networks that
engage a number of consultants, suppliers, contractors, and recruitment companies.
It is not unusual to have staff from a number of different employers in the same work-
place. However, from the perspective of an employer's own company, it is important
in the long term to find a balance between internal skills and the skills it can purchase
from various actors on the market. To be able to engage external actors well, it is often
necessary to have good internal operational skills.
A simple model is shown in Figure 15 .1. In the center, the company consists of a

r ·
.............................
............ . ....................
··........
/ .......········
Peripheral group ··········....
Staffing Sub-
agency contractor
'
Wage-subsidized
employees
....·"
FIGURE 15.1
Staffing in a flexible
···... ..... ····
company. •• ...••••.•• Outsourcing •··••••
relatively fixed core group of employees who maintain the company's functional key
skills. Around the center are the more peripheral groups of employees and external
actors who do not possess the same key skills but are still important for operations and
the company's capabilities. Many companies create the opportunity to quickly change
the company's resources in relation to demand by making use of various forms of tem-
porary employees, part-time employees, recruitment companies and consulting firms.
Exactly where the boundary should lie between these circles is an issue that occupie
many actors on the labor market. While employers often strive to increase the size of
the peripheral group to create greater numerical flexibility or to reduce staff costs, trade
unions often see this as a threat to employment security and the work environment.
1s.2 The employee and the work

Work is an important part of our lives. However, work is not everything for most people.
Family, children, relatives, friends, and leisure interests also play a major role. However,
studies have shown that having work is extremely important for our health. Poor health
is statistically higher in the long-term unemployed than in those who have jobs. At
the same time, the work environment also affects our lives away from work. Although
the primary task of working life is not to promote human health, work should at least
not have a negative impact on or harm people. People who work in poor conditions
for a long period of time also react to them sooner or later, for example with anger or
resignation, which does not promote the work climate, the individual, or productivity.
368 © THE A UTHO RS A ND STUDENTLITTERAT R

Sociologists call this type of negative reaction to poor work conditions alienation, a
feeling of isolation and meaninglessness in relation to work. Authoritarian structures
in which employees have little opportunity to influence their situation often create the
reaction of not caring about either performance or the company.
EXAMPLE: Hawthorne studies
The Hawthorne studies were carried out between 1924 and 1932 at Western Electric's production
plant, Hawthorne Works, outside Chicago by a group of researchers from Harvard led by Elton
Mayo, a professor of labor psychology. In one of their first studies, the researchers studied how
the intensity of the lighting affected the productivity of the workers. A test group was created in
which the intensity of the lighting was increased, and a control group in which the intensity was
kept constant. The result was the productivity increased, and not only in the test group (which
had been expected) but also in the control group despite it not having had better lighting. After
a number of studies to understand these surprising results, the researchers concluded that it was
not the changes in the workplace that they were testing that affected productivity. It was simply
the fact that someone was interested in the workers and their conditions that made them work
faster. So the most important thing was not exactly the type of change that was made but that
someone cared about them at all. The importance of taking account of employees and their social
needs to achieve good performance was highlighted for the first time through the Hawthorne
studies. Or as one of the participating researchers explained the research results:
"What is meant is that the worker is not an atomic individual; he is a member of a group, or
groups. Within each of these groups the individuals have feelings and sentiments toward
each other, which bind them together in collective effort."
SOUR C E: ROETHLISBERGER, 1941
- FIGURE lS.2
Haw t horne Wo rks, 1925 .

PART IV a MANAGEMENT AND OR GANIZING
At the same time, the opposite also applies. A manager or employer who pays atten-
tion to their employees can get a lot in return. A famous example is the Hawthorne
effect, named after an extensive study oflabor organization in the U.S. in the 19 20s and
30s. A general lesson from the Hawthorne studies was that employees tend to behave
as they are treated by the employer. Another lesson was that the informal relations and
work climate in the organization are just as important to the employees as the formal
structures. The Hawthorne studies had a significant impact, not least because they form
the basis of what came to be called the human relations movement in organizational
research and, by extension, of research into labor organization, social engineering,
group dynamics and leadership in later years.
Human needs and motivation

In psychology, there are a number of theories of motivation that are based on the
assumption that people's actions are guided by the drive to meet certain needs, both
at work and in other contexts. The best-known model is Maslow's hierarchy of needs
(after psychologist Abraham Maslow, 1908-1970). According to this model, people have
a few fundamental survival needs, such as eating and drinking, warmth and protection
(see Figure 15.3). When these needs have been met, others arise such as belonging to
a group, feeling social safety, and gaining acknowledgement. Only when these need
have also been adequately met are we able to start concentrating on self-actualization,
i.e., creating self-esteem by developing our interests and identities.
According to this model, people therefore strive to meet their needs in a specific
order. Fundamental needs must be met before people have time and energy to devote
FIGURE 15.3
Maslow's hierarchy of needs
(after Maslow, 1943).
370 0 THE AUTHORS AND STUDENTLITTERAT I

themselves to the higher-level needs. Consequently, an employer cannot motivate an

employee to do their utmost in a difficult task if the fundamental needs of safety and
reasonable compensation have not first been met. According to Maslow, it is also pos-
sible to relate the different needs in the pyramid to people's views of colleagues and
other people. While a person with "deficiency needs" (i.e., in the lower levels of the
pyramid) depends on others to have their needs met, a person with "growth needs"
(i.e., in the higher levels of the pyramid who is striving for self-actualization) may,
according to Maslow, instead experience other people as obstacles to the satisfaction
of their own needs.
An additional contribution to Maslow's hierarchy of needs is the two-factor theory
developed by psychologist Frederick Herzberg (1923-2000) (see Figure 15-4). In his
studies of job satisfaction and motivation, he found that the factors that create high job
satisfaction are not the same as those that eliminate dissatisfaction. He called the factors
that must be met to achieve acceptable job satisfaction, i.e., that the individual does not
feel dissatisfied, hygiene factors. And he called the factors that motivated employees to
perform well motivational factors. While hygiene factors typically consist of external
factors such as pay, material benefits, work environment, work conditions, and staff
policy, motivational factors primarily consist of internal factors such as interesting
work content, a feeling of professional recognition and opportunities for development
and responsibility.
Herzberg's point was that these factors cannot compensate for each other. The
hygiene factors must be in place for employees not to be dissatisfied, but when they
are in place they cease to have any actual impact. Then it is the motivational factors
that matter instead. On the other hand, unless the hygiene factors are in place, they can
Motivation
Amount of satisfaction
FIGURE 15.4
Herzberg's two-factor
theory (after Herzberg
et al., 1959).
CTHE AUTHORS A ND STU D EN TLITTER A TUR 371

never, according to this model, be compensated for with extremely strong motivational
factors . Consequently, an employee may be dissatisfied if the pay is not good but, if it is
regarded as adequate, a further pay rise does not create positive motivation.
Neither Maslow's nor Herzberg's model is undisputed. Some research studies have
supported them, others have not. However, with the reservation that they are simplifi-
cations, both models contain a lot of common sense. They are also easy to understand
and remember. In this way, the models summarize some essential aspects for employers
and managers to take into account.
Stress, demand, and control

In everyday language, the word stress is often used in situations of urgency, when having
too little time, being highly-strung, or when we are working too hard. In these senses,
we are all a little stressed from time to time. However, in medical terms, stress means
something more serious: it is a hormonal change triggered by physical and mental
strain. In this sense, stress may be defined as mental overexertion. An individual is
subject to more strain than they can cope with and the consequences are displayed
physically, mentally, and socially.
Stress may have several causes, including pain, fear, high workload, noise, and too
little support. A person may also experience stress from being under-stimulated, from
not feeling needed. People need a certain element of stress. Short episodes of stress
can promote health and performance. This is what happens in sport and it is also used
when companies formulate goals and performance targets for employees. However,
for stress to have a positive effect, the body needs to rest after performing. If there is
not enough time and space for recovery, long-term stress risks causing various types
of physical and mental reaction such as problems sleeping, reduced immune defense,
back problems, muscle pain, problems concentrating, irritation, and depression fatigue
(burnout). In some groups, stress may also lead to frequent conflicts, high sickne s
absence, and high staff turnover.
However, people react differently to different situations. What one person finds
stressful, another may not. It depends on the individual's ability and self-image and the
resources they have available. If an individual considers their possibilities of coping with
a certain situation to be good, the external demands may be seen as a positive challenge.
When an individual finds that demands exceed their own capacity, negative stress occur ·
The sources of work-related stress usually lie in the labor organization, management,
or the social relations in the workplace. To this may be added what we sometime
call IT stress. The volume of information received via email and social media mar be
experienced by some as stressful and difficult to handle. The stress may be worsened by
the feeling of needing to be constantly accessible by mobile phone or email, and being
able to respond rapidly to various queries.
c, THE AUTHORS AND STUDENTL,TTERAT I

372
Control
Activity direction
\E!le:<_~~ Ac.:i;ie>"
........ ,. .... "
............ . ........ .
,,...;;········)<........~;~;... FIGURE 15.S
...... 6- Tension direction The demand-control model

(after Karasek & Theorell,
Demands 1992).
An individual's ability to meet various performance demands is usually linked to their

degree of self-determination and freedom of action. This situation can be illustrated
with the demand-control model (see Figure 15.5). A person can cope with high mental
demands if they have the opportunity to plan and control the work themselves. In
such situations, employees are stimulated to be active and to develop both themselves
and the organization. Situations with high demands without freedom of action, on the
other hand, risk resulting in burned-out employees, while low demands in combina-
tion with low opportunity to exercise control over the work, lead to employees being
bored and passive.
The point of the model is therefore not that low demands should be set. It is that the
demands should be balanced in relation to the employees' freedom to make their own
decisions and opportunities for learning, variation, and development. In addition, the
balance between demand and control may be moderated by a third dimension: social
support, which comprises practical and emotional support from managers, colleagues,
family, and friends.
Great freedom may, however, also be experienced as a burden, particularly if it
involves difficult decisions with major consequences. It is therefore no solution to
delegate decision-making to employees without giving them the necessary support
and clear frameworks as this can create major work environment problems. Knowing
that support is available from managers, experts, and experienced colleagues when it
i needed often provides fundamental reassurance at work. However, the optimum
balance between demand, control, and social support varies greatly between individ-
uals and work situations.
C THE AUTHORS AN D STUDE N TL I TTE RATUR 373

Work organization and sustainable working systems

There is no perfect organizational model that always produces the best work environ-
ment and productivity. However, an organization is a process as well as a structure , a
constant ongoing organization of work involving the distribution and redistribution
of tasks between employees. How to create long-term sustainable work systems in
which employees can work hard to achieve the company's goals without developing
health problems is a question that has occupied engineers and supervisors ever since
the industrial revolution in the late 19th century. This question includes aspects such as
ergonomics, workload, and payroll systems, as well as the design of tasks, participation,
group affiliation, and professional development. In the second half of the 20th century,
Sweden was world-famous for its initiatives to combine high production efficiency
with good work environments. Swedish industry applied a number of reforms to move
away from the model for organizing labor that had been dominant since the early 2oth
century. The aim was to put an end to monotonous work at piece rates performed with
short cycle times by unqualified staff at remotely-controlled assembly lines, and to
create inclusive, socially sustainable workplaces instead.
Some of the most common ways of making work more sustainable, without having
a negative impact on quality and efficiency, that were developed from these initiative
were one or more of the following methods (the first two are illustrated in Figure 1s.6):
• Job extension:
An employee's tasks are extended to include others tasks within the same area,
resulting in greater variety and meaningfulness in their work and better overall
understanding of operations.
• Job enrichment:
An employee's tasks are deepened in the sense that employees are given greater
responsibility for planning, implementation, results, and productivity. As the
employee develops at work, responsibility and authority can increasingly be
decentralized from management to the employee.
• Job rotation:
An employee switches between different tasks over time. Job rotation reduces
the risk of monotonous workload but also the risk of burning out. Job rotation
also means that skills are distributed between employees and that the workplace
becomes less dependent on key individuals than it would otherwise be.
• Team organization:
Instead of management directly controlling and monitoring individual
employees, tasks are deliberately designed to be performed in collaboration in
a team. This reinforces employees' social cohesion, and management is able to
prioritize issues other than the day-to-day coordination of operations.
374 © THE AUTHORS ANO STUOENTLITTERAT I

CHAPTER 15 • LEADERSHIP AND HUMAN RESOURCE MANAGEME NT (HRM)
More authority
Job
enrichment
FIGURE 15.6
Job extension Job extension and job
enrichment - two ways
of developing the work
More tasks organization .
, Seif-governing groups and groups managed by objectives:

Responsibility is extended so that, based on agreed operational objectives, the
members of a team are granted a high degree of autonomy and can jointly plan
and decide how the work is organized and implemented. The intention is to enrich
the work and also for employees to feel greater responsibility and commitment,
and to receive help and support each other when needed.
The debate about work organization and work conditions is currently not as lively as it
was. At the same time, issues relating to work organization remain extremely relevant,
but the difference is that now they concern not only manual labor. They are at least
equally applicable to a wide range of qualified white-collar occupations such as ana-
lysts, doctors, engineers, teachers, and administrators. The boundaries between work
and leisure are no longer as clear as they once were. In the same way, organizational
tructures are also often unclear. Many employees work in projects with tight deadlines
and deliveries for which they are expected to be extremely flexible and autonomous.
A shared physical workplace seems to be on the way out for many jobs. IT systems,
mobile phones, and computers mean that many tasks can be carried out remotely and
we can collaborate over long distances.
However, at this time of apparently borderless working, it is even more important
for employers to pay attention to the organization of work. If an employer wants a
sustainable workplace that is efficient and profitable in the long term, they must actively
create suitable structures, set goals and define limits so that employees set the right
priorities, are given opportunities to concentrate and are able to develop their skills
and receive feedback between periods of high work intensity.
THE AUTHORS A ND ST UDENTLITTER ATUR 375

,s.3 Working groups

People are essentially herd animals. At the workplace, the work environment and
the work climate often manifest in the working groups. Therefore we are each other's
work environment. The work climate is associated with everything that is created in
relation to the group, including conflicts, relations, communication, social support,
friendship, and leadership. Small talk and gossip are important ingredients of all types
of groups. Small talk often enables decisions by managers and signals from the business
environment to be interpreted and made sense of by group members. Small talk is
also the medium through which many of the standards in the group are created and
maintained. All managers and leaders must, therefore, understand how working groups
function and develop.
Different types of groups

A working group is usually defined as three or more people who depend on each other
to achieve one or more shared goals. Consequently, the group members have reasons for
seeking each other out and trying to help each other in their work. In practice, however,
not all groups at work are groups in the psychological sense. Group or team may also
be names of organizational units in which the mutual dependence between members
is weak. A group of salespersons or lawyers need not be particularly dependent on
each other to do their jobs. However, there may be other ties that bind them together
administratively or socially. By being part of a group, an employee can maintain a
steady workload, receive support and advice in their work and, in particular, be stim-
ulated socially by working with other people.
A distinction is often made between formal and informal groups. While a formal
group is created by the company to perform a specific function or achieve a specific
goal, an informal group is created by people who have voluntarily sought each other
out. Informal groups are naturally independent of the formal structures, and most
employers also want the formal groups to meet employees' social needs (but it is far
from obvious that they always do).
Group dynamics
The social relations between group members maintain the stability of the group; at the
same time these relations are constantly subject to influence and change. For a group to
last over time, the group members must be prepared to follow its explicit and implicit
rules. All groups develop norms, i.e., assumptions and expectations regarding what type
of behavior is right or wrong, good or bad, permissible or prohibited. Norms may be
explicit, but they are often implicit and unconscious. Many of those who follow what
376 © THE AUTHORS AND STUDENTLITTERA

regarded as normatively correct do not even think about the fact that they are following
a norm: "they simply behave as expected". Norms are also rarely absolute. They function
more as a tolerance range within which it is permitted to roam. The norms come to
the surface in the event of deviations from what is normatively correct. However, it is
important to distinguish between a normal situation in a group and a group's norms.
A group of white female nurses in a rural area may have worked together for a long time
but, over that time, they may have developed a norm in which diversity is essential and
therefore they seek new colleagues with different backgrounds. The more important
a norm is perceived as being to a group's physical or mental survival, the stricter the
requirements for members to follow it usually are. This is often called group pressure.
Rules and norms change over time and vary from group to group in society. Some of
the norms in a working group support the group's formal goals ("we maintain high qual-
ity in this group"), while other norms may be contradictory ("it is not so important to
arrive on time here"). Relevant norms for a working group are beneficial to efficiency and
how members work together. Examples of irrelevant norms may be norms that discrim-
inate against group members on account of their leisure interests, ethnicity, or gender.
Consequently, being a member of a group means subordinating yourself to the
group's norms. Depending on their personality, different people are more or less com-
pliant to norms. However, if you want to belong to a group, you have to be prepared
to compromise with other group members. An individual 's willingness to comply
of course also varies according to the importance they ascribe to a group. Different
members also have different levels of freedom to deviate from the norms. The group
members with the highest status in the group usually have the greatest freedom, while
the middle layer of the group's informal hierarchy is often most conformist. They have
more to lose by deviating than those with the lowest status in the group.
The development of group norms is closely linked to the fact that different members
typically assume different roles in a group. The roles may be formal or informal, but
they guide the members' behavior. The different roles are shaped by the expectations
of the individuals in their different positions. For example, one member may be the
group leader, another the group joker, one the mediator who seeks compromises and
resolves conflicts, one the group rebel who questions and tests boundaries, and one
looks after the others, ensuring they feel good and are included. In a well-functioning
group, all members have roles in which they thrive. However, the problem is that the
roles may also be inhibiting. Individuals with a specific role may find it difficult to break
away from role expectations without changing group or workplace. For example, it is
usually difficult to be promoted to group manager and have to make decisions that
affect your former colleagues.
Role expectations may also be negative. It is not uncommon for a specific group
member to be informally appointed as the "scapegoat" who is at fault if the group suffers
•setback. In the same way, there is nearly always someone who is "worst" in the group
THE AU T HORS AND STUDE NTLITTE RA TU R 377

and if this person leaves, someone else assumes this role. These mechanisms also form
the breeding ground for exclusion, bullying, and harassment.
A well-functioning group has a strong sense of cohesion. The group members help,
protect, and support each other. However, a closely-knit group can also start to develop
negative attributes. By working well together and enjoying each other's company, there is
a risk that the group becomes closed and does not want to adopt new ideas. Consequently,
in such groups there is a risk of developing group thinking, i.e., the group members agree
with each other to such an extent and the group is so homogeneous that it fails to notice
warning signals from the environment, which differs from the group's strong norms,
and therefore fails to notice that it is in the process of making a wrong decision.
EXAMPLE
The group thinking behind the disastrous invasion of the Bay of Pigs.
On 17 April 1961, exiled Cuban troops invaded Cuba in the Bay of Pigs. The troops were supported
by the U.S. (primarily by the CIA) and the idea was for the landing to rapidly become a general
uprising against Fidel Castro, the Cuban leader at the time, who was moving towards increasingly
Soviet-friendly policy. The invasion was a fiasco. The invading force was defeated in three days
by regular Cuban forces under the direct leadership of Castro. The operation had been planned
under the previous President, Ike Eisenhower, but it was executed under the relatively new incum-
bent, John F. Kennedy. The lack of commitment by the new President Kennedy, and Castro's direct
involvement in the Cuban defense forces, led to the disastrous result for the invading force.
The researcher Irvin Janis (1918-1990) coined the term groupthink to describe how those
involved in the planning of the execution of the operation (i.e., the CIA and Eisenhower's planning
staff) could not imagine a situation in which the invasion would not lead to a general uprising in
Cuba, Kennedy was not wholeheartedly behind the operation and Castro would lead his troops in
the field. The consequence was devastating for relations between Cuba and the U.S. for more than
50 years.
Development of groups
All groups change and develop over time according to internal and external condition ·
. There are many models that describe this development process. The process is mo t
evident in the development of a new group, but the same pattern can also be identified
in connection with changes in more established groups, for example when a member
leaves or a new member joins.
One of the best known of these group dynamics models is the PIRO model (FIRO
is short for Fundamental Interpersonal Relations Orientation), under which a group
develops from immaturity to maturity by passing through three phases: the "i nclu ion
phase", the "control phase", and the "openness phase" (see Figure 15.7).
378 O THE AUTHORS AND STUDENTLITTERA

CHAPTER 15 • LEADERSH IP AND HUMAN RESOURCE MANAGEMENT (HRM)
FIGURE 15.7
The FIRO model
(after Schutz, 1958).
The first stage, the inclusion phase, during which the group is formed, is characterized
by uncertainty. In this phase, the group dynamics are focused on establishing who
must/may/wants to belong to the group and who must not be included. Communication
is superficial and tentative, as members try to learn the norms that will apply. There is
often competition for power and influence in the group, but rivalry is rarely explicit,
rather it is hidden.
When all group members have agreed to belong to the group, it can direct its inter-
est towards role distribution in the group. In the control phase, members try to take
control of their situation. They seek their group roles and find their places in the group
hierarchy. In this phase, contradictory interests come to the surface and competition
between members for roles and positions may impede work. However, competition does
not have to result in open conflict. It is usually masked in various ways, for example
in the form of objective discussions between the members competing to be the group
leader. A group that gets stuck in the control phase becomes so occupied with this that it
becomes difficult for it to operate. Its task is negatively affected by the rivalry and com-
petition. In addition, the control phase is not a one-off phase. The group tends to return
to it in new situations, for example in connection with setbacks, fatigue, and stress.
When the role distribution has been accepted by everyone, the group enters the next
phase: the openness phase. In this phase, the group can work efficiently towards its goals.
The term team is sometimes used for this type of ideal, mature, well-functioning group
(the fact that many teams do not function like this ideal in practice is another matter).
In such an ideal group, all members are satisfied with their roles, individual differences
between the members are accepted, joint decisions are made via rational discussions,
and no attempt is made to force decisions or construct false unity. The members work
together to achieve the group's common goals and look after each other. In addition,
conflicts in such a group are not about the group's structure or the members' roles or
personalities. They are about circumstances, goals, and methods.
However, like the previous phases, the openness phase is an unstable phase. New situ-
THE AUTHORS AN D STUDENTLITTERATUR 379

ations may cause the group to revert to previous phases. However, a mature group has a
greater ability to pass through both the inclusion and control phases and rapidly return
to the openness phase. But there is never any guarantee that the group will manage this.
1s.4 Management and leadership

When a person is appointed to be a manager, this means that the employer and usually
also the manager's subordinates expect this person to lead their employees. However, it
is important to distinguish between managers and leaders. A manager is a person who
has a formal managerial position in an organization, i.e., they have subordinate staff.
Being a manager often involves leading staff, i.e., exercising leadership. However, a man-
ager also has a number of other tasks. A manager plans operations, recruits employees,
acquires resources, has financial responsibility, is often external spokesperson and,
in particular, provides support, advice, and instructions in matters concerning the
technical content of operations.
A manager who exercises leadership is a formal leader. A formal leader has a mandate
from both their superiors and their subordinates. There are often also informal leaders
in different groups, i.e., members who have no formal management function but who
influence the thinking, attitudes, and conduct of the other members on various issues.
Disagreement between a formal leader and an informal leader is a typical conflict that
must be resolved if a group is to develop past the control phase (which was described
in the FIRO model in Section 15.3).
There is a great deal of literature on personal leadership, describing how a good
leader should be, think, and act. However, the leadership qualities that are highlighted
in literature are often thought to be universal good qualities that also characterize a
good colleague and employee. For example, an effective leader is usually described as
being generally intelligent, having a sense of responsibility, being self-confident and
independent, having emotional balance, being creative, having an ability to perform,
being interested in people and, in particular, having excellent social skills.
Three of the best-established models of different leadership styles are described
in the following sections. These models do not describe a leader's personal qualitie .
They describe a leader's behavior in relation to the group they have the task ofleading.
A one-dimensional leadership style model

One of the most well-known leadership models is based on a one-dimensional scale
extending from an authoritarian leadership style at one end, to a democratic leadership
style at the other. The authoritarian leadership style entails the leader making decisions
and then issuing direct orders for execution. An authoritarian leader requires uncondi
tional obedience and any attempts by subordinates to influence decisions are perceived
380 C> THE A U T H O RS A ND STUDENTL ITTERAT

CHAPTER 15 a LEADERSH IP AND HUMAN RESOURCE MANAGEMENT (HRM)
as criticism or obstruction. The antithesis is the democratic leadership style, which is

based on subordinates participating in planning, being encouraged to discuss and
criticize, and influencing the leader's decisions. There is also one other style, which is
neither one nor the other, laissez-faire, a leadership style under which the formal leader
is passive, exercising minimum control, i.e., they do not exercise any leadership at all.
The different styles have different effects on subordinates. Studies have shown that
an authoritarian leader can often achieve much better production results than the
others. However, this only applied when they were present. When the authoritarian
leader left the group, results deteriorated considerably. However, when the democratic
leader left the group for a while, production results were not affected noticeably. The
group managed on its own. The laissez-faire leader's group had the worst results. The
reverse occurred when the laissez-faire leader left the group. From having had the very
lowest productivity, results improved considerably when the laissez-faire manager was
absent, only to return to a low level again when the leader returned.
The fundamental values we have in Sweden in general, and at work in particular,
usually mean that we have democratic leadership. However, this should not be mis-
understood to mean that the manager should not make decisions, that every decision
should be discussed and that everyone is always entitled to have their voice heard. The
formal leader (i.e., the manager) always bears ultimate responsibility and this cannot be
decentralized to the employees. A well-functioning democratic leader formulates goals
and guidelines that give the group structure and with which the employees can identify.
Multidimensional leadership style models

An analysis of the difference between democratic and authoritarian leaders shows that
democratic leaders devote relatively high levels of attention to meeting their employees'
psychological needs so that they can function as well as possible. However, the one-di-
mensional model is inadequate for understanding how this can be combined with the
requirements made by the operations.
In a supplementary model, the managerial grid, two independent variables are iden-
tified: the manager's concern for people and the manager's concern for production/
results (see Figure 15.8). The leader focused solely on production (9.1 in the scales in
the figure) is synonymous with the authoritarian leadership style. All that counts are
results. The employees are of no interest. The team-oriented leader (9.9) in the model
i synonymous with the democratic leader and the impoverished leader (1.1) with the
laissez-faire leader. The fourth leader type, focused solely on employees (1.9), "country
club", represents a distortion of democratic leadership: "the most important thing is
that everyone feels good, not that we achieve anything".
However, neither of the models above takes account of the nature of the operations
and tasks to be led, nor of the knowledge, qualities, or maturity of the subordinates.

Concern for people
9 "Country Team-
club" oriented
"Middle of
the road"
"Produce
FIGURE 15.8 "Impoverished" or perish"
The managerial grid (after Concern for production/results
Blake & Mouton, 1964). 9
Therefore, an attempt is made to take account of this in models that emphasize situa-
tional leadership. Consequently, a new dimension is added: the situation. According to
such models, the leaders who function best are those able to vary their behavior accord-
ing to the prevailing situation. Sometimes, for example in acute situations, managers
have to act with authority and demand obedience, while in other situations they can
keep a lower profile and, in principle, let group members make decisions on their own.
One such well-known leadership style model is the situational leadership model,
which includes not only the leader's behavior but also the maturity of the employee
being led. According to the model, the leader must identify the maturity of the working
group they are to lead and then apply the right leadership style in four phases (see
Figure 15.9). In this model, the group and the leader follow an undulating path from
right to left (compare the description below with the description of group development
in Section 15.3).
For a newly-formed, immature group (bottom right corner of the model), leadership
must be strongly focused on the task. The leader must provide the structure, is ue
instructions, and focus on making the group understand and accept the task. When
the group has understood the task, the leader can focus their leadership on the various
individuals instead (top right corner). A certain amount of task focus is still required,
but in this phase the leader should instead devote themselves to convincing the employ-
ees in a free exchange of views and making the group enjoy working together. When the
group has thus gained experience of performing the task, the leader may then reduce
their task-focused leadership and instead devote more energy to the individuals and
the relations within the group (participatory leadership, top left corner). In the la t
stage (bottom left corner), the group has achieved a level of maturity that permit the
382 ,o T HE AUT H O RS AND STUDENTLITTERAT

Supportive behavior
(relationship focus)
FIGURE 15.9
The situational leadership
Controlling behavior model (after Hersey &
(task focus) Blanchard, 1969).
leader to reduce their individual-focused leadership and, in principle, leave the group.
The group can largely manage on its own. In this box, the leader has delegated their
leadership. The leader is an authority who establishes goals and guidelines and is on
hand if problems arise in the group or in the work.
15.5 A company's HRM and its HR department

Staff management or, as it often is called today, Human Resource Management (HRM),
is an established field that involves issues such as staff administration, talent manage-
ment, the work environment, labor organization, and leadership. All managers with
staff responsibility must practice HRM. However, this should not be confused with the
fact that virtually all large operations have an HR manager and an HR department.
The HR department is usually a specialist staff unit focusing on employment issues
such as law, pay, and other benefits, plus recruitment and possibly laying off staff. The
HR department is often contacted if staff or collaboration problems arise that cannot
be resolved within a department itself. The HR department also often develops staff
strategies, policies relating to pay, and procedures for recruitment and pay reviews.
In other words, HRM in a company is therefore carried out by all managers and
leaders in the company who are responsible for the working conditions of the employ-
ees. The formal aspects of employment contracts and labor laws are naturally basic
aspects that have to be managed, but other equally important aspects are the more
informal ones (motivators) discussed in this chapter, for example personal leadership
by managers and group dynamics in the workplace. Staff management and HRM are
essentially about a company creating the conditions to be attractive and able to recruit
OTHE AUTHORS A N D STU D EN TL I TTE RATU R 383

PART IV • MANAGEMENT AND ORGAN IZING
good employees and to ensure that all employees are able to do a good job. An impor-
tant aspect of this is how operations and work are organized. This is discussed in the
next chapter.
Summary
This chapter has discussed HRM and leadership, i.e., the company's relations with its
employees and issues relating to the work environment, labor organization, and leader-
ship. As employees carry out and develop operations, their motivation and well-being
are important efficiency factors for management in every company.
The recruitment of new employees is one of the most important decisions made
in a company. Recruitment involves ensuring access to the skills required in opera-
tions. Employing staff involves a number of requirements being made of employers.
In Sweden, these are usually regulated in laws and collective agreements. Employment
confers a number of rights on employees, for example relating to pay, annual leave,
sickness absence, and parental leave. An employer may not disadvantage an employee
on the basis of their gender. In Sweden, all employers must also carry out systematic
work regarding the work environment. This means that physical and psychosocial
work conditions must always be taken into account when making decisions about the
management and organization of operations.
Employees' motivation to perform good work is essential to operations. Two of the
best-known theories of motivation are Maslow's hierarchy of needs and Herzberg'
two-factor theory. While the former is based on the necessity of meeting fundamental
human needs before it is possible to concentrate on developing interests and identitie ,
the latter is based on the fact that different factors have different effects. External work
environment factors tend, according to Herzberg's model, only to be able to eliminate
dissatisfaction in employees, while it is the internal factors, for example interesting
tasks and a sense of meaningfulness in work, that can create a high level of job satis-
faction. Work-related stress is often caused by how work is managed and organized
or by poor social relations in the workplace. High performance requirements can be
extremely stimulating for an employee but, in combination with little control over the
task and their own working conditions, they can easily generate negative stres and
even burnout. Organizing work in such a way that employees can work well in the long
terin is therefore essential for all companies.
As a large part of operations are carried out in working groups of various kinds, the
environment in each working group is one of the most important work environment
and efficiency factors. An efficient working group is characterized by the fact that rule •
norms, relations and roles that create a good, supportive climate have been developed.
However, to reach this point, a working group must normally pass through the initial
O THE AUTHO RS AN D STUDENTLITTERAT I

384
inclusion phase and the subsequent control phase to reach the openness phase described
in the FIRO model.
When a person is appointed to be a manager, this means that the employer expects
this person to lead their employees, among other things. Popular leadership models
often emphasize a leader's leadership style, for example whether a leader is authori-
tarian, democratic or passive and disinterested (laissez-faire leadership), or whether
a leader emphasizes an interest in the employees or the efficiency of operations. How-
ever, the need for a leadership style may vary according to the employees' experience
and the working group's maturity, for which reason situational leadership is usually
recommended today.
References
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Maslow, A. (1943). A theory of human motivation. Psychological Review, 50, 370-396.
Mayo, E. (1933). The Human Problems of an Industrial Civilisation (2nd ed.). Macmillan.
Roethlisberger, F. J. (1941). Management and Morale. Harvard University Press.
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Chicago. Harvard University Press.
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CTHE AUTHORS AND STUDENTLITTER A TUR 385

······· ......................................................................................~.
~
ORGANIZING THE BUSINESS

OPERATIONS
In many small companies, the same individual (the owner/entrepreneur) per-

forms all work activities. Sweden, for example, has many small companies in
which the owner him- or herself does all purchasing; creates, manufactures, and
sells all the products; deals with all the customers; takes care of all the adminis-
tration and accounting; etc. However, if the company grows and hires employees,
the work tasks, authority, and responsibility have to be structured between the
people involved. The business operations need to be formalized and organized.
This includes choosing a juridical form for the company, dividing the operations
into suitable areas of responsibility as well as finding ways to manage and coor-
dinate the business operations. These are the questions that will be discussed
in this chapter.
16.1 The juridical form

The freedom to be an entrepreneur and run your own business, rather than being an
employee, is a fundamental right in every democratic country. There are a number
of different legal forms of companies. In Sweden, for example, you can run business
operations in the form of "aktiebolag", a limited liability company; "enskild firma", a
sole proprietorship; "handelsbolag", a partnership; "kommanditbolag", a limited part-
nership; "ekonomisk forening", an economic association; "ideell forening", a non-profit
association, a consortium, etc. Each form comes with its own legal framework which
governs that specific form of business.
CTHE AUTHORS AND ST UD ENTLITT ER ATUR 387

Limited liability company

Next to sole proprietorships, limited liability companies are the most common corpo-
rate form in Sweden. A limited liability company (Swedish: aktiebolag) can be financed
through capital from several owners without them being personally liable for the debts
of the company. This is the most distinguishing feature of this type of company: that
shareholders limit their financial risk to the capital they have invested. Due to this
limited risk, there is a relatively comprehensive legislation which regulates the activities
oflimited liability companies. A limited liability company always has to include the word
limited in the company name (in English abbreviated as Ltd) and be registered with the
government agency in charge of registering new companies (in Sweden, the Swedish
Companies Registration Office). After registration, the company becomes a legal entity.
In a limited liability company, assets always have to correspond to the share capital.
It is thus the share capital which makes up the financial basis of the limited liability
company. As the shareholders have no personal liability, the share capital constitutes
the financial security for the company's creditors, that is, the stakeholders to whom the
company owes money. In short, the share capital can be seen as the security which the
shareholders offer in exchange for limited liability. The share capital does not, however,
relate to the market value of the company's shares, that is, the price which a buyer i
willing to pay for a share.
By law, a limited liability company has to have an annual meeting, a Board of
Directors, and an auditor. Large limited liability companies also need to have a Chief
Executive Officer (CEO). The Annual Meeting is the highest decision-making body of
the limited liability company. All shareholders can attend and practice their right to
vote in relation to the number of shares he or she owns. In small and medium-sized
Limited liability company
Most countries have a company form with limited financial risk for the owners. Below are
examples of abbreviations, used in different countries, which have to be included in the company
name to signal this limited liability:
• AB, aktiebolag - Sweden

ltd, limited company (from limited liability) - Great Britain, Ireland, Canada
PLC, public limited company (listed companies) - Great Britain, Ireland, Canada
Inc., incorporated ("incorporated company" implied) - United States
AG, Aktiengesellschaft - Germany and German-speaking countries
SA, societe anonyme - France and French-speaking countries
AS, aksjeselskap (Norwegian), aktieselskab (Danish) - Norway, Denmark
Oy, osakeyhtiii (Finnish), AB, aktiebolag (Finland-Swedish), or both Oy Ab - Finland

CHAPTER 16 • ORGANIZING THE BUSINESS OPERATIONS
companies, the shares are generally owned by a few people, while the shares in large
companies are often owned by thousands of people. The Annual Meeting appoints
the company's Board of Directors, who will be responsible for the management of the
company, and an auditor, who will be in charge of auditing the company's operations
on behalf of the owners (primarily).
A limited liability company is a taxable entity, which means that the company pays
corporate tax irrespective of the personal tax rates of the owners. The tax on the com-
pany's profits is thus paid by the company. If the company thereafter pays dividends
to the shareholders, they also have to pay tax on these dividends as "capital income"
in their income tax return.
Sole proprietorship
Every Swedish citizen who has reached lawful age has, in principle, the right to run his
or her own business. The easiest way to do so is to operate a sole proprietorship (Swedish:
enkild firma), which means that a physical person owns and runs business operations
under a specific corporate name. This is the most common type of enterprise in Sweden.
A sole proprietorship is not a company in a legal sense; rather the firm is synon-
ymous with the person who runs it. Thus, there can only be one owner. Nor does a
sole proprietorship have its own capital; instead all of the company's assets and debts
belong to the owner.
There is no particular legislation applying to sole traders. However, the person
who runs a sole proprietorship is, just like all traders, obliged to maintain accounting
records in line with the Swedish Bookkeeping Act. Moreover, the owner of a sole pro-
prietorship is personally obliged to submit a tax return for the company's activities
and has to account for any profits as "income from business activity" in his or her
income tax return.
Within a sole proprietorship it is possible to run large operations, have employees,
own assets and make big business deals. In practice, however, most sole traders run
small companies.
Partnership
In Sweden, the legal form partnership (Swedish: handelsbolag) refers to a company
where at least two people have agreed to run a business together. As opposed to a sole
proprietorship, this type of partnership constitutes a legal entity. This means that the
company can enter agreements, shoulder liabilities, and attain rights. Thus, the partners
of a partnership do business on behalf of the company under the corporate name and
not under their own personal names. By law, a trading partnership has to include the
words trading partnership ("handelsbolag", HB, in Swedish) in the corporate name.

A partnership can have its own assets and debts. However, just like sole proprie-
torship, each of the partners is liable for all of the company's activities with their own
personal assets. You could say that the liability of the owners applies as "one for all and
all for one". Thus, if a partnership is unable to pay its debts, it can lead to bankruptcy
for both the company and one, or several, of the partners.
It is fully possible to conduct large-scale business operations in a partnership. How-
ever, this type of enterprise is in Sweden mainly valid for small companies. The principle
that each of the partners is personally liable for all the debts of the partnership means
that it usually is considered unsuitable for large businesses with many partners (in such
situations, a limited liability company is usually a better alternative).
'
Limited partnership
A limited partnership (Swedish: kommanditbolag) is a partnership with two types of
partners: those with limited financial liability, limited partners (sometimes referred to
as a silent partner) and at least one partner with unlimited financial liability, general
partner (sometimes referred to as the partner in charge). Limited partnerships are legal
entities in the same way as partnerships and limited liability companies. A limited
partnership can, just like a limited liability company, have a number of partners who are
liable only for the financial capital which they have invested in the company. However,
the general partner always has full personal responsibility for all the company's debts
and other liabilities.
Associations
An association (Swedish: forening) is, in principle, open to all of its members on equal
terms. In Sweden there are, legally speaking, two types of associations: economic and
non-profit. Economic associations (Swedish: ekonomiska foreningar) are association
which have been created to promote the members' interests through economic activ-
ities. The members of an economic association have to participate in the activities of
the association in some way, for example as consumers, boat owners, residents, parents,
or suppliers. Some typical examples of economic associations in Sweden are housing
cooperatives, boat clubs, retail cooperatives such as Coop, producer corporatives such
as the Federation of Swedish Farmers ("Lantbrukarnas riksforbund", LRF), and parent
cooperative daycare centers.
Associations with religious, political, or other non-economic purposes are, on the
other hand, categorized as non-profit associations (Swedish: ideella foreningar). It i •
however, perfectly possible for non-profit associations to run large-scale operation
with a large number of employees. In actual fact, there are many non-profit a socia-
I
tions which finance their operations through different types of economic activities.
10 THE AUTH O RS AND STUDENTLITTERATUI

390
CHAPTER 16 • ORGANIZING THE BUSINESS OPERATIO~IS
Voluntary organizations such as the Red Cross, football clubs, Christian churches, as
well as political parties and trade unions are some examples of non-profit associations
which can be very large.
Consortium
A consortium (Swedish: konsortium) is a group of individuals or companies which aim
to implement a common business project which requires capital or which is considered
risky. Consortiums between companies are, for example, common in large construction
and industrial projects. A consortium is, thus, a type of temporary company which
dissolves once the project or business deal has been completed.
A consortium is not a legal entity. Instead, it is based on a consortium agreement
which divides the financial rights and liabilities of the consortium between its members.
Thus, a consortium does not formally have its own corporate name (even though it
might have an informal name which is used in the day-to-day operations). Conse-
quently, the consortium as such has no rights or liabilities. They are instead placed
with its members.
16.2 The company as an organization

A company which has more than one member, or employee, constitutes an organization.
Within the field of organization theory, the term organization has at least two meanings,
partly in the sense of"unit" or "association", and partly in the sense of"structure" as in
organizational structure (see Section 16-4). In the first meaning of the term, it is usually
said that a formal organization, as opposed to for example a spontaneously formed
gathering or group of people, has the following four characteristics:
• the organization is an association of individuals

• the individuals perform different work tasks
• the work tasks are performed in a coordinated way
• the purpose of the work tasks is to reach a common goal.
There are many different types of organizations that are created to meet the goals and
interests of different stakeholders. You can, for example, distinguish between member
organizations, for instance a sports club or a trade union, which primarily support the
interests of their members; business organizations, which primarily promote the interests
of the owners, for example a private limited liability company; service organizations,
which primarily look after the interests of the customers, for example a healthcare center;
and societal organizations, which protect the interests of the citizens, for example the
police and the courts. Which of these categories an organization belongs to, that is, which
objectives have the highest priority, greatly influences its management and operations.

Different environments create different prerequisites

Forming an organization creates a structure for collaboration between the members
of the organization. This means that managers do not have to negotiate with each of
the members regarding their roles and reimbursement every time something needs to
be done. Instead, there is a division oflabor where different members are responsible
for different tasks in exchange for an already set reimbursement. Exactly what this
division of labor looks like in different organizations depends on, for example, the
nature of the operations and the external demands on the organization. Moreover,
different traditions and norms can also have a strong impact on what is viewed as the
appropriate way to structure an organization within different sectors of society.
Some organizations operate in what we might refer to as a typical technical environ-
ment, where the organization is rewarded for high efficiency. Today, both private and
public organizations are under extensive pressure to utilize their resources as efficiently
as possible. A typical example is a paper mill, which has well-defined, clear objectives
and where the measurements of efficiency and productivity are unequivocal.
For other types of organizations, internal efficiency is not the most important factor,
but rather that the norms, values, and rules of the operations are carefully followed.
These types of organizations operate in a typical institutional environment. In this
environment, the key for the organizations is that they are perceived as legitimate in
the eyes of the public, that is, as working "with the right things" in an appropriate way.
The most important task of a court oflaw, for example, is to make sound and correct
decisions in accordance with the legislation in force. In the same way, a university
gains legitimacy through competent students, successful alumni, strong traditions,
and good research environments, rather than efficient use of resources. Activities of
organizations operating in strong institutional environments are usually governed by
a number of formal rules and routines to which both management and members of
the organizations have to oblige.
The demands on efficiency and legitimacy do not, however, necessarily exclude
one another. Some organizations, for example banks and hospitals, operate with high
demands on both efficiency and legitimacy, which means that they have a number of,
sometimes contradictory, demands to meet at the same time. These types of organiza-
tions are often very complex. Other organizations operate in environments where the
surrounding world demands neither high internal efficiency nor compliance with a ho t
of no~ms and rules. In these types of organizations, management has more autonomy
to organize the work. Given that, for example, a restaurant or a design agency do not
breach any fundamental laws, the key to success is rather about the popularity among
the customers than, for example, the educational background of the chef in the kitchen,
or the exact work procedures used in the design studio.

Different types of operations create different prerequisites

It is not, however, only the environment which creates different prerequisites for differ-
ent organizations. The nature of the operations, for example the technical content, the
production volume, to what extent the volume varies, and how fast it is evolving, has a
great impact on what is deemed a suitable form of organization. A large organization
requires significantly more bureaucracy and well-structured administration, in other
words, impersonal formal roles and routines, than does a small organization where
everyone knows each other. An organization with high production volume and small
variance in output means that it is possible to standardize and streamline work in a dif-
ferent way, compared to an organization with low production volume and low variance
in output, which instead requires flexibility and broad organizational skills (cf. Section
3.2). Moreover, some organizations have to maintain a high level of preparedness in
order to quickly be able to handle unforeseen events (which requires excess capacity),
while other operations are predictable and thus, to great extent, can be planned in
detail far in advance.
A common misunderstanding when it comes to organizing is that large organiza-
tions always include economy of scale, i.e. that the organization, thanks to its size, can
run its operations more rationally and cost-efficiently than a corresponding small-scale
business. The misunderstanding probably originates from the traditional manufac-
turing industry, where large-scale operations usually require a large organization and
where large companies often can compete on different terms than small companies.
Business operations
Small scale Large scale
Hospitals Industrial goods

Universities manufacturing
Police forces Retail chains
C:
0
.:;
"'N
·1:
FIGURE 16.1
"'~
0 Large organizations do not
always equal large-scale
Attorneys at law Music studios operations and large
Craftsmen Video game studios operations do not always
equal large organizations:
some examples (based on
Tyrstrup, 2014).
C THE AUTHOR S AND STUDENTLITTERATUR 393

The principle of efficient mass-production is, for example, absolutely essential to many
industrial companies. Through large production volumes it is possible to standardize,
rationalize, and maintain lower costs in production than small-scale manufacturing,
similar to craftsmanship (see Figure 16.1). The same principle applies also to, for exam-
ple, retailing.
For other types of operations, however, this connection is debatable. The video game
developers Mojang (creator of Minecraft) and King (creator of Candy Crush Saga) have
created products that are used by millions of customers all over the world. However, the
companies themselves are not particularly large in relation to their operating volumes.
The same applies to the music industry. The "Swedish music wonder", with producers
like Dennis Pop and Max Martin and bands and musicians like Abba, Roxette, Swedish
House Mafia, Avicii, and Zara Larsson, has created music with worldwide success. In
relation to the sales volumes, however, the Swedish music industry has always had a
relatively small number of employees. Instead, the operations are run by a number
of producers and musicians in different small-scale studios. That the music industry
would be more efficient by being operated by one or a few large studios instead, is
highly questionable.
On the other hand, there are also large organizations which on the surface might
seem to run large-scale operations, but which in actual fact consist of a large number
of distinctly different, small-scale operations. General hospitals are typical examples
of this . Even though a hospital might conduct certain medical activities which benefit
from large-scale production (e.g., standard operations or X-rays using very expen-
sive MRI scanners), most of the operations are by nature small-scale. This includes
diagnoses and care for individual patients at different clinics, where each patient has
his or her own individual needs. These types of operations are difficult to run on a
large scale without making them both complex and hard to plan. The same thing
applies to many other organizations, for example the police force, the prosecution
authority, a pharmaceutical company's research department, or a university. Certain
processes and certain parts of the activities at a university, for example IT and facility
management, might be possible to streamline through large-scale operations, but the
majority of a university's main activities, that is, education and research, are primarily
run as relatively small-scale operations via different courses, teams of professors, and
research groups.
There are, thus, many ways in which to organize an organization; there exists no
"one size fits all". Instead, the organizational form chosen has to correspond as closely
as possible to the demands on efficiency and legitimacy from external actors, as well as
to the inherent, technical logic of the operations that are to be organized.

CHAPTER 16 • ORGA NIZING THE BUSINESS OPERATIONS
16.3 Organizing an organization

Organizing typically means creating some kind of organizational structure. In other
words, organizing means the attempt to create an enduring pattern of behaviors and
actions among the employees that promotes effectiveness, efficiency, and enables
organized cooperation.
Organizational structure
All the formal means an organization uses to divide and coordinate the work with the intent of
creating stable behavioral patterns.
Specialization and coordination are two key concepts in the discussion about organiza-
tional structure. If a small company owner with five employees, for example, employs
an accountant to manage the company's financial accounting, the owner must define
the accountant's work and responsibilities. How shall the work tasks be designed? Other
than managing the bookkeeping and accounting, should the accountant also manage
company correspondence, make various calculations, deal with customers, and take
care of the archives? The accountant must know the limits of his or her decision-making
authority - that is, can the accountant make decisions or must the accountant always
consult with the owner (e.g., to purchase a new bookkeeping software or to change the
company's archiving system)?
So long as a company employs only a few people, most of the division of labor
between the employees is relatively simple and can be discussed informally. However, as
the company grows and hires more people, a much more elaborate and explicit division
oflabor is needed. Employees no longer know all the other employees or know what
these other employees do, particularly because the company now might have employees
at different locations. Individual employees thus lack the knowledge and competences
to solve every problem that the company encounters.
Therefore, division of labor is essential. This means that different people in the
organization allocate their attention to different issues and problems. Through this
specialization, the various employees develop their knowledge of and competences in
particular areas. Their expertise in these areas thus enables the company to develop
its operations and become more effective and efficient.
At the same time that jobs are specialized, coordination is required among various
parts of the organization so that everyone works towards the same goals. It is coordi-
nation that makes an organization more than just a collection of scattered individuals.
The idea behind organizing is that it is easier to achieve an objective by a collective
group effort than by many individual efforts.

Organized action requires coordination

Coordination and control of activities and behavior in larger companies are best accom-
plished by creating organization rules and roles and by establishing norms and values.
Rules standardize certain behaviors and actions, such as how to make financial reports,
how to submit vacation requests, how to implement changes in product design, or
who has the right to purchase office equipment. Some rules are formalized as written
instructions, decisions, or plans while others are implicit and manifested as routines
applied during the daily operations.
However, you cannot depend only on rules because rule-makers cannot predict
all situations and required work tasks in advance. Even if that were possible, it would
be impossible for people to remember all the rules for every situation. Therefore, all
organizations also have more or less standardized organizational roles. Department
head, project manager, senior engineer, and marketing executive, are examples of such
organizational roles. A role defines a broader framework for action than specific rules.
At the same time, a role is limited by the various expectations and values associated
with it. The greater the unpredictability in an organization's operations, usually the
greater importance the roles have compared to the rules.
An organization also coordinates and controls employee behavior through organi-
zational norms and values. Many companies work deliberately to create a company cul-
ture that shapes their employees' attitude towards the value of work and the importance
of the company's customers. These norms and values are often evident in the company's
general business principles, its hiring and promotion policies, its compensation and
benefits packages, its personal behavior standards, and so forth. Such control resembles
the ideological kind of norm-setting that is evident in, for instance, political parties,
religious groups, or non-profit activist organizations.
Five coordination mechanisms

The coordination and control of the various activities in an organization can also
be described by the following five coordination mechanisms, which together enable
organized action (identified by Mintzberg in 1979):
1 Mutual adjustment:
Coordination occurs informally by direct communication between individuals.
An example is the coordination in a team where everyone knows each other and
each other's responsibilities well.
2 Direct supervision:
Coordination occurs when an individual supervises the work of other
employees. An example is the coordination by a military officer in charge of an
396 IO THE A UTHOR S AND STUDENTLITTERATUR

CHAPTER 16 • ORGANIZI NG THE BUSINESS OPERATIONS
operation. The manager issues orders and checks that the orders are followed by
the employees.
3 Standardization of work processes:
Coordination occurs when the work is described in detailed procedures and
instructions. Sometimes such instructions are "embedded" in the technical
equipment and tools applied. Examples are the screen designs of webpages of
computerized administrative systems.
4 Standardization of"output":
Coordination is achieved through clear specifications of the intended work results.
A typical example is the workstations of an assembly line in which the output of
each station is standardized so that the process can continue at the next station.
5 Standardization of knowledge and skills:
Coordination is achieved when the participants of a process have specific
education or training that allows them to coordinate their work through
well-defined terminology and the application of standard operating procedures.
An example is the cooperation of different medical specialists involved in a
complex surgery at a hospital. Another example (of informal coordination) is
the coordination of traffic in a city where all drivers with a driver's license have
a common understanding of traffic rules and appropriate driving behavior from
similar driving lessons.
In summary, we can conclude that coordination and control in an organization do not

always require a supervisor who closely monitors and supervises the work. Rather, the
opposite is true. Most daily activities at large companies are coordinated without the
direct involvement of a supervisor. Much of the coordination is governed by organiza-
tional routines, rules, roles, norms, and values. To a great extent, these are influenced
by the employees' education and training.
16.4 Organizational structure

If you ask employees to describe their company's organization, they will usually refer to
the company's official organization chart (also called organogram). Although it may be
drawn in various ways, the chart presents the official picture of how the organization is
assumed to function and how the responsibility within the organization is distributed.
A traditional organization chart consists of boxes that are linked with lines so that they
form a pyramid (see Figure 16.2). Each box represents a person or a department (or unit)
in the company with lines of authority drawn between them. Thus, the chart depicts the
organization's hierarchy of superiors and subordinates. The chart answers the following
questions: Who is the manager of whom and which activities? Who has the authority
to give orders to whom? And who should act as mediator if two employees disagree?
THE AUTH ORS A N D STUDE N TLITTERA T U R 397

Purchasing Production
FIGURE 16.2 I 7
Classical organization chart
of an industrial company.
The organization chart in Figure 16.2 is a typical example from a small company. In
principal, however, it is generic and valid for most formal organizations - privately
owned companies, public organizations, and non-profit organizations. The Board of
Directors appoints the Managing Director (sometimes called Chief Executive Officer,
CEO). He or she is the company's most senior executive and reports directly to the
Board. Below the Managing Director/CEO, the organization is structured into various
vertical levels and into various horizontal departments with different specializations
and responsibilities.
The formal and the informal organization

The organization chart presents the essential elements of the company's formal organ-
izational structure. The idea behind the formal organizational structure - how the
work is allocated and organized - is that it presents the most effective way of achiev-
ing the company's objectives. In addition, the organization chart is a representation
of the company's various relationships as defined by job descriptions, instructions,
and procedures.
Even if the departments shown in the organization chart appear independent of one
another, it is a mistake to assume this is how the company operations actually function .
The informal organizational structure, consisting of personal contacts, friendships, and
common interests among employees, is at least as important (if not more important) a
the formal organizational structure. This informal organization usually plays an essential
role in making the daily operations run smoothly and with high efficiency. If employees
rigidly follow the formal structure, they usually accomplish less work at a slower pace.
The formal and informal organizational structures exist together within the organ·
ization. While the formal organizational structure is impersonal and (in theory)
independent of individuals, the informal organizational structure consists entirely of
individuals, their characteristics, and their personal relationships. Thus, one important
management challenge is to mesh these two structures so that they complement rather
than oppose each other.
398 © THE A UTH O RS A ND STUDENTLITTERATUR

Positions, authority, and responsibility

The work of an organization is defined in accordance with how the various formal jobs
and positions are located in the organization chart. Before creating a position in the
organizational structure, a company must identify the tasks as well as the authority
related to that position. For example, does the individual in the position have the
authority to sign contracts or to hire new employees? Typically, the authority of a
position allows the employee to delegate some work tasks and authorities to his or her
subordinates. Such authority may or may not be written as formal procedures.
However, even if authority is possible to delegate to subordinates, it is not possible
to delegate the responsibility. Anyone who delegates a task to someone still retains
responsibility for its completion. Thus, it is always essential to define in detail which
authority has been delegated and which has not.
EXAMPLE
At the company Constellation AB, none of the employees has the authority to purchase materials
or equipment or to register for mobile telephone subscriptions. If employees need work gloves or
new computers, for example, they must check with their managers before making the purchases.
The managers, in turn, can only make purchase decisions for items below SEK 20,000 or less. For
larger amounts (e.g., purchases of new machines or expensive training programs), the managers
must check with the production manager. In turn, the production manager is limited to making
purchase decisions of up to a couple hundred thousand SEK. For more costly purchases, only the
CEO, in consultation with the Board members, has the decision authority.
16.S Various organizational forms

For many years, researchers and practitioners have tried to formulate general rules and
principles for the ultimate organizational structure. Although many of these principles
are still valid, few today accept the idea that one particular organizational structure
always is better than all the others. Quite the opposite is true. The organizational struc-
tures of companies vary, and they do this for several reasons, e.g., company size and age,
industry sector, and business environment. Today there is a common understanding
that an efficient organizational structure can be designed in many different forms.
The design of an organizational structure can be examined according to three
aspects: the division oflabor; the integration of its activities; and the control of employee
behavior and performance.
Division oflabor:
• horizontal specialization
• vertical specialization.

Integration of activities:
• vertical relationships: superior-subordinate
• horizontal relationships: associate-associate.
We shall, in the following, discuss these organizational dimensions one at a time, as

well as describe the organization designs which are associated with them.
Horizontal specialization
A principal purpose of organizing is to structure work tasks and teams into separate
departments, units, sections, and so forth. This practice is called horizontal specializa-
tion. This division oflabor depends primarily on the competences in the organization in
relation to the work to be performed. In theory, we can identify four bases for grouping
positions into departments and other types of organizational units:
• function
• product
• customer
• geography.
The functional structure

The functional structure is one of the most common ways to structure the operations of
industrial companies. The work is grouped according to functional expertise. The work
tasks are divided into several main areas such as product development, manufacturing,
and sales. Each area employs people with relevant expertise who develop the methods
and procedures for their work. Through specialization, they create swift problem-solv-
ing routines while they develop their long-term competences. For example, by grouping
all experts on solid mechanics in the same department, conditions are created for the
company to become less dependent on each of the expert's personal knowledge, than
if the experts on solid mechanics were situated separately at different departments of
the company (see Figure 16.3).
Of course, there may be disadvantages with a functional structure. Various teams
and departments (with their experts) can tend towards isolation when they focus on
their own tasks rather than on what is best for the organization. The functional struc-
ture has a tendency to over-emphasize how the tasks should be done, rather than what
ii@Mil-j:MiM@i
_J
FIGURE 16.3
Engineering design Manufacturing Sales
The functional structure.
400 <O TH E AUTH O RS AND STU DENTLITTERATUR

CHAPTER 16 • ORGANIZING THE BUSINESS OPERATIO NS
(which tasks) should be done. Also, many departments are inclined to engage with
every problem/issue, which creates coordination problems for the management.
The product structure

The product structure is another commonly used organizational design. It is especially
appropriate when the company produces goods and services that are significantly different
from each other. In the pure form of this organization design, each product department
takes responsibility for its own purchasing, operations, and sales. In this way, each depart-
ment avoids many of the coordination problems that the functional structure experiences.
Another advantage of the product structure is that it creates a holistic view of each prod-
uct's requirements and characteristics. Furthermore, it may be easier to control operations
if there is only one department responsible for each product. However, a disadvantage of
the design is that every department requires its own specialists, which means that certain
functions and tasks are duplicated throughout the company. Atlas Copco is an example
of a global manufacturing company using a product structure (see Figure 16-4).
The customer structure

The customer structure is a way to group departments and teams by customers and
customer categories. For example, the sales operations may be structured in one depart-
Vacuum Construction
Technique Technique
Compressor Technique Industrial Technique Mining and Rock Vacuum Technique Construction
Service Service Excavation Service Service Technique Service
Industrial Air MVI Tools and Underground Rock Semiconductor Service Specialty Rental
Oil-free Air Assembly Systems Excavation Semiconductor Portable Energy
Professional Air General Industry Tools Surface and Exploration High Vacuum Construction Tools
and Assembly Systems Drilling
Gas and Process Industrial Vacuum
Chicago Pneumatic Drilling Solutions
Medical Gas Solutions
Tools Rock Drilling Tools
Alrtec
Industrial Assembly Rocktec
Solutions
Common service providers
FIGURE 16.4 The Atlas Copco corporate structure. Source: Atlas Copco, 2016.
THE AU T HOR S A ND ST UD ENTLI TTERA TU R 401

ment for commercial customers, one department for non-commercial customers, and
one department for export customers. The significant advantage with this organiza-
tional design is that it minimizes the number of contact points between the company
and its customers. Because specific departments manage different customer categories,
the departments have good knowledge of their customers' needs and preferences. At
the sales departments of industrial companies, there are often sales representatives ,
account managers, and senior sales representatives, key account managers, who are
designated to develop and coordinate the sales activities to specified major customers.
The disadvantage of this organizational design is that it reduces the benefits of the
functional organization in supporting long-term development of functional expertise.
The geographic structure

The geographic structure is a way to group departments on the basis of the physical work-
place locations. In many ways, this organizational design is the simplest to understand
and implement, especially when a company has operations at multiple locations in many
countries (see Figure 16.5). It is often efficient for employees who work closely on a daily
basis to also report to the same manager. The advantage of this organizational design is
that it creates possibilities for developing local knowledge. The disadvantage is the same
as for the customer organization - the difficulty of supporting long-term development
of functional expertise. However, many manufacturing companies acting on a global
market do not have much choice but to use the geographic structure, since they are
obliged to set up local subsidiaries for product development and/or manufacturing in
order to obtain contracts from the local customers.
Mixed organizational designs

In practice, most large companies use a mixture of these four organizational struc-
tures. Different principles are applied in different areas and at different hierarchical
levels. Major industrial companies tend to structure their operations into business
................. 1 .................. .
1_Internal auditor _1
FIGURE 16.5 Forestry Admin.

Region North Region Central Region South
Swedish Forest Agency's Department Department
geographical structure.
Source: Swed ish Forest Depart- Depart-
District District District
Agency (Skogsstyrelsen), ments ments
2017,
402 © THE AU TH O RS A ND STUDENTLITTERATUR

CHAPTER 16 • ORGANIZING THE BUS INESS OPERATIONS
areas and subsidiaries according to products, customers, or geographical locations.

At the lowest organization level of the hierarchy, however, most industrial companies
apply the functional structure. Atlas Copco, for example, is not structured only by
product. The Swedish Forest Agency is not entirely structured on a regional basis.
These organizations have rather matrix-like organizational structure (see Figure 16.10).
Vertical specialization
Most large organizations have a formal hierarchy based on responsibility and authority
that ranks individuals and departments. In other words, the structure is based on a
system of superiors who have more decision-making power than their subordinates.
It is common to talk about the different decision levels in which the people who hold a
superior rank in the hierarchy have more authority to make important decisions than
the people below them.
Hierarchy and span of control

Vertical specialization refers to the number of organization levels - whether the hier-
archy is flat (broad) or tall (narrow). The number of levels also determines the size of
the span of control, which is a measure of the number of subordinate employees, or
l. .J .J J
L
Flat (broad} span of control is suitable under the following conditions:
a high degree of work standardization
a high degree of similarity in work tasks
a strong need for employees' independence and self-reliance, and
a strong need to reduce disturbance in the vertical information flows in the hierarchy.
_J
Tall (narrow} span of control is suitable under the following conditions:

a strong need for direct management control of work tasks
a strong need for reciprocal adaptation to manage work tasks that are tightly
linked to each other FIGURE 16.6
employees have a strong need to contact managers for help and advice, and Advantages of different
managers have many other work tasks besides their managerial responsibilities. spans of control.
C THE AUTHORS AND STUDEN TLITTERATUR 403

departments, which is coordinated by one manager. The optimal size of the span of
control is one of the most debated issues in the history of organization theory. A classical
organization principle, created by the French industrialist Henri Fayol (1916), states that
a manager should not have more than six subordinates. But in a large organization, this
would require an enormous number of hierarchical levels. More recent organization
theory instead focuses on the advantages of the flat organization, which broadens
the span of control. Figure 16.6 summarizes the advantages of the flat and the tall
span of control.
Hierarchies may seem old-fashioned and undemocratic. However, in many cases,
hierarchical levels are a practical necessity, especially in organizations that must
respond swiftly to urgent problems. When swift decisions are needed, all employees
cannot be involved. Fire fighters, the police, and the military provide the purest exam-
ples of hierarchical organizational designs where even clothing, the uniform insignia,
makes it clear who is in charge. Moreover, if a superior in this kind of organization (e.g.,
a military officer) is absent, injured, or even deceased, it is a simple matter for everyone
to determine who should assume the position of authority.
16.6 To coordinate operations

Once the activities have been structured in an appropriate manner, they must be coor-
dinated so that the specialized departments (units, subsidiaries, etc.) work towards the
common objectives.
Vertical relationships: superior-subordinate

Naturally, there must be established relationships between the various organization
levels. Vertical relationships deal with the connections (especially via communication)
between superiors and subordinates and between subordinates and other subordinates.
The line organization

Perhaps the most well-known organizational design is the hierarchical line organization
(cf. line of command). Its basic principle is the scalar principle, i.e., that authority
is distributed top down so that every employee has one, and only one, direct senior
manager, and that the managers have authority only over their closest subordinates
(see Figure 16.7). This line organizational structure is the traditional way to draw the
organization chart and it has taken its inspiration from the military. The advantage
of the line organization is its simplicity and clarity, which makes it suitable for direct
supervision. A company that consistently uses the line organizational design, would
in most cases, however, get very rigid and formal decision making.
In practice, staffpositions are used to adapt or modify the line organizational struc-
404 c, THE AUTHORS AND STUDENTLITTERATUR

FIGURE 16.7
The line organizational
structure: The principle of
unity of command in which
each subordinate has only
one superior.
ture. Staff positions, or staff units, are not part of the formal line of command. People
in these positions have no formal decision authority but can provide advice to deci-
sion-makers as well as to the departments in the line of command. This concept - the
line-staff organization - also has its origin in the military services (see Figure 16.8).
Usually, staff positions exist at several levels in the organization and can therefore
be of different size and have different responsibilities and functions. The organization
chart in Figure 16.8 could be an example of a small organization, where the Managing
Director is at the top level with two staff units (e.g., a secretary and a financial assistant).
On the next level, there are three Department Managers with their staff units. Note
that the staff units are not part of the direct line of command. The same general outline
appears even in large, global companies in which each business area has its own staff.
There are two categories of staff units: support and expert units that support man-
agement as well as provide expertise to the operational units of the line organization;
and general service units that provide the operational units with various services.
1he unity of command and staff units

In practice, the classical principle of unity of command is regularly abandoned in most
industrial companies today. Experience has shown that the pure line organizational
structure is unsuitable when a company grows and becomes increasingly complex. In
fact, already the introduction of staff units violates the principle of unity of command.
FIGURE 16.8
The line-staff organizational
structure.
C THE AUTH O RS AND STU DENTLIT TE RA T UR 405

A small or medium-size company can rarely afford to employ experts at every level
(e.g., experts in sustainability, healthcare, or legal issues). Instead, members of the staff
units attached to top management typically take the role of such experts. In theory, a
company's legal counsel (lawyer), for example, can only offer advice to the different
departments, not make managerial decisions. However, this is rarely the case in prac-
tice. Because of their specialized, legal expertise, a legal counsel can often exert a strong
influence on, for example, purchase and sales contracts. It is doubtful that a company
would enter into a large contract against the advice of its legal counsel.
Thus, line managers seldom have the clear-cut authority indicated by the line organ-
ization design. Even when they have full formal responsibility, his or her autonomy is
often limited in practice by different directives, instructions, and company procedures,
as well as established norms and values among the employees.
Functional work supervision

Frederick W. Taylor (1856-1915), one of the early pioneers of industrialization at the start
of the 1900s, proposed a new view of management efficiency which he labeled functional
work supervision (as opposed to functional structure, described in Section 16.5). An
essential element of Taylorism was that division of work into very small tasks makes
manufacturing more efficient. The theory also proposed that there are advantages to
be gained from dividing and specializing the work of managers as well. Depending on
the matter at hand, the worker in the functional organization was to take orders from
different functional experts (see Figure 16.9).
The principles behind functional supervision may seem somewhat strange. Early on,
advocates of unity of command also challenged these principles. From the perspective
of a subordinate employee, however, the difference between functional work super-
vision and the line-staff structure is not particularly distinct. The difference between
formal orders from a manager and informal "advice" from a staff unit expert (e.g., a
design engineer or a production engineer) is often rather subtle.
Equipment Maintenance Planning

Inspector Time manager manager
manager manager
FIGURE 16.9 Employee Employee Employee Employee Employee

Functional supervision
406 © TH E AUTHOR S A NO STUDENTLITTERATUR

EXAMPLE
Frederick W. Taylor's main line of thought regarding the use of functional organization can be
expressed as follows: Supervisor A, the inspector, makes sure that the work instructions are being
followed, that the work meets quality standards, and that the work is carefully and precisely
performed. Supervisor B, the production manager, shows the employees how to operate the
machines and how to perform the operations. Supervisor C, the time manager, ensures that the
machines run at the proper speed in order to minimize the throughput time . In addition, the
worker receives orders and assistance from other managers, such as the maintenance manager
and the production-planning manager.
Horizontal relationships: associate-associate

The simplicity of the organization chart easily creates overconfidence in the ability of
leaders to manage an organization using a rigid and hierarchical format in which all com-
munication follows the line of command. Managing an organization is not that simple.
In reality, employees from different departments coordinate much of the company's daily
activities through both formal and informal communication channels (the coordination
described earlier in the chapter as "mutual adjustment"). Often, the company tries to
enhance these types ofhorizontal relationships through formalized horizontal relation-
ships that can be designed in several ways, for example, through liaison roles, standing
committees, temporary teams as well as projects, matrix structures, and networks.
Liaison roles
A simple way to improve communication between two departments, for instance prod-
uct development and manufacturing, is to appoint a design engineer as the contact
person for manufacturing issues. In this liaison role, the design engineer can simplify
and streamline the interdepartmental communication. Manufacturing staff learn that
they should contact this engineer who also understands their problems. If the two
departments are located some distance apart, the engineer may even have a workstation
at the manufacturing plant where he or she acts as the go-between "ambassador".
Standing committees
It is also quite common to create horizontal relationships that span organization bound-
aries using interdepartmental standing committees. These are groups of members from
different departments who meet regularly to discuss issues of common interest. Some
examples are committees for purchasing expertise, changes in product designs, and com-
pany-wide quality control measures. Although a standing committee might not have any
formal decision authority, it might still be very important for the company. When actors

PART IV • MANAGEMENT AND ORGANIZ ING
from different departments meet at regular intervals, many interdepartmental issues

can be resolved through agreement without the involvement of superior managers (i.e.,
mutual adjustment). Moreover, the exchange of information and knowledge between
the committee members can counteract the tendency towards an inward-oriented and
narrow focus that easily emerges in highly specialized organizational units.
Temporary teams and projects

A third way to create horizontal relationships is to establish temporary teams. These
teams are formed to solve problems that are unusual or particularly difficult, and that
require input from many different specialists (departments). An example is a temporary
team established to plan office space design and allocation of workstations when a com-
pany moves to a new location. Or a company may form a temporary team to investigate
an unexplored market or to study the company's need to invest in a new accounting
system. It is quite common to create such teams for investigations of various kinds.
A special kind of temporary team is the project organization. Originally, such tempo-
rary organizations were used for extremely large or extraordinary projects (e.g., devel-
opment of military jetfighter planes or construction of nuclear power plants). However,
today project organizations are created to coordinate many types of undertakings, such
as product launches, capital investments, or changes in manufacturing machinery.
Although there are no major differences between projects and other temporary teams, a
project organization is usually used for particularly important and long-lasting formal
undertakings. A project manager and a team of specialists are needed, although they
may not be permanent company employees. The project organization is tailored as far
as possible to match the specifics of the task at hand. Major projects may involve many
employees on a full-time basis for a long time, but most projects engage many of their
team members on part-time basis (see Chapter 17).
Matrix structure
A fourth way to enhance horizontal relationships in an organization is the matrix struc-
ture (see Figure 16.10). When applying this organizational design, a company deliberately
moves away from the line organization's basic idea of unity of command. Instead, the
company superimposes cross-functional coordination lines on top of the functional
lines of command for the departments. This kind of organization is common in many
organizations. In large engineering companies, for example, it is customary that pro-
ject managers have responsibilities that span across the compartmentalized, functional
departments. Furthermore, in global corporations it is common that the traditional
functional structure is combined with a geographic structure for different markets. Thus,
matrix structures involve at least two organizational dimensions, and in some cases,
even more. Depending on the nature of the issues at hand, the employees work with,
and are coordinated by, different managers (compare Taylor's functional supervision).
408 0 THE AUTH O RS AN D STU DENTLITTERATUR

Purchasing Manufacturing Sales

. . . .. . . . - •• - • - . . . . .. ... - . . . . . . . .. ...... - - • - ..... .. . .. - - •• • ••• - ••• - - • - •• • •••• ., I,. - ........... - - ..... - .... .. . . - •• - • ••
Product A
Product B
........................................ ·.. ................. ....... ............................ ,
Product C
:::: :::: ::: ::::::c::::::::::::::::::: :::::: ::::::: :::::: : ::::: :: ::::ri ;;:;:::::::::::::: : :::::: ::
FIGURE 16.10
Product D The matrix
organizational structure.
The matrix structure tries to combine the advantages of other organizational designs.
However, this is not easy. In most organizations, there are latent tensions between
different departments, for example concerning product responsibility versus functional
responsibility. These tensions have a tendency to surface in matrix organizations.
Formalized or not, most major industrial companies use the matrix structure in
one way or another. For example, employees from different departments work together
on various projects under the direction of various project managers. Thus, in order
to be efficient, a matrix organizational design requires shared responsibility and close
cooperation between, for example, the cross-functional project managers and the
functional department managers who "lend" their employees to the different projects.
Networks
Networks are the fifth way to enhance horizontal relationships within the company,
but also with actors outside the company. Networks, or communities, are composed of
actors with a common interest and identity and these relationships can be as strong as,
or stronger than, the formalized relationships within an organization or a company.
Many professions, such as physicians, attorneys, and accountants, have powerful pro-
fessional norms and often very formal rules that control their work procedures and
behavior in various situations. In addition, many company employees are engaged in
professional networks through contacts from college, contacts from executive edu-
cation and vocational training, or contacts in trade unions or professional interest
organizations. Many companies encourage employees to engage in "networking" and
even initiate the creation of networks for different purposes. One example is to enhance
the professional development of the company's project managers by, for instance, certi-
fications . Another example is to use networks as a tool for affirmative action to support
the professional careers of the company's female managers.
0 THE AUTHORS A ND STUDENTL I TTERATUR 409

Conflicts of goals
Different organizational goals often conflict. For example, a government agency might
have the objective to increase efficiency by reducing lead time to process a case. At
the same time, the authority has to ensure that all citizens are treated equally, which
requires careful processing. Within an organization, there are in similar ways different
types of sub-organizations with their own objectives and interests. A typical example
of this type of conflict ofgoals is when the marketing manager of a company asks for
many versions of the products in order to meet variety in customer demands, while the
production manager, on the other hand, wants few standarized products as it enables
streamlined and cost efficient production processes.
Thus, setting objectives for an organization involves negotiations between different
stakeholders, within and outside the company (see the stakeholder model in Section
14.3). These negotiations are dynamic and always ongoing. Thus, the organizational
objectives are never fixed; they are always under review and subject to reinterpretation.
Consequently, coordinating and controlling organizational behavior is a very complex
matter; far more so than it may have appeared in this chapter. It is important to bear
in mind that organizing is not merely a question of designing and redesigning organ-
ization charts. As was discussed in Chapter 15, all organizations consist of groups of
people that need to accomplish something together!
Summary
When a company grows and employs personnel, the operations must be organized
by defining appropriate responsibilities and introducing different mechanism:; for
coordination and control. This is what has been discussed in this chapter. First, the
business operations must be conducted in an appropriate legal form. In Sweden, the
most common corporate form, next to sole proprietorships, is the limited liability
company. This legal form allows the company to finance its operations with capital
from one or more owners without each of the owners being fully personally responsible
for the company's debts.
In addition, a growing company must establish an organizational structure to enable
collaboration between the employees (and groups of employees). The concept of organ-
izational structure is usually defined as all the formal means that an organization
uses to divide and coordinate the work in order to create stable behavior patterns.
In this context, five coordination mechanisms can be identified: mutual adjustment,
direct supervision, standardization of the work process, standardization of output, and
standardization of competences and skills.
An organization chart describes the company's formal organizational structure,
which is also manifested in the company's job descriptions, routines, and instructions.

The organization chart shows, among other things, how the company is divided into
units, how responsibilities are allocated, and how the units are coordinated to form a
whole. There is also an informal organizational structure, such as personal contacts,
friendships, education, and common interests of the company's employees, which is
just as important as the formal organizational structure in the daily operations.
Companies can be organized in many different ways. The organizational form
depends on the age and size of the company, the industry, the operations, and its
environment. Even if scholars and practitioners for a long time tried to formulate
generally valid rules and principles for all organizations, it is widely accepted today that
an effective organizational structure depends on the needs of the specific company, its
business operations, and its environment.
References
Atlas Copco (2016). Arsredovisningen.
Bjiirnfelt, P-0. (2017). Arbetsorganisation i praktiken - en kritisk introduktion till arbets-
organisationsteori. Studentlitteratur.
Bolman, L. & Deal, T. (2014). Nya perspektiv pa organisation och ledarskap. Studentlitteratur.
Bruzelius, L. & Skarvad, P-H. (2011). Integrerad organisationsliira. Studentlitteratur.
Eriksson-Zetterquist, U., Kalling, T. & Styhre, A. (2015). Organisation och organisering
(4th ed.). Liber.
Faa, P., Hofoss, D., Holmer-Hoven, F., Medhus, T. & Ronning (2011). Introduktion till
organisationsteori. Studentlitteratur.
Fayol, H. (2016). General and Industrial Management. Ravenio Books.
Galbraith, J. R. (1977). Organization Design. Addison Wesley Publishing Company.
Gulick, L. & Urwick, L. (Eds.) (2004). Papers on the Science of Administration. Routledge.
Larson, E. W. & Gobeli, D. H. (1987). Matrix management: Contradictions and insights.
California Management Review, 29(4), 126-138.
Lawrence, P.R. & Lorsch, J. W. (1967). Organization and Environment: Managing
Differentiation and Integration. Harvard University Press.
Lindkvist, L., Bakka, J. & Fivelsdal, E. (2014). Organisationsteori - struktur, kultur och
processer. Liber.
March, J. G. (1994). A Primer on Decision Making: How Decisions Happen. The Free Press.
Mintzberg, H. (1979). The Structuring of Organizations. Prentice Hall.
Morgan, G. (2007). Images of Organization. Sage.
Perrow, C. (1986). Complex Organizations: A Critical Perspective. McGraw-Hill.
Rhenman, E. (1964). Foretagsdemokrati och foretagsorganisation. Norstedts.
Scott, W. R. & Davis, G. F. (2015). Organizations and Organizing: Rational, Natural and Open
Systems Perspectives. Routledge.
Scott, W.R. & Meyer, J. W. (1994). Institutional Environments and Organizations: Structural
Complexity and Individualism. Sage.
Simon, H. A. (2013). Administrative Behavior. Simon and Schuster.

Skogsstyrelsen (2017). www.skogsstyrelsen.se

Taylor, F. W. (2004). Scientific Management. Routledge.
Thompson, J. D. (1967). Organizations in Action: Social Science Bases of Administrative
Theory. Transaction publishers.
Tyrstrup, M. (2014). I viilfiirdsproduktionens griinsland: om organisatoriska mellanrum i
vard, skola och omsorg. Entrepreniirskapsforum.
Tyrstrup, M. (to be published). Management och diirefter - tjiinstesamhiillets nya krav pa
ledarskap och verksamhetsledning. Vinnova.
Woodward, J. (1965). Industrial Organization: Theory and Practice. Oxford University Press.

....................................................................................... ~
······· . ~
PROJECT MANAGEMENT
Projects and project management are common features in most large organiza-
tions, both private and public. Creating temporary project organizations in order
to effectively manage complicated tasks and solve various problems is a way to
organize used in virtually all types of companies. But project management has
its own logic, and because it is often the first type of managerial position that,
for example, a newly graduated engineer encounters in his or her professional
career, we are devoting this chapter to this specific way of managing the execu-
tion of an assignment or undertaking.
11.1 What is a project?

The noun project derives from the Latin term projectum, meaning "thrown forward,"
something which becomes apparent in words such as "projectile" and "projector".
Often, the term project is used in general and slightly vague ways, referring to for
instance a venture, a proposal, a plan or a dream; references that actually are rather
close to the original meaning. When, for example, an architect says that he or she
"projects a building", this typically means that the architect is engaged in planning
and designing the layouts and physical shapes of, for instance, a house or an office.
In conjunction with project management, however, the term project has a much
narrower and more specific definition . In this context, project refers to a time-limited
assignment, that is, a demarcation to the actual work to implement a proposed idea
or plan. The important difference is that the term "project management" refers to the
process of executing the assignment and not to the object, product, or change in which
the execution of the assignment will result. For example, when labeling an undertaking
as a product development project, the last word, "project," refers to the work of planning,

PART IV a MANAGEMENT AND ORGANIZ ING
designing, engineering, testing and manufacturing the first sample of the new product.
The product itself, on the other hand, is the result; the actual outcome of the project.
For an assignment or task to be suitable to execute as a project, it is usually said that
(1) it should be time-limited, (2) it should be complex and contain some sort of unique
elements, and (3) there should be resources allocated to execute the assignment.
Project
A project is a time-limited assignment, which through the management of specifically allocated

resources should reach a specified goal.
Management through time limitation

A project can involve hundreds of people and many different companies and organ-
izations for a number of years, or only a few people for a couple of weeks or months.
Examples of projects include the construction of a bridge, the development of a new
jetfighter or a new drug, the deployment of a new IT system within a company, the
installation of a new production system, the implementation of a major reorganization,
or the execution of a consulting contract. Scope and content of projects vary consid-
erably. What makes a task a project is that it comprises a formal assignment, which
must be completed within a specific period of time. Project management means that
the person in charge (the project manager) deliberately uses the planned time limit in
the managing and controlling of the work.
The project manager is responsible for ensuring that the project assignment is per-
formed within a specified framework. Typically, a client (a customer, a superior man-
ager, another department within the company, etc.) places an order for the assignment,
and a customized temporary organization is then created to execute the project. This
project organization can be changed several times during the project lifecycle and
when the assignment has been completed, the organization is dissolved. No project
execution can be entirely foreseen from the beginning. One of the project manager's
most important tasks is therefore to handle the problems and unplanned events that
occur regularly throughout the execution of the project. Actually, the mere fact that
we know that problems and unplanned events will occur is one of the key reason to
create a project for the implementation in the first place.
11.2 The goal - the very core of the project assignment

The goal is the linchpin of the project. For a project manager, the goal is usually some-
thing concrete; he or she is responsible for achieving a definable result within a limited

CHAPTER 17 • PROJECT MA NAGEMENT
period of time. Because the goal of the project - unlike most other types of organiza-
tional goals - has a specific time frame, there is also a clear and measurable criterion,
a deadline, for determining whether or not the project goal has been met.
Different types of goals

A project goal is usually described as a desirable future condition. However, there are
many different types of organizational goals that match this definition. Thus, when
managing projects, a distinction is usually made between the overall impact goals of
the project and its more operative project objectives:
• The impact goals are the client's purpose with the project. They specify what
impact (for example, a new product, more efficient production or changed
working methods) the project should have achieved by a given point in time.
The impact goals thus describe why the project should be executed, that is, what
long-term benefit and impact will be achieved through the implementation (and
outcomes) of the project. Impact goals can, for example, be related to the client's
business targets, to customer satisfaction, or to some general societal benefit.
• The project objectives are a reformulation of the impact goals from the project
manager's perspective. While the impact goals are "owned" by the client, the
project objectives are "owned" by the project manager. The project objectives
define what the project organization must accomplish in order for the project to
reach the result the client wants to achieve. The project objectives are operative
and, when used properly, can serve as tools for directing, coordinating and
keeping the project work together.
The three dimensions of the project objectives - the iron triangle

A project assignment should meet the specified project objectives. This is usually
defined to mean that the project organization should fulfill predetermined require-
ments regarding the impact or quality of the project outcomes, that the project should
be completed within a specified time frame and that it must keep to a decided budget.
A well-formulated project assignment should, in other words, contain objectives that
are well-specified in the following three dimensions:
1 performance: what should be done - defined in the technical specification of the

project
2 time: when the project must be completed - defined in the project schedule
3 budget: how much resources can be spent, or what profit the project is expected
to generate - defined in the project budget.
<> THE AUTHORS AND STUDENTLITTERATUR 415

Product/ performance
FIGURE 17.1
Costs
The iron triang le. Time Revenue
To help clarify these three dimensions of the project objectives, we can visualize an
equilateral triangle with the vertices performance (product), time and budget (costs/
revenue) (see Figure 17.1). Between the base and apex of the triangle is a hypothetical scale
of the emphasis the time dimension exerts in comparison with the two other dimensions
(the weight is 100 % in the apex and o % in the base). Scales for the other two dimensions
can be similarly drawn between the triangle's other two sides and the respective oppo-
site vertices to these. The three parameters are mutually interdependent. At any point
within the triangle, the sum of the emphasis exerted by the three parameters is always
100 %. Placing an X where the objectives of the project fall in the triangle thus provides
an indication of what aspects ought to be prioritized when managing the project work.
The formulation of a project outline is always a compromise between the require-
ments in the three dimensions. Project objectives with the combination of"best possible
function, in the shortest possible time, at the lowest possible cost" are thus impossible
(you can't be in all three vertices at the same time). Consequently, under given cir-
cumstances, it is not possible to radically shorten the lead time for the execution of a
project without simultaneously adding more resources and/or lowering its specified
performance requirements.
It thus follows that different types of projects have different centers of gravity in the
triangle. There can also be different degrees of imperative requirements in the different
dimensions. In some projects, it is absolutely essential that the final results meet a
certain set of performance requirements, while the cost and time objectives are not of
equal relative importance. When a new railroad signal system is installed, for example,
the new system must be functional for safety reasons before any train traffic can start
running. Relative to this, minor cost increases for the installation are subordinate; nor
does it matter so much if the project is slightly delayed.
In other projects, the end point in time is more important than the performance and
cost objectives. Some projects have an absolute deadline that is virtually impossible to
change. If, for example, you end up in a pinch before an advertised sporting event, the
premiere of a theater play or the opening of a trade fair, it is usually the performance
and cost objectives that will have to be compromised. In these situations, the time
requirements are very difficult to change.
416 <> THE AU THOR S AND STUDENTLITTERATUR

CHAPTE R 17 a PROJECT MA NAGEMENT
In a third type of projects, it is instead the economic objective that cannot be influ-
enced. In many projects, it is often the funding (i.e., the budget) that actually sets the
limits for what is possible to achieve. Many development projects are of this type.
Often in organizations, a certain, limited amount of financial resources are allocated
for a special purpose, and it is then the task of the project manager to optimally utilize
these project appropriations in order to achieve maximum performance within the
given financial limits.
Changes in project objectives during the project process

While the project is being implemented, the predefined project objectives are often
subject to change. This can be due to external factors that are far outside the control of
the project manager, but also because of increased knowledge about the content of the
assignment during project execution, which means that the original objectives have
become obsolete or irrelevant.
In the initiation phase of a project, performance is often in the spotlight. In a product
development project, this can mean that the focus is on the functional and technolog-
ical features of the intended product. Those involved in the project want to develop
the best possible product design. As the development process continues, however, the
financial situation of the project usually takes on increasing relative importance. When
the development process has come so far that the costs for proposed technical solutions
are calculated, it is usually experienced that there is no room for all those costs in the
project budget. The previously set functional requirements must therefore often be
compromised in this stage. This can force some projects to radically reduce their level
of ambition in order to meet the financial requirements.
When the project execution approaches the final phase, however, the deadline often
obtains a predominant position. Projects are often delayed. Various practical problems
during the project process often mean that the work falls behind schedule, which is why
the set end time - the deadline of the project - often has a major impact on the work.
The deadline forces prioritizations and decisions that would otherwise be difficult for
project management to make. Thus, the pressure of time constraints before events such
as a theater premiere, an opening, or the delivery to a client often mean that the project
objectives must once again be called into question. As a rule, work is sped up by making
(yet another) compromise on the original ambition level while also bringing in new
resources to the project in the form of additional staff, overtime hours, consultants,
etc. The time objective tends to become increasingly predominant the closer the dead-
line gets, while the performance and budget objectives become largely interpreted as
mandatory minimum and maximum limits for what must be fulfilled in order for the
project outcomes to be approved by the client.
Changes to the initial project objectives are, thus, a natural element in a project pro-
c, THE AUTHORS AND STUDENTLITTERATUR 417

Product/performance
FIGURE 17.2
Focus in the project
objective shifting during
Costs
the project lifecycle. Time L-----------l. Revenue
cess (see Figure 17.2). What is important, however, is that project management should
permit such changes after careful consideration and thorough discussions with the
client about their potential consequences.
17.3 The project process

All projects go through a lifecycle from start to finish, in which the different develop-
ment stages often require different organizational structures, competences and types
of management. Usually, vastly different issues and problems arise during the various
stages, which means that the nature of the project work can vary significantly.
Because the project process is only run through once for each project, the balances
and choices made at the outset of the project often have a major impact on the work in
the subsequent phases. Also, unlike in repetitive, ongoing operations, a project rarely
has the time and resources to turn back and redo work that was done in earlier phases
and later proved to be wrong. In such situations, projects usually become both delayed
and more expensive. Performing the right activities in the right order is therefore of key
importance to reaching the project objectives. At the same time, it is often necessary,
at an early phase of a project, to set certain basic parameters so that further work can
proceed. In a construction project, for example, the architectural design must have
been decided before it is possible to seriously begin the planning and engineering of the
building. Similarly, the building's most important technical systems must be calculated
before construction can begin. Consequently, the initiation phase is therefore one of
the absolute key phases of a project. The foundation for the successful (or unsuccessful)
results of the project is often laid already at this stage.
This is the project management knowledge paradox. In the early phases, when you
have the least knowledge about the intended project outcomes, and the project assign-
ment often is at its most abstract and uncertain, the most important decisions are made.
In the final phases, when you have the most knowledge about the final result, the most
important decisions have already been made long ago and are, consequently, difficult,
and often very expensive, to implement changes.
418 © THE A UTHO RS A ND STU D ENTLITTERATUR

CHAPTER 17 • PROJECT MANAGEMENT
Phases of the project lifecycle

The project lifecycle is essentially the same for most projects. Generally, it can be
divided into the following four phases (see Figure 17-3):
1 In the initiation phase, the project is started, a project manager appointed,

necessary resources and competences specified, specification of project
objectives commenced and important stakeholders identified.
2 In the preparation phase, the ideas about what should be achieved in the project
and how to proceed are further developed. Planning begins for the project
work and directive guidelines are set for the continued process. Consequently,
this phase usually includes a number of different investigations and planning
measures. A difficult and important task is to try to conceptualize and specify
what the project assignment entails and what impact the client actually wants to
achieve, as well as to anticipate potential risks in order to achieve this impact. In
technical projects, this phase also usually includes extensive design, engineering
and technical planning.
3 In the implementation phase, the project results are realized. Unlike the previous
two phases, it usually becomes clear in this phase that tangible results are being
produced and that the project is successively approaching the specified project
objectives. The IT system is coded, the building is constructed, and the product
is engineered. In this phase the project organization typically involves the
largest number of project participants. Often, a large number of sub-projects
are executed concurrently towards the end of this phase, and when these sub-
projects are brought together, any errors and deficiencies in the work during the
previous phases are usually detected.
Costs
FIGURE 17.3
Typical resource
consumption per unit of
time during the project
Initiation Preparation : Implementation Conclusion lifecycle.
C> THE AU TH ORS AN D ST U DENTLITTER ATUR 419

4 In the conclusion phase, the final results of the project (the investigation, the
product, the computer system) are put in order for delivery to the client. Irregu-
larities are adjusted and the documentation is compiled, and many participants
leave the project for other assignments. However, finishing a project can be
both difficult and time-consuming. In large technical projects, a list is therefore
usually established, specifying tasks that were not completed and irregularities
that need to be corrected, after the formal project completion.
Resource consumption over time

Because project work typically changes over time, the resource consumption is also
unevenly distributed over the various phases of the project. In most projects, the curve
of costs, or work hours spent, matches the profile shown in Figure 17.4.
At the beginning of a project, there are usually few resources consumed, few
people involved, and the fundamental preparations do not require much equipment
or material resources. As the work progresses and the project advances, gradually more
employees become involved, more materials and equipment are purchased and, where
applicable, suppliers, consultants or contractors are engaged. Resource consumption
sharply increases. During the implementation phase, consumption per time unit is at
its highest. In product development projects, resource consumption usually reaches
a peak when about two-thirds of the project lifecycle has been completed. After that,
resource consumption usually de-escalates and towards the end, the project engages
only a few people who will, for example, complete documentation, identify remaining
work to be done and perform follow-ups . Finally, the project organization is dismantled.
Accumulated
resource consumption
FIGURE 17.4
Accumulated resource
consumption during the
project lifecycle. Implementation
420 © THE AUTHORS ANO STUDENTLITTERATUR

Summing up the resource consumption per time unit in Figure 17.3 results in a
chart of accumulated resource consumption, which typically follows the basic shape
an S-curve (see Figure 17-4).
This S-curve provides a simple overview of the profound challenges in project man-
agement. As previously mentioned, it is in the earliest phases of a project, when few
resources are consumed and the project objective is at its most unclear, that the most
crucial decisions for the project work are made. But it is also not until the late stages
of the project, when the results begin to be achieved, that the actual consequences of
the earlier decisions become apparent. In the later phases, it is often very tempting to
suggest both changes and improvements to the produced results (scope creep), but to
implement them at this stage can be difficult and very expensive. A rule of thumb in
industrial projects is that ifit costs 1 dollar to introduce a change during the preliminary
study of the project, the same change will cost 10 dollars during the planning phase,
and at least 1,000 dollars if it is introduced during the final phase.
The ability to influence the final result within the scope of the project assignment is
therefore significantly reduced during the project lifecycle. It is in the earliest phases
that the project manager actually has the ability to influence the final result; this is
when the conditions are set. It is in this stage that the project manager's strategic lead-
ership is put to the test. The later phases are more about ensuring that the project stays
within the given framework, as well as following up and taking action to control and
coordinate the work towards the specified objectives. These stages are, thus, primarily
about avoiding delays and extra expenses. Consequently, project management's ability
to influence the final result of a project can be represented as a reverse S-curve, that is,
a mirror image of the accumulated resource consumption (see Figure 17.5).
Percent
100
resource consumption
FIGURE 17.5
Accumulated resource
consumption and project
\,\
manag ement's ability to
\ influence the final results
\ Ability to influence
'•,,,____the final result of the project in different
................................ _ stages of the project
o ----=::.._-----------~ -----+ Time lifecycle.
Cl THE AU TH O RS AND STUDENTLITTERATUR 421

17.4 Project organization

In its simplest for_m , a project organization can consist of a client and a small project
team. This often applies to smaller internal projects, such as an investigation conducted
by a group of employees for their department manager. However, larger projects can
engage hundreds of project participants, several sub-project managers, project plan-
ners, project controllers, purchasers and a large number of engineers.
The project manager leads and coordinates the project work. This includes ensuring
that the work is carried out at the right time, calling project meetings when an issue
needs to be addressed, monitoring schedules and budgets, making various technical
decisions, representing the project externally and handling urgent problems that arise.
The other participants of the project team have specific tasks and responsibilities. In
larger projects, the work is often structured into different sub-projects with their own
sub-project managers responsible for the management and direction of their own
sub-project teams (where the engineering work is carried out) (see Figure 17.6). In such
projects, one of the primary functions of the project manager is to coordinate the
various sub-projects and keep them together.
In many projects, the composition of the project team often changes during the life-
cycle of the project. Different stages in a project often require different skills, and since the
project organization is based on the tasks to be performed, organizational changes are a
FIGURE 17.6
A typical project
organization.
422 © THE A UT H O RS AND STUDENTLITTERAT U R

natural part in projects with long duration. Different employees can also have different
levels of engagement in the project. The project manager and his or her closest co-workers
may be employed full-time throughout the project lifecycle, while others involved in
the project only allocate a small portion of their working hours during a specific phase.
The project team constitutes the heart of the project organization. The aim is to
bring together the competences and skills needed to complete the project assignment,
resources that are typically spread across various disciplines inside, and outside, the
company. Consequently, a project organization often transcends established organi-
zational borders and sometimes includes persons employed outside the company. In
larger projects, the project manager often has an assistant project manager and project
administrative staff who assist him or her with scheduling, finances and management
accounting, procurement, monitoring, documentation, quality assurance, and other
administrative issues.
Project manager, steering committee, project owner and

reference groups
The project manager is the key person in managing the project. It is the responsi-
bility of the project manager to lead the project towards the set objectives, using the
assigned resources. The project manager personifies the project. He or she should be
the driving force of the project work, coordinating various functions and resources,
identifying risks, making comprehensive assessments and judgements concerning
technical issues, making decisions within the project scope and keeping the project
stakeholders informed. Moreover, the role as project manager often means working
across traditional boundaries and functional disciplines within the line organization.
The ability to enthuse, motivate, explain and make an argument is, thus, among the
most important qualities of a project manager.
The project organization includes the staff who are active in the project work. Other
stakeholders and experts who are not participating on a daily basis, but whose support
and knowledge still are important for project success, can be engaged in the project's
steering committee or in a reference group tied to the project. These groups are not always
necessary, but when they are included they often fill significant roles.
In principle, a steering committee functions as the board of the project organiza-
tion. The committee is superior to the project manager and is responsible for deci-
sions regarding the project scope, the allocation of resources to the project, as well as
monitoring the work of the project manager. The steering committee meets regularly
throughout the project lifecycle and has an active role with influence over the objectives
and resource allocation of the project. The steering committee is constituted by relevant
representatives, usually managers, from the parent organization of the project. The
composition of the committee often reflects the project's level of priority.
e THE AUTHORS AND STUDENTLITTERATUR 423

Instead of a steering group, some project managers have a superior manager to whom
they report. This type of project sponsor or project owner is often head of a number of
project managers running different projects. In the process industry, for example,
where the pulp and paper companies execute an extensive amount of capital invest-
ments, there is often a formal project director who is responsible for a group of profes-
sional project managers who are running the company's various investment projects.
The advantage of having a project owner is that is makes it clear who has the superior
responsibility for the project. The disadvantage is that the project is not as well-an-
chored in the parent organization as it might have been with a steering committee.
A project can also have one or several reference groups. These are advisory groups and
may have several different roles. For example, a reference group in a research project
may consist of prominent international researchers who are not directly involved, but
who can provide useful advice and opinions. Many system development projects have
reference groups who represent the users of the new IT system, and in construction
projects it is common to have reference groups with representatives of the neighbors
who live close to the construction site.
Own project staff or not?

Project organizations can be roughly divided into two categories based on whether
the project manager (1) has authority or (2) does not have authority over the project
organization's members. In the first category, the project organization comprises a
separate, independent organizational unit - a pure project organization - in which the
project manager is the head of his or her project staff. In these projects, the conditions
of the project organization in many ways resemble a traditional department within a
company, albeit with a limited life span. The project organization commands its own
human resources and premises, and the project manager is entitled to lead, coordinate
and command work assignments in the same way as a regular functional manager. Such
project organizations can be found in research departments but are also common in
the construction industry and various types of consulting firms.
However, most project organizations constitute a significantly more disorganized,
sometimes even informal, grouping of people and units involved in the project work on
a part-time basis. In these projects, the project manager is responsible for managing and
coordinating the work, but he or she lacks the formal authority to directly command
the project participants to perform specific tasks. Instead, the project manager shares
the human resources with the functional department managers. This type of matrix
structure (see Section 16.6) is often the only realistic alternative in small projects, or
when several projects need to use the same resources or skills of the parent organiza-
tion. Being a project manager in a matrix structure thus means managing employees
who have other formal department heads, which can be a delicate task. Instead of giving

CHAPTER 17 • PROJECT MAN AGEMENT
orders, the project manager has to "sell" the project to his or her project participants,
spur them on and continuously try to maintain good relations with the functional
managers who formally represent the project participants' employer.
11.s Project management methods

There exist a large number of project management methods and techniques. Below, we
will discuss some of the most common techniques for formulating project objectives
as well as for scheduling, follow-ups, and project control. In addition to these, many of
the methods and techniques that were discussed in Section 7.3 on product development
are also relevant to project management. There are also many methods to create a
functioning project team, for example, project-start seminars and different types of
team building exercises.
The project objectives as a management tool

The formulation of the project objectives is one of the most powerful tools for leading
and coordinating the project work. However, in order to function as a management
tool, the project objectives have to be as concrete as possible. Any overarching aim
and vision behind the project assignment should be broken down and specified in the
operational objectives, so that the content of the project tasks becomes clear to everyone
involved. Well-functioning project objectives should, thus, always contain measurable
results or verifiable conditions which are specified in time.
This is the same basic idea as in the mnemonic rule which says that good project objec-
tives should be SMART, that is, "Specific", "Measurable", "Acceptable", "Realistic" and
"Time-bound" (cf. Section 14-4). If these criteria are not met when specifying the project
objectives at the start of the project, there is a major risk of confusion arising about both
the content and the limitations of the project assignment during the project execution.
However, in some projects, for example within research and development, it may be
difficult to establish the exact final objectives in advance, as well as what the customer
really wants and exactly which work tasks to perform. In this type of vague projects,
the knowledge about the problem or issue (which the project is supposed to solve)
grows gradually as the project work progresses. This means that the management has
to be agile and flexible and understand that the project objective will change during
its execution (cf. the discussion on agile product development in Section 7.3). Even if
there was a clear idea about what the project should achieve when it started, the project
objectives often change as the knowledge increases, sometimes to the extent that the
objectives have to be reformulated. In these types of projects, the objectives are instead
usually formulated step_by step, for the different phases, which makes it possible to
gradually revise the direction during the course of the project.

PAR T IV • MANAGEMENT AND ORGAN IZING
Project stages and project management models

A common way to deal with the profound uncertainty of projects is to structure the
projects into different stages. Each such stage is assigned its own objective, which should
be achieved by a specific point in time, on the way towards the final result of the project
as a whole. Consequently, the level of uncertainty of the project is reduced successively
as the objectives are specified and the measures for how to reach the objectives become
clearer. This way of setting interim objectives that need to be achieved during a specific
period in time is an effective way to control the project process. In organizations where
a substantial part of the operations consists of projects, there is usually an established
standard (formal or informal) on how to structure the project into stages. This struc-
ture is in many companies connected to a decision-making procedure, resulting in a
formalized stage-gate model (see Section 7-3), so that each new stage of the project starts
and ends with a formal decision by, for example, the project's steering committee.
Many companies have also introduced a standardized project management model to
support project execution. A project management model usually includes a description
of processes, routines, roles, policies and templates to be applied in all projects of the
company. This type of management model defines a standard operating procedure for
how the projects should be executed, which makes it easier for new employees and
inexperienced project managers. Moreover, a common project management model
leads to common rules which means that the company's various project teams will
follow uniform procedures and that the participants in a recently appointed project
team use the same language, and understand each other, right from the start. A project
management model can, thus, have a socializing function which enables the company
to quickly create project teams by defining work tasks, relationships and responsibilities.
Structure and plan the project

When the project objectives have been formulated, the next step is to structure the
project in sub-deliveries and interim goals. Sub-deliveries are measurable results which
should be achieved in order for the project or sub-project to be completed. An effect of
an accurate structuring of the project is to arrive at a reasonable division of the work
between the project participants. The structure is usually achieved by systematically
breaking down the project objectives into sub-projects, which in turn are broken down
into work packages, work items, and activities. A common tactic is to clearly define the
different sub-projects so that they become as independent in relation to each other as
possible. This facilitates monitoring and control.
Thus, the basic idea is to be able to identify what needs to be done, who is responsible
for each package, and how the different packages relate to the final result, as well as to
each other. Formulating the project objectives and breaking them down into smaller
elements is often a good way for a new project team to work together in order to learn
426 <O THE AUTHORS AND ST U DENTLITTERATUR

CHAPTE R 17 • PROJECT MA NAGEMENT
what the project is about, identify unclear issues and potential problems, and define
the demarcations between the project and its external environment.
For technical projects there are, in principle, two different ways to break down the
project: Product Breakdown Structure (PBS) and Work Breakdown Structure (WBS).
When a PBS is used, the main idea is to analytically break down the intended project
result (the product) into a hierarchy of parts and components (see Figure 17-7). In this
way, the final PBS describes the result of the project, but not the work required to reach
it. A well-executed PBS can be used as a starting point to specify the work tasks required
to achieve the project objectives. In addition, these work tasks can be described in a
WBS, which is used to facilitate the project scheduling. When a project is described
using a WBS, the emphasis is on what needs to be done in order to get the result (the
product) delivered on time. The WBS includes a hierarchy of all the work packages and
activities that need to be executed. This means that the project work is gradually broken
down to smaller and smaller activities. When you create a WBS, it is a good idea to use
verbs, for example, "to design", "to install", or "to deploy".
ProJect: Development
of company website
FIGURE 17.7
Example of a Product
Breakdown Structure (PBS).
c, THE AUTHORS AND STUDENTLITTERATUR 427

Scheduling techniques
The most well-known scheduling techniques are the Gantt chart and the network
techniques PERT (Program Evaluation and Review Technique) and CPM (Critical Path
Method). The Gantt chart was developed in the early 20th century, aimed at production
scheduling, and is a graphic model where different activities are visualized along a time
line. The result is a simple and easily comprehensible time scale of the project activities,
showing how much calendar time the different activities, as well as the project as a
whole, will require (see Figure 17.8).
In small projects, it is often enough to use Gantt charts. However, in large and more
complex projects, the logic and dependencies between the different activities may be so
complicated that it is difficult to conceptualize the entire work with the help of this type
of time schedule. A good scheduling tool in these types of projects is provided by the
network techniques. The most famous of these techniques are CPM and PERT, which
were developed simultaneously in the U.S. at the end of the 1950s. These techniques
have somewhat different starting points but are so similar that today they usually are
seen as one single method. Irrespective of the technique, the initial steps of planning
and scheduling revolve around defining activities, identifying dependencies, deciding
on sequences, and defining the time and resources needed for each of the activities.
Once the network is established, the next step is to identify the critical path of the
project, and this is the sequence of activities in the network which takes the longest
time to perform and, thus, determines the shortest total execution time of the pro-
ject. By analyzing these critical activities in the project, it is possible, if necessary, to
allocate extra resources (if there is a lack of time, for example) to these activities, and
consequently shorten the total time for project execution.
Project activities
Pave way
Dig foundation
Construct foundation
Transport house
Assemble house
Paint and decorate house
Dig well
Install pump
Lay out garden
Plant plants
Day
5 10 15 20 24
FIGURE 17.8 Example of a Gantt chart.
428 e THE AUTHOR S AND STUDENTLITTERATUR

2 days 1 day
2 days ---- 3 days 1 day 2 days
5 days
1 day 4 days 10 days
FIGURE 17.9 Example of a CPM/PERT network plan.
It can sometimes be difficult to apply the network techniques in a suitable way. The
network charts can also be difficult to read. Network techniques are, therefore, mainly
used for the project managers' more theoretical estimations and analyses. For the
more practical use of project management, for example, meetings, monitoring, and
follow-ups, a Gantt chart is much easier to understand for different stakeholders.
Working procedure for systematic project planning
1 Formulate project objectives.

2 Structure the objectives and break them down into activities.
3 Identify dependencies between the activities.
4 Set the logical order between the activities.
5 Define the timeframe for each activity.
6 Estimate the total project execution time and needed resources.
7 Decide who should be responsible for each activity.
Project budgeting and cost engineering

Project cost management can be described as a combination of two challenges: firstly,
to create a project budget, and secondly, to monitor the cost development during the
project execution in a relevant way.

A project budget should include the costs of all activities that are part of the project
assignment, regardless of where, when, and by whom they are performed. Often a
project budget is established at the start of the project and applies until the project is
finished. It can, thus, stretch across several of the company's normal budgetary periods
and fiscal years. Since the resource consumption can vary significantly between the
different project phases, the budget items have to be structured according to the same
WBS as the time schedule. This means that the cost of each activity has to be estimated
and assigned to the different activities in the time schedule. In this way, it is possible
to visualize how the costs are allocated across the timeline of the entire project (the
S-curve described in Figure 17.4). Creating this type of"budget with a time axis", some-
times also referred to as a "budget distribution", enables accounting and monitoring
of the costs for each completed sub-activity.
The second challenge is to record and account the cost development of the project in
a way that enables project management to understand how far the work has progressed
in relation to schedule and budget. One technique to handle this is disposition account-
ing. The principles of this technique are so different from the traditional accounting
principles, described in Chapter 10 and 11, that it usually has to be managed outside of
the company's regular accounting system. However, the main principle is easy: instead
of only recording costs that can be verified afterwards by, for example, an invoice or
a receipt, the expected costs of work and supplies that have been ordered are also
recorded, so-called tied up costs. If performed consistently, project management can
in this way, at any point during the project execution, be in control of how much of the
original budget has been spent, that is tied by ordered work and is no longer disposable,
and how much of the budget is yet to be allocated (see Figure 17.10).
A related challenge is to evaluate how much of each budgeted activity has been
performed. If the costs reported at a certain point in time are below the budgeted
Orders (non-
Changes Adjusted Recorded recorded Sum Forecast
Cost item Budget Addition budget transactions transactions) restricted final costs
Mech. equipm. 100 20 120 50 70 120 130
El. equipm. 35 - 35 35 - 35 35
Control system 45 5 50 45 2 47 50
Alarm 17 - 17 - 10 10 17
Constr. work 30 20 50 35 10 45 53
I i
FIGURE 17.10 Economy report with disposition accounting .
430 © THE AU THOR S A ND STUDENTLITTERATUR

costs, this might be due to at least two reasons. It can either be that the work has been
performed more cost-effectively than planned, or that the work is behind schedule
(and, thus, the budget as well) which means that budgeted resources have not yet been
used as planned (i.e., the scheduled activities have not yet been performed). In order
to obtain correct performance measurements, some companies therefore apply the
Earned Value Technique, which aims to connect the cost development of the project
with its time schedule and performance.
The Earned Value Technique (see Figure 17.11) is based on the project's budget dis-
tribution, that is, the Budgeted Cost for Work Scheduled (BCWS, dark blue line in the
figure), which is compared to the reported financial outcome, that is, the Actual Cost
for Work Performed (ACWP, red line). It is common that delays and cost increases
occur in projects, which means that the work has taken more (calendar) time than
what was originally intended, at the same time as the work also often ends up being
more expensive than what was originally budgeted. Thus, to see to any delays or cost
increases, another line is added to the diagram, which shows the earned value of the
actual work performed, that is, the Budgeted Cost for Work Performed (BCWP, light
blue line). Using this as a starting point, different analyses can be made. Based on
experience, early delays and cost increases are very difficult to compensate for in later
phases. Consequently, you can easily, at any point during the project, make a rough
forecast concerning the final costs and finishing time, by simply adding upcoming
delays and cost deviations to the BCWS line.
Costs
Budgeted
final cost
------ Earned value

(BCWP)
FIGURE 17.11
Time The Earned Value
Delay
Now Technique.

17.6 Projects - short-term and flexible

Project management is widely used in virtually all types of organizations in the private
and public sector in Sweden. This means that Swedish industry has pecome successively
more "projectified", which could be seen as an attempt to solve or circumvent the
problems that large organizations often struggle with, for example, conservatism, silo
mentality, and bureaucracy. It is often argued that project-based activities are stimu-
lating for the individual and spur on personal growth, at the same time as they open
up more career opportunities and make the work environment more flexible, efficient,
and suitable for collaboration between the employees. However, many project-based
companies state that they experience other problems instead, for example, lack of feed-
back and knowledge sharing between projects, difficulties with resource allocation, and
employees who feel that they are being pulled in different directions. Instead of using
the experience of previous projects, each new project organization tends to "start from
scratch". It can also be difficult to maintain the same level of quality and a uniform
standard between the various projects in the company.
Long-term competence development, standardized routines, and well-established
procedures are the primary advantages of the line organization's permanent depart-
ment structure. The challenge for a company is, thus, to find a balance between the
short-term and "swift" project organizations and the long-term and "conservative" line
organization. Having strong and competent departments in its line organization is for
many companies a prerequisite for project success.
Summary
This chapter has discussed project management, a common organizational principle
which is frequently used to manage complex undertakings and solve various problems.
A project is a time-limited assignment, and project management refers to the process
of executing this assignment. The project manager is responsible for ensuring that the
project assignment is performed within the specified scope. One of the project manag-
er's most important tasks is, therefore, to handle problems and unplanned events that
usually occur during project execution. In order execute the project work, a tailored
project organization is created, which dissolves once the assignment has been completed.
A project usually has impact goals and project objectives. While the impact goals are
about the client's purpose with the project, the project objectives constitute a concreti-
zation of this purpose from the project manager's perspective. All projects go through
a lifecycle from start to finish, with the typical phases project initiation, preparations,
execution and completion. The work in the different phases often differs significantly
and might therefore require different types of methods, skills, and management.
There are a number of project management tools and techniques. The formulation of
432 © THE AUTHOR S AND ST U D ENTLITTERATUR

project objectives constitutes, for example, one of the most important means for direct-
ing and coordinating project work. When the project objectives have been formulated,
the next step is to structure the project work into sub-deliveries and interim objectives.
During the project execution, it is important that the progress is monitored regarding
time, performance and budget so that any problems and deviations can be handled swiftly.
References
Davies, A. & Hobday, M. (2005). The Business of Projects: Managing Innovation in Complex
Products and Systems. Cambridge University Press.
Engwall, M. (1995). Jakten pa det effektiva projektet. Nerenius & Santerius.
Engwall, M. (2003). No project is an island: linking projects to history and context. Research
Policy, 32(5), 789-808.
Engwall, M. (2012). PERT, Polaris, and the realities of project execution. International
Journal of Managing Projects in Business, 5(4), 595-616.
Engwall, M., Steinthorsson, R. S. & Soderholm, A. (2003). Temporary organizing: a Viking
approach to project management research. In Czarniawska-Joerge, B. & Sevon, G. (Eds.),
The Northern Lights: Organization Theory in Scandinavia . Liber.
Hallin, A. & Karrbom Gustavsson, T. (2012). Project Management. Liber.
Jerbrant, A. (2009) . Organisering av projektbaserade foretag: Ledning, styrning och genom-
forande av projektbaserad industriell verksamhet. Kung!. Tekniska hiigskolan.
Lundin, R., Arvidsson, N., Brady, T., Ekstedt, E., Midler, C. & Sydow, J. (2015). Managing and
Working in Project Society. Cambridge University Press.
Lundin, R. A. & Soderholm, A. (1995). A theory of the temporary organization, Scandinavian
Journal of Management, 11(4), 437-455.
Macheridis, N. (2009). Projektaspekter: kunskapsomraden for ledning och styrning av projekt.
Studentlitteratur.
Marmgren, L. & Ragnarsson, M. (2014). Att leda osiikra och komplexa projekt: fran styrning
och kontroll till stod for sjiilvorganisering. Studentlitteratur.
Maylor, H. (2010). Project Management (4th ed.). Prentice Hall.
Morris, P. W., Pinto, J. K. & Soderlund, J. (Eds.) (2012). The Oxford Handbook of Project
Management. Oxford University Press.
Packendorff, J. (1995). Inquiring into the temporary organization: new directions for project
management research. Scandinavian Journal of Management, 11(4), 319-333.
Pinto, J. (2015). Project Management - Achieving Competitive Advantage. Pearson Education.
Project Management Institute (2017). A Guide to the Project Management Body of Knowledge
(5 th ed.). Project Management Institute.
Soderlund, J. (2005). Projektledning och projektkompetens. Liber.
Soderlund, J. & Tell, F. (2012). Styrning med projekt och kunskap i fokus . Studentlitteratur.
Tonnquist, B. (2016). Projektledning. Sanoma utbildning.
Wene!!, T. (2012). Wene/I om projekt. Liber.
Wene!!, T. (2014). Projektledarskap. Studentlitteratur.

.. ..............................................................................................'-1
~
CSR AND SUSTAINABLE

OPERATIONS
Companies both affect and are affected by stakeholders in the surrounding soci-
ety. Consequently, it is important for most companies to be good citizens and
behave ethically and sustainably in relation to their communities. This chapter
discusses a company's responsibility to the society at large. This area is often
labeled Corporate Social Responsibility (CSR) and sustainable development with
respect to economic, ecological, and social aspects. In addition to an overview
of these increasingly important concepts, the chapter also discusses some of
the standards, certifications, and other systems that show that the company's
operations are being conducted in a responsible way.
1s.1 A company's social responsibility

Business operations are often perceived as being in opposition to the surrounding com-
munity. On the one hand, enterprises are sometimes presented as crude capitalists chas-
ing short-term profits. On the other hand, society is sometimes described as consisting
of a bureaucratic public sector that, in various ways, seeks to regulate, complicate, and
increase the costs of business operations and transactions. However, companies are
an inseparable part of society. Companies produce goods and services that society
needs and create jobs that enables citizens to pay taxes, and a well-developed society
takes responsibility for companies' basic safety in the form of police and the judicial
system, for the laws and rules that enable trade and business to function, as well as for
the existence of a necessary physical infrastructure, a good education system, and good
healthcare and childcare. Most modern democracies are characterized precisely by the
fact that society is responsible for these institutions, not the companies themselves.
Furthermore, in most developed societies the public sector is a significant customer
for the goods and services supplied by private companies.

Companies may, of course, assume their social responsibility in many different ways.
This chapter focuses on the following specific areas: Corporate Social Responsibility
(CSR), sustainable development that is linked to economic, environmental and social
responsibility, as well as sustainable business development.
Corporate Social Responsibility

Corporate Social Responsibility (CSR) is a concept that encapsulates how a company
should take responsibility for the society in which it operates from economic, envi-
ronmental and social perspectives. Sometimes, ethical responsibility is also included;
a fourth dimension concerning the values that should guide a company's actions and
its control mechanisms to ensure that these values are followed.
CSR has grown in importance since the early 2000s in line with the growing
awareness of environmental issues and differences in working conditions between
rich and poor countries. Historically, CSR was understood as a way for companies to
take responsibility for their social impact as well as a way to minimize the risk of fraud
and corruption. This view is reflected in the European Commission's definition of CSR
(see the box "European Commission's definition of CSR"). However, CSR is nowadays
increasingly understood as something that also contributes to increased profitability
by avoiding the unnecessary consumption of human, physical and financial resources,
at the same time that the use of available resources is optimized.
The European Commission's definition of CSR
The Commission has defined CSR as the responsibility of enterprises for their impact on society.
CSR should be company-led. Public authorities can play a supporting role through a smart mix of
voluntary policy measures and, where necessary, complementary regulation.
Companies can become socially responsible by: following the law; integrating social, environ-
mental, ethical, consumer, and human rights concerns into their business strategy and operations.
Having a clear approach to CSR issues has become an important strategic matter for
many companies. Consumer power and requirements from both society and customers
have an impact on a growing number of areas. Today, various social actors, in par-
ticular non-profit interest organizations and other non-governmental organizations
(NGOs), raise demands and assess the companies' operations with respect to human
rights, corruption, working conditions, payments to subcontractors, and environ-
mental footprints. The media also devote increasing interest to examining activities
in the business community. Several scandals and environmental crimes have made
the headlines over the years.
436 C> T HE AUTHOR S AND STU D ENTLITTERATUR

CHAPTER 18 • CSR AND SUSTAINABLE OPERATIONS
Many companies have defined their CSR activities as a desire to take social respon-
sibility, which may cover various aspects depending on how the CSR concept is inter-
preted. A narrow interpretation is that the company is only responsible for avoiding
negative actions that directly harm society. A broader interpretation is that CSR rather
is about performing positive actions that contribute to society in a fruitful way.
Thus, one problem is the lack of consensus about the concept of CSR. Attempts to
widen it to "Corporate Societal Responsibility" have not succeeded very well and in
the U.S., where the concept of CSR started to be used back in the 1960s and 1970s, the
terms "Corporate Citizenship" and "Corporate Responsibility" are now often used to
avoid restricting it to just social responsibility. In addition, two closely related terms
are "Environmental and Social Governance" (ESG), which is primarily used in the
financial sector, and "Creating Shared Value" (CSV), which was launched to emphasize
that long-term value creation in companies can only take place if the company also
creates value for its environment.
Sustainability
The concept of sustainability is used to describe a company's strategies and measures
to reduce or eliminate negative impact on people, climate, and ecosystems. While
the concept of CSR emerged from issues relating to companies' social responsibility
and therefore makes the company the key actor, sustainability emerged as a global
social issue with emphasis on the Earth's assets as well as countries' socioeconomic
development. The term sustainable development is considered to have been coined by
the U.S. environmentalist Lester Brown (1934-) and was launched in 1987 by the UN
World Commission on Environment and Development (the Brundtland Commission)
as the overall purpose of all environmental work. The term was described as follows
in the Commission's report:
Susta inable development is development that meets the needs of the present with -
out comp romising the abi lity of futu re gene rations to meet t heir own needs.
Sustainable development is usually considered to comprise three aspects that are closely
linked to each other: economic sustainability, environmental sustainability, and social
sustainability. However, traditional economic models find it difficult to manage the
requirements contained in the definition of sustainable development, which partly
entail taking responsibility for pollution that has already taken place, integrating costs
for what was previously considered to be "external effects", and taking the interests and
rights of future generations into account.

Economic responsibility
Economic responsibility means that companies act in a long-term sustainable manner
from an economic perspective. This often involves ensuring that company operations
are performed in a manner that is effective from a long-term perspective. If the com-
pany is not profitable, its operations will not be sustainable in the long term, which
means that it will be unable to contribute to the development of society. Furthermore,
this concerns the ethics in accordance with which the company claims to act and how
well this is achieved, which concerns not only the own business ethics (internal ethics)
but also, for example, how the company acts in relation to its stakeholders (external
ethics), as well as the policies and guidelines it requires its suppliers to follow. This may
involve both the company's own employees and the employees of subcontractors having
tolerable working conditions and reasonable working hours, their workplaces being
safe, the absence of child labor, and that the employees are have the right to organize
themselves (e.g., in trade unions). In addition, it also encompasses the company's prod-
uct liability in relation to customers and users, i.e., taking responsibility for products
not being dangerous, either for the users or for the surrounding environment.
Environmental responsibility
Environmental responsibility means that the company acts in a manner that is sustain-
able in the long term from an environmental perspective, both internally, for example
in the design of production methods and workplaces, and externally, for example by
minimizing the negative environmental impact of its operations. It is about promoting
the employees', the customers' and the subcontractors' awareness of how the individ-
ual companies affect the environment, about the company using various resources
efficiently, about the products not being harmful to the environment, about delivering
the products to the customers as environmentally friendly as possible and, in various
ways, compensating for the ecological footprint that is left.
Social responsibility
Social responsibility involves companies acting in a manner that is sustainable in the
long term from a social perspective, i.e., that they promote an equal society in which
people live good lives with good health and without unjust differences. Social responsi-
bility can also be divided into internal and external issues. Internal social responsibility
involves ensuring that the company's employees have a good work environment, both
physically and mentally. To achieve this, the company is responsible, among other
things, for all employees being treated equally and that no one suffers from discrimi-
nation due to gender, age, ethnicity, or religion.
438 c, THE AUTHORS AND STUD ENTLITTERATUR

CHAPTER 18 a CSR AND SUSTAINABLE OPERATIONS
The company's external social responsibility involves contributing to the communi-

ties in which the company operates in a positive way. This may be manifested, for exam-
ple, by permitting employees to participate in voluntary work during working hours,
or actively trying to employ employees from groups which often suffer discrimination
(for example people with disabilities) or who may find it difficult to find employment
(for example, long-term unemployed persons or recently arrived migrants).
Important sustainability issues for executive management
Economic responsibility
Long-term efficiency
Ethical actions, both internally and externally
Environmental responsibility
Climate compensations
Lifecycle analyses
Resource uses (energy, water, raw materials)
Non-toxic, healthy products
Low-energy, clean transports
Social responsibility
Employee safety and physical and mental work environment
Employees' working conditions
Diversity and gender equality
Company's societal engagement and contributions to social institutions
Company's core values and ethics
Sustainable business development

Sustainable business development revolves around how a company can, and should,
carry out its operations based on its long-term social responsibility, while benefiting
from performing ethical, sustainable business. The idea is to create and offer shared
values, i.e., value for the company, for the customers as well as for the society at large
(see Figure 18.1 on the next page). In other words, an active sustainability approach
may result in greater innovation capabilities and other improvements that, in the long
term, create competitive advantages for the company, even if it may entail higher costs
in the short term. Consequently, by acknowledging an increasing share of sustainable
principles in its business development, a company may achieve the following:
• increased customer value

• increased opportunities to enter new markets or attract new customers

•
.
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FIGURE 18.1
Sustainable business devel -
opment means creating
value for the company, its
customers, and society at
large.
• increased staff commitment and motivation to remain with the company

• reduced business risks
• increased access to financial capital.
More specifically, a company's sustainable business development initiatives can be

manifested as follows:
• Sustainability issues permeate and are part of the company's business concept and
strategy.
• The company's business development means that the company both takes respon-
sibility and is profitable in the long term.
• The company's business development involves sustainability issues being an
important driver of business strategy, product development, production, and
marketing.
• By investing in innovation for new products and services or by introducing
existing products and services on new markets, solving environmental problems
and/or social problems, while at the same time creating value for the company.
• The company's business development involves sustainability issues being fully
integrated in all of the company's strategies and processes, for example for
product development, production, purchasing, marketing, and sales.
Most societies now expect companies to engage in all three dimensions of sustainabil-
ity, i.e., economic, environmental and social. It is also an opportunity for companies to
minimize their risks (for example by working against corruption and thus not risking
involvement in bribery scandals that may have a negative impact on the corporate
brand) as well as increase their business opportunities (for example by entering new
440 © THE AUT H O RS AN D STUDENTL ITTER A TUR

Some drivers behind initiatives for sustainable business development
The sustainability challenges faced by society create new needs that can be met by developing
new products and services. Successively, more consumers are prepared to pay more for
sustainable products.
2 New regulations are forcing companies to develop new technology and more sustainable
products. The companies leading this development can gain competitive advantages on the
market.
3 Sustainability offers opportunities for profiling and branding, which can benefit a company's
business, create commitment among employees, and facilitate recruitment in the future.
4 Sustainable companies are less affected than non-sustainable companies when, for example,
stricter environmental laws and regulations are introduced.
markets with new products). Ultimately, it is about companies being important actors
in society, who consequently have to take responsibility for the role they play and
contribute in various ways to strengthening society.
1s.2 The environmental issue and climate change

One of the most important long-term issues for both the global community and com-
panies is the environment. Since the turn of the century, the issue of climate change
has increasingly come into focus. Several initiatives have been taken to deal with these
problems in various ways. One of them involves designing more circular production
and business processes to reduce the use of virgin resources and enhance long-term
sustainability.
The environmental issue

For many years, "the environment" referred to external conditions of various kinds,
for example the natural or societal conditions of the company's operating setting.
Consequently, the environment was not regarded as a subject in itself. However, the
environmental issue had a breakthrough in the early 1960s with the U.S. biologist
Rachel Carson's (1907-1964) book Silent Spring, in which she described the negative
effects of the use of the pesticide DDT. The first political environmental bills in Sweden
were also submitted at this time. The Swedish Environmental Protection Agency was
set up in 1969 and three years later the first UN conference on the environment was
held in Sweden. During the late 1960s and early 1970s, there were several high-profile
environmental conflicts in the Nordic region, among other things, about protection

for the remaining unstructured rivers Vindelalven in Sweden and Altaelva in northern
Norway. Vindelalven was protected and became one of Sweden's four national rivers.
Altaelva was finally developed, but to a limited extent. At the same time, criticism of
the development of nuclear power plants increased in Sweden.
Environmental issues were long considered to be local or national issues. However,
awareness of acidification and long-range air pollution widened the geographical per-
spective. At the end of the 1970s, the problem of the thinning of the ozone layer in the
stratosphere also began to be highlighted. The Montreal Protocol, which was signed
in 1987, was the first global environmental agreement. With the Protocol, UN Member
States agreed to phase out substances and chemicals that are harmful to the ozone
layer. The business community was required to implement the necessary conversions
and changes. The Swedish company Electrolux resisted at first, but then changed its
strategy and decided relatively early to make a full transition to Freon-free refrigerants
(that do not affect the ozone layer) in the refrigerators and freezers manufactured in
the industrialized world. However, it was first in 2003 that Electrolux fulfilled the same
objective in its manufacturing operations in India.
The Earth Summit in Rio de Janeiro in 1992 was in many ways a milestone for
sustainability and environment work worldwide. Five years earlier, in 1987, the Nor-
wegian Prime Minister Gro Harlem Brundtland submitted the report Our Common
Future to the UN. The report emphasized the concept of sustainable development, which
subsequently came into use worldwide. The Rio summit resulted in several important
documents, initiatives, and agreements at global level, including:
• The United Nations Framework Convention on Climate Change

• The Convention on Biological Diversity
• The United Nations Convention to Combat Desertification.
The work on various documents and initiatives has continued and the UN has, at
present, enacted 17 sustainable development objectives that are to be achieved by 2030.
The issue of climate change

The issue of climate change has obtained a unique position among global environment
issues, at least in a Swedish context, on account of the long-term risks of climate change
and its consequences. If the Montreal Protocol was a success for the work to counter
ozone-depleting substances, the United Nations Framework Convention on Climate
Change's protocol with binding commitments for member states, the so-called Kyoto
protocol, was less successful. It did lead to initiatives and measures in many industri-
alized countries, but it was impossible to develop it further to achieve real reductions
of emissions at a global level. In Paris in 2015, however, an agreement was reached

CHAPTER 18 • CSR AND SUSTA INABLE OPERATIONS
aimed at limiting the temperature increase to 1.5 degrees above pre-industrial levels.
Many countries have voluntarily agreed to reduce emissions of greenhouse gases to
achieve this target.
During the years since the Rio summit, the business community has increasingly
begun to work with other societal actors to counter climate change. Many companies
are starting to see new business opportunities in climate-smart technologies and are
increasingly accepting political measures, such as the introduction of economic policy
instruments. However, there is today generally a large difference in attitudes to and
knowledge about climate change and other environment issues, between the business
community in Sweden and the rest of Europe, and the business community in devel-
oping economies, for example in Asia.
Circular economy
It is, of course, a major challenge to remodel the economic system to make it more sus-
tainable in relation to climate. The concept of circular economy (see box) was launched
to highlight the importance of recycling, and not consuming, resources in the technical
and economic systems. The idea is that new business opportunities will be created when
Circular economy
Circular economy concerns operating models in companies and in society that focus on cyclic,
rather than linear, flows and processes. In a linear operating model, a flow has a clear beginning
and a clear end. Goods are produced and used. When they are worn out or obsolete, they are
disposed of. A circular model, however, is based on feedback and closed flows in various stages.
Although closed flows via recycling and reuse have been common in many sectors for many
years, a circular economy means that the dominating idea of the linear economy is replaced with
another, hopefully more sustainable, model. For example, waste is not regarded as something
unnecessary that goes to landfill. It becomes raw material instead.
In a circular economy, products must be designed so that they are simple and profitable to
reuse in various cycles. It must be possible to dis-assemble them or separate them into their
material components, and residual materials must be biodegradable. The long-term goal is that
no material should be disposed of and the consumption of virgin raw materials should be mini-
mized, while production and transport are powered by renewable energy. Materials should be
reused where possible, recycled or, as the last option, used for energy recovery.
In 2015, the European Commission adopted a Circular Economy Package to stimulate the
transition to a more sustainable economy in Europe. This road map includes specified objectives
for landfills, reuse and recycling of waste flows and for an extended producer liability within the
EU Member States.
Cl THE AUTHORS AND STU D ENTLITTERATUR 443

new technical solutions for reuse, recycling, energy recovery, and production are devel-
oped. However, at the same time, new types of business models need to be developed.
Examples may be that we lease products instead of buying them, that producers sell
services rather than physical products (for example truck transportation, instead of
trucks), that companies take back and renovate products that are then resold, or that
many users make use of new IT tools to share expensive consumer durables that are
idle for long periods of time (for example cars).
,s.3 Ethical responsibility

All industrial operations must, of course, follow laws, rules and standards that apply
to the location as well as the situation in which the operations are carried out. This
section discusses a few areas in which companies sometimes fail to take long.term
ethical responsibility for their operations: corruption, collusion, and payment of taxes
and other duties to the state.
Corruption and bribery

An important aspect of sustainability is that companies and organizations behave cor-
rectly in their business transactions and other activities. Telia Sonera's transactions in
Central Asia, Saab's sales ofJAS Gripen to South Africa and the Czech Republic, SCA's
Group management's private use of corporate jets and other benefits, Volkswagen's
manipulation of emissions measurements in its vehicles, the City of Gothenburg's lack
of supervision of construction projects, the trade union Kommunal's real estate and res-
taurant operations, and Volvo AB's and Scania's involvement in a cartel to maintain high
prices for trucks are a few examples of affairs that have received extensive media attention.
However, Sweden is regarded as one of the least corrupt countries in the world.
Doing business in Sweden is regarded as low risk, in relation to corruption and bribery.
However, the issue of corruption, bribery, ethics, and attitudes in business and other
relations must be kept alive in all companies and organizations. Employees need to
be aware of what is happening in the business, not only in their own organization but
also at suppliers, customers, and business partners.
There are various rules for how gifts and other benefits may or may not be provided
to persons in decision-making positions. For example, it is prohibited to give a gift or
offer a benefit to anyone who exercises authority or decides on a public procurement. In
principle, all public sector employees are subject to restrictions. In private companies,
benefits may be granted to employees if it takes place openly, if it is moderate and if
the benefit is not otherwise such that it may be regarded as affecting one's behavior,
i.e., it affects or risks affecting the recipient's decision or the way in which the recipient
perform her or his work.
© THE AUTHOR S AND STUDENTLITTERATUR

444
What is corruption?
Corruption exacerbates poverty worldwide, undermines democracy and the protection of human
rights, harms trade and prevents investments, jeopardizes good social governance and reduces
confidence in Society's institutions and market economies. Consequently, it is necessary to fight
corruption in all its forms.
Corruption is usually considered to exist when someone exploits their position of power for
their own benefits, for example a decision-maker in a public agency or a purchasing manager in
a private company. It may also involve favoring an interest that is close to the decision-maker, for
example politicians who accept a donation for their party against a promise to promote a specific
political decision.
Corruption is not usually a legal concept. The punishable actions are usually specified with
terms such as giving and taking bribes. Integrity is the opposite of corruption.
Transparency International Sweden

Corruption is a serious societal problem in much of the world. Transparency Interna-
tional is an independent non-profit organization that fights corruption worldwide. The
organization is known for its Corruption Perceptions Index that attempts to measure
the degree of "perceived corruption" in a country (see Figure 18.2). In the 2016 index,
Denmark, New Zealand, Finland and Sweden were ranked highest of all countries
=- • • a::=;:::;:::;::;.
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FIGURE 18.2 Estimated corruption worldwide according to Transparency International (2016) Light yellow - low
corruption; Dark red - high corruption. Source: Transparency International, Creative Commons CC BY-ND 4 .0.
0 TH E AUT H O RS A ND STU D ENTLITT ERAT UR 445

worldwide. However, as the examples above show, this does not mean that either these
or other industrialized countries are free from corruption. Transparency International
reports, for example, that half of all countries in the OECD (Organization for Economic
Co-operation and Development, organizing 35 of the most developed countries in the
world) are in breach of agreed commitments to take actions against companies in their
countries that are accused of corruption in connection with business in other countries
(frequently in developing countries). At the very bottom of Transparency International's
list are countries that are very poor and seriously afflicted by war and other conflicts.
In Sweden, there is also the private, non-profit organization the Swedish Anti-corrup-
tion Institute (IMM), which was founded back in 1923 and promotes the development
of good practice regarding influencing decision-making in industry and society, and
counteracts the use of bribes and other inappropriate benefits as the means for such
influence. The Institute's principals are the Stockholm Chamber of Commerce, the
Confederation of Swedish Enterprise, the Swedish Association of Local Authorities
and Regions, the Swedish Association of the Pharmaceutical Industry and the Swed-
ish Trade Federation. 1 The Institute publishes and administers the Code of Business
Conduct, which covers gifts, rewards, and other benefits in the business community.
IMM also has an ethics committee which promotes good practice in the field.
Collusion and cartels

Companies sometimes attempt to eliminate competition. This usually takes place by
companies agreeing to limit the supply of products or by coordinating their pricing.
The aim of this type of cartels is to reduce competition and thus be able to set prices
with a higher profit margin than otherwise.
In most countries, cartels are prohibited by law, and companies that are caught
forming cartels are often subject to large fines. However, there are several examples of
cartels being formed both in Sweden and abroad. A few years ago, a number of Swedish
construction companies were convicted of having divided up markets and agreed on
tender prices prior to procurements of road construction contracts. All companies were
convicted in both district courts and appeal courts. According to the European Com-
mission, several of the leading European truck manufacturers also worked together in a
cartel for several years with the aim of jointly maintaining high prices and postponing
the enactment of regulations demanding new exhaust emission control technologies.
These companies were sentenced to pay high fines in 2016.
From the perspective of the individual company, it may be tempting to join a cartel,
despite it being unlawful. However, the long-term beneficiaries of cartels are always
1In Swedish: Stockholms handelskammare, Svenskt Naringsliv, Sveriges kommuner och landsting,
Lakemedelsindustriforetagen och Svensk Handel.
446 0 THE AU T HORS AND STUDENTLITTERATUR

CHAPTER 18 • CSR AND SUSTAIN ABLE OPERATIO NS
The OPEC cartel
The most famous cartel is between countries rather than companies: the Organization of
Petroleum Exporting Countries, OPEC. The organization was formed in 1960 in response to the
increased oil production by the then Soviet Union and was an attempt to control the supply of
oil on the market. The idea was that the countries involved in the cartel would commit to keep
certain production quotas to control supply and increase prices. However, the cartel has led to
two probably undesirable consequences for its founders. As demand for oil has risen constantly
since 1960, countries other than those in OPEC, for example the UK and Norway, have developed
their own oil industries, with the result that OPEC's share of the world market has gradually
decreased. The other consequence is that there almost always seem to be incentives for the
participants to breach the agreement and produce more than the agreed quota to increase their
revenue. This has often been the case for various OPEC countries, which usually depend entirely
on oil for their public revenue.
the inefficient and non-innovative companies who are unable to compete in any other
way. Companies that strive to be good citizens should, of course, avoid cartels. How-
ever, there is always a risk of individual employees being tempted to make this sort of
unlawful agreement to eliminate market mechanisms without the knowledge of the
corporate management. It is therefore essential for a company's policies on collusions
and cartels to be clear, explicit, and well communicated throughout the organization.
Tax
An important aspect of companies' role as social actors is to contribute to the public
sector by paying taxes and duties of various types. Just like individuals, companies
are under an obligation to submit a tax return and pay taxes, in addition to their
mandatory financial statements. This entails a contradiction, of course. On the one
hand, companies want to minimize their costs, for example by reducing tax payments
of various kinds. On the other hand, most companies want to follow laws and rules
and be responsible social actors by paying the taxes and duties society has determined
they are liable to pay.
Companies pay different types of tax. One significant tax is on the profits from
business. For limited companies, this is called corporate tax. In Sweden, the tax rate is
currently (2017) 22 percent of the profit for the year, which is roughly at the same level
as other developed, industrialized countries. However, since the turn of the millen-
nium, many countries, including Sweden, have reduced their corporate tax rates. One
reason for these reductions is that many countries want to attract companies to locate
operations in their countries by having favorable tax systems. However, it is important

to be aware that the tax rate itself does not tell the whole story. The applied rules for
the tax deduction, etc. are at least as important for a country's corporate attractiveness
in terms of taxation.
Social security contributions are a tax paid to the state by an employer in addition
to the salary paid to its employees. In Sweden, the social security contribution is a
social tax linked to the social insurance system. Most countries have some form of
social security expense, but its size and what it covers vary. In Sweden, the social
security contribution amounts to 31.42 percent of an employee's gross salary, i.e., before
income tax (2017).
In Sweden, companies also function as tax collectors for the state since the income
tax that its employees pay is a tax deducted at source. All companies that pay salaries
to employees must therefore prepare a preliminary tax calculation, deduct this tax
from the salary and pay it directly to the Swedish Tax Agency at the same time as the
company pays the salary. In the same way, companies function as tax collectors for the
value added tax (VAT), i.e., the tax paid in connection with a product or service being
purchased by a consumer (VAT exists in most industrialized countries). Consequently,
a company does not pay any VAT. It sets off input VAT and output VAT against each
other (see Section 10-4 and 11.5).
Depending on the type of operations, a company may also be forced to pay other
types of taxes and duties, in Sweden, for example, real estate fee (municipal) and real
estate tax (state) and various environmental taxes.
Studies show that, in practice, many of the largest companies (both in Sweden and
worldwide) pay no, or very limited, corporate tax. For these actors, there are extensive
opportunities to reduce or defer corporate tax by means of permitted tax deductions
and various provisions. Multinational corporations with operations located in different
countries also have great opportunities to designate the subsidiary in which profits
should be recognized and taxed, for example by means of internal pricing. This type
of active tax planning often generates debate but is not unlawful, in principle, provided
that laws and regulations are followed. However, the ethical aspects of advanced tax
planning are open to discussion. In Sweden, there is also a special law, the Tax Evasion
Act, which states that a procedure that is formally lawful may actually be considered
to be unlawful if it breaches the spirit of the tax legislation.
A term that is often used in discussions about tax planning is shell company, a
company that, in principle, has no operations and is created only to permit unlawful
tax planning or to conceal other criminal activities. A similar concept is a mailbox
company, which has an address at a certain location but has no actual operations there.
The management is somewhere else and any local staff exist solely to pay invoices and
comply with local regulations. Shell as well as mailbox companies are often based in tax
havens, i.e., countries with no, or very limited, corporation tax, but the phenomenon
also exists in Sweden.
448 © THE AUTHORS ANO STUDENTLITTERATUR

CHAPTER 18 a CSR AND SUSTAINABLE OPERATIONS
Other obligations
Companies also have other types of obligation to fulfill. For example, many companies
that produce goods carry out operations that require a permit. This usually means
some form of environmental permit that companies are required to hold. The process
of obtaining a permit may be extensive and time-consuming and companies are often
required to present various measurements (often covering all seasons, which means
series of measurements for at least a year). This is sometimes followed by enduring
procedures at public authorities and judicial courts. The permit is usually time-limited
and often involves regular follow-ups and reporting of measured data, inspections by
public authorities and recurring applications to renew the permit. For many companies,
such reporting and follow-up of both the internal environment (work environment and
safety) and the external environment entail extensive work. The corporate manage-
ment, an environmental manager, or equivalent, is responsible for this work.
Companies are also responsible for carrying out systematic work environment work,
which is sometimes summarized under the acronym OSH (Occupational Safety and
Health). Issues relating to the work environment, safety, and protection are crucial for
the operations of many companies.
18.4 Standards, systems, and guidelines

The environmental discipline contains a large number of guidelines, labels, standards,
and certifications that are used by many companies. There are also many informal ini-
tiatives, both national and international. In addition, several occupational groups have
ethical guidelines that members are expected to follow. One example is the Swedish
Association of Graduate Engineers' code of honor (see box on page 452), which was
written in order to guide engineers to assume ethical and environmental responsibility
in their professional activities.
Sustainability reporting
The Swedish Annual Accounts Act requires that companies that carry out operations
requiring a permit under the Swedish Environmental Code should add an environ-
mental report to their annual financial statements. However, it is becoming increas-
ingly common for other companies to voluntarily choose to report their impact on
the environment in connection with their financial statements. For many companies,
their policies for sustainability and environmental work are important elements in
their strategic communication with external stakeholders.
Most large companies now publish a sustainability report. Many companies in
Sweden and worldwide use the GRI (Global Reporting Initiative) for this work. GRI is
<> THE AUTHORS AND STUDENTLITTERATUR 449

PART IV • MANAGEMENT AND ORG ANIZING
a non-profit organization that provides a framework for reporting sustainability work,

the sustainability reporting guidelines. The guidelines indicate the principles applica-
ble to reporting and aim to ensure the quality of the content. Swedish state-owned
companies have to report using GRI, but the exact content of the report is decided by
each company itself.
Environmental and sustainability labels, standards, and

certificates
There are a number of tools that companies and other organizations can use to manage
their environmental and sustainability work in a structured way, for example standards
and certificates. The International Standardisation Organisation (ISO) has published
ISO 14001, the generic name for a group of standards on the subject of environmental
management. The aim is that companies can use this standard to create documented,
systematic environmental management procedures, with information and expertise at
the accurate levels of the organization. In this way, the standard creates a structure for
the work on matters such as environmental issues, the work environment and social
responsibility within an organization, while it also aims to enhance the efficiency of
this work. Many companies decide to become certified by ISO 14001. This means that
they engage an independent certification body to examine and, hopefully, approve the
environmental management system the companies have introduced.
The following are some of the requirements an organization must meet to obtain
an ISO 14001 certificate:
• The organization has a quality management system that meets the requirements
of the standard to be applied.
• The system is a natural part of the organization's daily operations.
• The system is described in written format.
• The system and its description are maintained continually.
• The operations are examined by an accredited certification body.
ISO has also created guidance for social responsibility, ISO 26000, which describes
what a company or an organization can do to contribute to social sustainability. The
standard contains voluntary guidelines but does not include certification.
Many companies also decide to become certified and/or have their products certified
using some of the various labels that have emerged on the market. The better-known
labels in Sweden include the Nordic Ecolabel and the EU Ecolabel (from the state-
owned company Miljomarkning Sverige AB), Good Environmental Choice (the Swed-
ish Society for Nature Conservation), KRAV (a cooperative association), and Fairtrade
Sverige (a limited company as well as an association).
450 <0 T H E AU TH O RS A N D STUD E NTLITTER A TUR

Human rights Working conditions Environment Anti-corruption
Gender equality Entitlement to salary Climate Gifts and trips

Discrimination Working hours Biodiversity Representation
Local population Working conditions Ecosystem services Dinners FIGURE 18.3
Accessibility Safety Water Contract/employment The four areas in the UN
Parenthood Chemicals Bribes Global Compact. Source:
UN .
Another example of a standard in the area of sustainability is the Global Compact,

developed by the United Nations (UN). The UN Global Compact is a guide consisting
of principles concerning human rights, working conditions, the environment and
anti-corruption that describes how a company should act ethically and sustainably.
Many companies worldwide have decided to adopt the UN Global Compact, and the
principles are designed so that they suit all companies, regardless of size or sector.
Figure 18.3 provides examples of issues included in the various categories.
Voluntary commitments and advocacy

Since the end of the 2000s, an increasing number of large companies have joined
interest organizations on environment and climate issues, outside their ordinary trade
organizations. One well-known example is the Haga Initiative, a network of Swedish
companies formed in 2010 to reduce emissions from the business community and to
increase interest in climate change. Another example is the 2030-secretariat, which aims
to influence the development of the transport sector in a sustainable direction so that
Sweden's national goal of a fossil-free fleet of vehicles can be achieved no later than 2030.
International collaborations
In the international arena, there are also several initiatives in which companies and
organizations make commitments of various kinds. One of the most recent is the Non-
state Action Zone for Climate Action (NAZCA) which, with the Lima-Paris Action
Agenda (LPAA), was launched in connection with the Climate Change Conference in
Lima in 2014 and paved the way for the Climate Change Conference in Paris in 2015 .
NAZCA addresses companies, local authorities, organizations, and investors that,
under NAZCA, make their own commitments and register them in an international
database. One example is Ikea Sweden, which has joined four different initiatives:
Caring for Climate, Corporate Engagement in Climate Policy, Global Green Freight
Action Plan, and RElO0 (100% renewable power generation).
0 THE AUT HO RS A ND STU DEN TL I TT ERA T UR 451

PART IV • MAN AGEMENT AND ORGA NIZING
Ethics and professional codes

It almost goes without saying that doctors and lawyers have a particular need for ethical
guidelines. Medicine and law therefore have several institutions that have the task of
enhancing and spreading knowledge about ethical questions, including the National
Board of Health and Welfare's ethics council and the Swedish Bar Association. There
is also a number of specific rules and recommendations for civil servants.
The Swedish Association of Graduate Engineers' code of honor
Technology and science are powerful tools that serve humanity, for better or for worse. They
have essentially completely transformed our society and will continue to have a profound effect
on humanity even in the future. Engineers are holders and trustees of technological knowledge.
This entails a special responsibility to ensure that technology is used for the good of society and
humanity and that it is passed on to future generations in an improved form.
The Ten Principles of the Code of Honor:
Engineers in their professional capacity ought to feel personally responsible for technology
being used in a manner that benefits humanity, the environment, and society.
Engineers ought to strive to improve technology and technological knowledge so as to achieve
more efficient use of resources without harmful effects.
Engineers ought to offer their knowledge in both public and private contexts so as to ensure
the best possible basis for decisions and to illuminate both the opportunities and the risks
associated with technology.
Engineers ought not to work for or cooperate with companies and organizations of a
questionable nature or with objectives that conflict with personal beliefs.
Engineers ought to show complete loyalty to employers and colleagues. Difficulties in this
respect ought to be raised in open discussions, in the first instance at the workplace.
Engineers must not use inappropriate methods when competing for employment, assignments,
or orders, and nor should they attempt to damage the reputation of colleagues with unfounded
allegations.
Engineers ought to respect entrusted information of a confidential nature and others' rights to
ideas, inventions, studies, plans, and blueprints.
Engineers must not favor vested interests and ought to openly report financial and other
interests that could impair confidence in their impartiality and judgement.
Engineers ought to both publicly and privately, in writing and rhetoric, strive for factual
presentations and avoid erroneous, misleading or exaggerated statements.
Engineers ought to actively support colleagues who encounter difficulties as a result of acting
in accordance with these principles and, to the best of their belief, avert criminal actions against
them.
452 I:> T H E AUTH ORS A N D STUDE N TL IT TERATUR

Some trade unions have also initiated discussions on professional ethics. As an

example, the Swedish Association of Graduate Engineers, a trade union for universi-
ty-trained engineers, has produced a code of honor that members are recommended
to follow (see box).
To conclude, we can acknowledge that many companies and organizations are
important societal actors that both affect and are affected by societal development.
An increasing number of companies are beginning to see the commercial benefits
of conducting their business in a manner that is sustainable in the long term from
economic, social, and environmental perspectives. Sustainable business is essentially
also a profitable business.
Summary
This chapter discussed Corporate Social Responsibility (CSR) and economic, environ-
mental, and social sustainability. CSR is about companies taking responsibility for the
society in which they operate, which includes the values that direct the business as well
as the control mechanisms that ensure that the values are complied with. The concept
of sustainability is broader and is often used to describe a company's strategies and
measures to reduce or eliminate its negative impact on people, climate, and ecosystems.
Economic responsibility is about companies operating in a long-term sustainable
manner from an economic perspective. Environmental responsibility involves acting
in a long-term sustainable manner from an environmental perspective, both internally
and externally. Social responsibility means acting in a manner that is sustainable in the
long term from a social perspective, for example by promoting an equal society in which
people live good lives with good health and without unjust differences in conditions.
Sustainable business development is about how a company should strive to oper-
ate based on its long-term social responsibility, while benefiting from doing ethical,
sustainable business. The idea is to create and propose shared values, i.e., value for
the company, for the customers, and for society as a whole. Most large companies
today also publish sustainability reports, and for many companies their policies for
sustainability and environmental work constitute important elements of their strategic
communication.
© THE A U THOR S AND STUDENTLITTERATUR 453

PART IV • MA NAGEMENT AND ORGANIZING
References
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& Windell, K. (2012). CSR - corporate social responsibility: en guide till foretagets ansvar.
Sanoma utbildning.
Brytting, T. (2005). Foretagsetik. Liber.
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Carson, R. (2002). Silent spring. Houghton Mifflin Harcourt.
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Grafstrom, M., Gothberg, P. & Windell, K. (2012). CSR: Foretagsansvar i fori:indring. Liber.
Grankvist, P. (2012). CSR i praktiken - hur foretag jobbar med hallbarhet for att tji:ina pengar.
Liber.
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Studentlitteratur.
Jutterstrom, M. & Norberg, P. (Eds.) (2011). Foretagsansvar: CSR som managementide.
Studentlitteratur.
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Stockholm School of Economics Institute for Research.
Laestadius, S. (2013). Klimatet och vi:ilfi:irden: Mot en ny svensk modell. Borea Bokforlag.
Porter, M. E. & Kramer, M. R. (2007). Strategy and Society: The Link Between Competitive
Advantage and Corporate Social Responsibility. Harvard Business Review, 84(12), 78-92, 163.
Transparency International, www.transparency.org
454 e THE AUTHOR S AND STUDEN TL ITTERATUR

GLOSSARY: ENGLISH-SWEDISH
A-share A-aktie annuity ratio annuitetskvot

absorption costing palaggskalkylering appropriations bokslutsdispositioner
accounting plan kontoplan articles of incorporation bolagsordning
accounts payable leverantorsskuld asset tillgang
accounts receivable kundfordran asset account tillgangskonto
accrued costs upplupna kostnader asset side aktivsidan
accrued revenues upplupna intakter auditor revisor
accumulated additional depreciations ackumulerade auditor's report revisionsberattelse
overavskrivningar authority befogenhet
acid test ratio kassalikviditet authorized public accountant auktoriserad revisor
activity based costing ABC-kalkylering average interest on debt genomsnittlig skuldranta
additional depreciations overavskrivning
additional depreciations avskrivning over plan B-share B-aktie
additional sales til laggsforsaljning balance account balanskonto
adjusted equity justerat eget kapital balance carried forward utgaende balans
administrative overhead (AO) administrationsomkostnad (AO) balance sheet balansrakn ing
advance payment forskott bank balances banktillgodohavande
aftermarket eftermarknad basis for overhead charge palaggsbas
allocation to a particular time period periodisering board of directors styrelse
amortization amortering bond obligation
Annual Accounts Act arsredovisningslagen bond loan obligationslan
annual ccounts book arsbok Bookkeeping Act bokforingslagen
annual financial statements arsbokslut break-even chart resultatdiagram
annual meeting bolagsstamma business administration foretagsekonomi
annual profit/loss arets vinst/forlust business concept affarside
annual report arsredovisning business model affarsmodell
annuity annuitet business ratio nyckeltal
annuity factor annuitetsfaktor business-to-business products producentprodukter
annuity method annuitetsmetoden business transaction affarshandelse
© THE A UTHOR S AN D 5TU D EN TL ITT ER AT UR 457

GLOSSARY ENGLISH-SWEDISH
capital gain realisationsvinst cost of acquisition anskaffningsvarde

capital investment analysis investeringsbedomning cost of capital (cost for financing) kapitalkostnad
capital investment appraisal investeringskalkyl cost of capital (interest rate) kalkylranta
capital requirements kapitalbehov cost of goods sold kostnad salda varor
capital stock aktiekapital cost of production tillverkningskostnad
capital tied up kapitalbindn ing cost unit kalkylobjekt, kostnadsbarare
cash (in hand) kassa, likvida medel credit kredit
cash flow analysis finansieringsanalys, kassaflodesanalys credit rating kreditvardering
cash flow forecast finansieringsprognos credit risk kreditrisk
cash payment (out) utbetalning creditor fordringsagare
cash payment surplus critical volume kritisk volym
utbetalningsoverskott cumulative present value nusumma
cash receipt (in) inbetalning cumulative present value factor nusummefaktor
cash receipt surplus inbetalningsoverskott current assets omsattningstillgangar
change of working capital forandring av rorelsekapital current liabilities kortfristiga skulder
checking account checkkredit current ratio balanslikviditet
chief executive officer (CEO) verkstallande direktor (VD) current recording of transactions lopande bokforing
civil law civillagstiftning
closing balance utgaende balans debit debet
code kontera debt/equity ratio skuldsattningsgrad
common cost samkostnad debts skulder
common stock stamaktier deferred income forutbetalda intakter
Companies Act aktiebolagslagen deferred tax liabilities latent skatteskuld
conditions for liability (debt) payment aterbetalningsvillkor depreciation avskrivningar
consolidated balance sheet koncernbalansrakning depreciation according to plan planenlig avskrivning,
consolidated financial statement koncernredovisning avskrivningar enligt plan
consolidated income statement koncernresultatrakning depreciation as recorded in the books rakenskapsenl iga
consortium agreement konsortialavtal avskrivningar
consumables forbrukningsvaror direct cost direkt kostnad
consumer products konsumentprodukter direct labor cost direkt Ion
contract manufacturer legotillverkare direct material cost direkt material
contribution costing bidragskalkyl dividend utdelning
contribution margin tackningsbidrag division of labor arbetsfordelning
convertible instrument konvertibler double taxation dubbelbeskattning
convertible loan konvertibla forlagslan double-entry bookkeeping system dubbel bokforing
co-operative ekonomisk forening DuPont chart DuPont-schema
coordination samordning
core business karnverksamhet earnings vinst
corporate income tax bolagsskatt economic association ekonomisk forening
cost kostnad Economic Association Act lagen om ekonomiska foreningar
cost account kostnadskonto economic cycle ekonomiskt kretslopp
cost center kostnadsstalle economic life ekonomisk livslangd
cost driver kostnadsdrivare economics nationalekonomi
458 C> THE AUTHORS ANO STUDENTLITTERATUR

economy of scale stordriftsfordelar gearing skuldsattningsgrad

effectiveness yttre effektivitet general ledger huvudbok
efficiency inre effektivitet general partner (in limited partnership) komplementar
employers' social cost for labor arbetsgivaravgift (i kommanditbolag)
entrepreneur foretagare generally accepted accounting principles god redovisningssed
equity eget kapital geographical structure geografisk organisation
equity method kapitalandelsmetoden goods varor
(i koncernredovisning) goodwill goodwill
equity method reserve kapitalandelsfond group (consolidated company) koncern
equity ratio soliditet group contribution koncernbidrag
equity/assets ratio soliditet
equity/debt ratio soliditet income inkomst
estimate forka lkyl income statement resultatrakning
ex post costing efterkalkyl income statement classified by function funktionsindelad
expenditure utgift resultatrakning
expenditure account utgiftskonto income statement classified by nature of cost kostnadsslags-
expense kostnad indelad resultatrakning
externally generated funds externt genererade medel index for distributing overhead fordelningsnyckel
extra ordinary costs (expenses) extraordinara kostnader indirect cost indirekt kostnad
extra ordinary income extraordinara intakter industrial management industriell ekonomi
industry industri, bransch
finance company finansbolag informal structure informell organisation
financial accounting affarsredovisning, extern redovisning input goods insatsvaror
financial analysis rakenskapsanalys input market anskaffningsmarknad
financial cost finansiell kostnad input VAT ingaende moms
financial ratio finansiella nyckeltal installed base installerad bas av salda produkter
financial revenue finansiell intakt interest ranta
finished products inventory (stock) fardigvarulager interest rate risk ranterisk
first tier supplier forstaledsleverantor interest-bearing liability rantebarande skulder
fixed asset cash requirement interim claim interimsfordran
anlaggningskapitalbehov interim debt interimsskuld
fixed assets anlaggningstillgangar intermediate stock me IIan lager
fixed cost fast kostnad internal financing sjalvfinansiering
formal structure formell organisationsstruktur internal rate of return internranta
full costing method internal rate of return method internrantemetoden
sjalvkostnadsmetoden internally generated funds internt genererade medel
functional staff structure internally provisioned funds internt tillforda medel
linje-stabsorganisation inventory forrad
functional manager linjechef investment investering
functional structure funktionsorganisation, linjeorganisation investor finansiar
functional work supervision funktionell arbetsledning invoice faktura
funds provided til lforda medel issue for non-cash consideration (in kind) apportemission
funds utilized anvanda medel
Cl THE AUTHORS AND STUDENTLITTERATUR 459

job description befattningsbeskrivning municipal tax law (in Sweden)

jobbing enstycksproduktion kommunalskattelagen
joint venture konsortium
journal dagbok net present ratio nuvardekvot
net present value nuvarde
knowledge intensive business service kunskapsintensiv net present value method nuvardemetoden,
tjansteverksamhet kapitalvardemetoden
net sales nettoforsaljning, nettoomsattning
labor intensive services personalintensiva tjanster new capital issue nyemission
land assets markanlaggningar nominal value nominellt varde
legal entity juridisk person non-profit association ideell forening
leverage equation havstangsformeln non-restricted equity fritt eget kapital
leverage risk havstangsrisk
liabilities skulder obsolescence inkurans
liability account skuldkonto one-of-a-kind production enstycksproduktion
liability side (in the financial statement) passivsidan opening balance ingaende balans
(i balansrakningen) operating cost rbrelsens kostnader
limited partner kommanditdelagare operating volume verksamhetsvolym
limited partnership kommanditbolag operational investment
line organization linjeorganisation rationaliseringsinvestering
loan interest laneranta operational liabilities rbrelseskulder
long-term debt langfristig skuld operational risk rbrelserisk
lower of cost or market lagsta vardets princip operations verksamhet, produktion, drift
organization chart organisationsplan
machinery and equipment maskiner och inventarier organization design organisationsform
make to order kundorder organization structure
make to stock lagerorder organisationsstruktur
management accounting original investment grundinvestering
internredovisning other direct manufacturing cost bvriga direkta
management report tillverkningskostnader
forvaltningsberattelse other operational costs bvriga rbrelsekostnader
managing director verkstallande direktbr other operational revenues bvriga rbrelseintakter
manufacturing overhead tillverkningsomkostnad output market avsattningsmarknader
manufacturing overhead output VAT utgaende moms
charge til lverkningsom kostnadspalagg overhead charge omkostnadspalagg
marketing marknadsforing overhead cost omkostnad
marketing process owner's capital, equity riskbarande eget kapital
marknadsforingsprocessen owner's capital, equity riskkapital
material overhead materialomkostnad
material overhead charge parent company moderbolag
materialomkostnadspalagg partnership handelsbolag
matrix structure matrisorganisation payback method aterbetalningsmetoden, pay-back-metoden
mortgage pantforskrivning payback period aterbetalningstid
460 © T H E AU TH ORS AND ST UDENTLITTERATUR

GLOSSARY ENGLISH-SWEDISH
payment utbetalning receivable fordran

performance measurement prestationsmatning, replacement cost ateranskaffningsvarde
resultatmatning required return avkastningskrav
pooling of interest method poolningsmetoden (inom residual value restvarde
koncernredovisning) restricted equity bundet eget kapital
preferred stock preferensaktier restricted shares bundna aktier
prepaid expenses forutbetalda kostnader return rantabilitet, avkastning
present value nuvarde return on capital employed rantabilitet pa sysselsatt kapital
present value factor nuvardefaktor return on equity rantabilitet pa eget kapital
private placement riktad emission return on total capital rantabilitet pa tota lt kapital
process costing divisionskalkyl revaluation reserve uppskrivningsfond
procurement upphandling revenue intakt
product cost estimate produktkalkyl revenue account intaktskonto
product costing produktkalkylering revenue unit intaktsenhet
product development produktutveckling rights issue foretradesemission
product structure produktorganisation
product variety produktvariation safety margin sakerhetsmarginal
production flow produktionsflodet sales omsattning, forsaljning
productivity produktivitet sales & administrative overhead forsaljnings- och
products in progress produkter i arbete administrationskostnad
profit vinst sales overhead forsaljningsomkostnad
profit (or loss) brought forward sales revenue forsaljningsintakter
balanserade vinst-(forlust-)medel second tier supplier andraledsleverantbr
profit/loss resu ltat service business tjansteverksamheter
profit and loss account vinst- och forlustkonto services tjanster
profit center resultatenhet share aktie
profit charge vinstpalagg share capital aktiekapital
profit margin vinstmarginal share issue aktieemission
profit/loss account resultatkonto share premium reserve bverkursfond
profitability lonsamhet share register aktiebok
project structure (organization) shareholder aktieagare
projektorganisation small business famansforetag
proportional method klyvningsmetoden (inom social security costs sociala avgifter
koncernredovisning) sole proprietorship enskild firma
purchase accounting method forvarvsmetoden (inom sole trader enskild naringsidkare, enmansforetagare
koncernredovisning) span of control kontrollspann
special direct sales costs speciella direkta forsaljningskostnader
quarterly report kvartalsrapport specific cost sarkostnad
specific revenue sarintakt
raw materials inventory ramaterialforrad staffing agency bemanningsforetag
real estate fastighet stakeholder intressent
real estate tax fastighetsskatt standing committee staende kommitte
receipt inbetalning step costing stegkalkyl
<0 THE AUT H ORS AND STUDENTLITTERAT U R 461

stock dividend fondemiss ion total assets totalt kapital, balansomslutning

stock issue aktieemission transfer pricing internprissattning
strategic investment turnover omsattning, forsaljning
inriktningsinvestering turnover rate omsattningshastighet
structure of equity and liabilities kapitalstruktur type of cost kostnadsslag
sub-contractor underentreprenbr
subordinated loan eftersta llt Ian, subordinerat Ian unappropriated equity disponibelt eget kapital
subsidiary dotterbolag unit sales enhetsforsaljning
sub-supplier underleverantbr unrestricted shares fria aktier
supplier leverantbr untaxed reserves obeskattade reserver
supply chain forsbrjningskedja
Swedish Accounting Standards Board Bokforingsnamnden valuation of assets vardering av t illgangar
Swedish Company Registration Office Bolagsverket valuation of current assets vardering av omsattningstillgangar
Swedish Financial Reporting Board Radet for finansiell valuation of fixed assets vardering av anlaggningstillgangar
rapportering valuation of liabilities (debts) vardering av skulder
Swedish Financial Supervisory Authority Finansinspektionen valuation of time tidspreferens
Swedish Institute of Authorized Public value added foradlingsvarde
Accountants Fbreningen auktoriserade revisorer (FAR) value added tax (VAT) mervardesskatt (moms)
Swedish Tax Agency Skatteverket value chain vardekedja
value creation vardeskapande
T-account T-konto value depreciation vardeminskning
task force ti llfallig arbetsgrupp value proposition vardeerbjudande
tax skatt variable cost rbrlig kostnad
tax allocation reserve periodiseringsfond venture capital company riskkapitalbolag
tax debt skatteskuld vertical integration vertikal integration
tax law skattelagstiftning voucher verifikation
tax return sjalvdeklaration
tax subject skattesubjekt working capital rbrelsekapital
taxpayer skattebetalare working capital change rbrelsekapitalforandring
technical life tekn isk livslangd working capital requirement rbrelsekapitalbehov
tender offert
tender engineer offertingenjbr year-end closing bokslut
terminal value slutvarde yield avkastning
terminal value factor slutvardefaktor
462 © T HE AU T HO RS AND STU DEN TLITT ERATUR

GLOSSARY: SWEDISH-ENGLISH
A-aktie A-share arbetsgivaravgift employers' social cost for labor

ABC-kalkylering activity based costing auktoriserad revisor authorized public accountant
ackumulerade overavskrivningar avkastning return, yield
accumulated additional depreciations avkastningskrav required return
administrationsomkostnad {AO} avskrivning over plan additional depreciations
administrative overhead {AO) avskrivningar depreciation
affarshandelse business transaction avskrivningar enligt plan depreciation according to plan
affarside business concept avsattningsmarknader output market
affarsmodell business model
affarsredovisning financial accounting B-aktie B-share
aktie share balanserade vinst-{forlust-)medel profit (or loss) brought
aktiebok share register forward
aktiebolagslagen Companies Act balanskonto balance account
aktieemission stock issue, share issue balanslikviditet current ratio
aktiekapital share capital, capital stock balansomslutning total assets
aktieagare shareholder balansrakning balance sheet
aktivsidan asset side banktillgodohavande bank balances
amortering amortization befattningsbeskrivning job description
andraledsleverantor second t ier supplier befogenhet authority
anlaggningskapitalbehov fixed asset cash requirement bemanningsforetag staffing agency
anlaggningstillgangar fixed assets bidragskalkyl contribution costing
annuitet annuity bokforingslagen Bookkeeping Act
annuitetsfaktor annuity factor Bokforingsnamnden Swedish Accounting Standards Board
annuitetskvot annuity ratio bokslut year end closing
annuitetsmetoden annuity method bokslutsdispositioner appropriations
anskaffningsmarknad input market bolagsordning articles of incorporation
anskaffningsvarde cost of acquisition bolagsskatt corporate income tax
anvanda medel funds utilized bolagsstamma annual meeting
apportemission issue for non-cash consideration (in kind) Bolagsverket Swedish Company Registration Office
arbetsfordelning division of labor bransch industry

bundet eget kapital restricted equity finansiell kostnad financial cost

bundna aktier restricted shares finansiella nyckeltal financial ratio
finansieringsanalys cash flow analysis
checkkredit checking account finansieringsprognos cash flow forecast
civillagstiftning civil law Finansinspektionen Swedish Financial Supervisory Authority
finansiar investor
dagbok journal fondemission stock dividend
debet debit ford ran receivable
deklaration tax return fordringsagare creditor
direkt kostnad direct cost formell organisationsstruktur formal structure
direkt Ion direct labor cost fria aktier unrestricted shares
direkt material direct material cost fritt eget kapital non-restricted equity
disponibelt eget kapital unappropriated equity funktionell arbetsledning functional work supervision
divisionskalkyl process costing funktionsindelad resultatrakning income statement classified
dotterbolag subsidiary by function
drift operations funktionsorganisation functional structure
dubbel bokforing double-entry bookkeeping system famansforetag small business
dubbelbeskattning double taxation fardigvarulager finished products inventory (stock, inventories)
DuPont-schema DuPont chart forbrukningsvaror consumables
fordelningsnyckel index for distributing overhead
efterkalkyl ex post costing Foreningen auktoriserade revisorer (FAR} Swedish Institute of
eftermarknad aftermarket Authorized Public Accountants
efterstallt Ian subordinated loan foretagare entrepreneur
eget kapital equity foretagsekonomi business administration
ekonomisk forening co-operative, economic association foretradesemission rights issue
ekonomisk livslangd economic life forkalkyl estimate
ekonomiskt kretslopp economic cycle forrad inventories
enhetsforsaljning unit sales forskott advance payment
enskild firma sole proprietorship forstaledsleverantor first tier supplier
enskild naringsidkare, enmansforetagare sole trader forsaljning sales, turnover
enstycksproduktion jobbing, one-of-a-kind production forsaljnings- och administrationskostnad sales & adminis-
extern redovisning financial accounting trative overhead
externt genererade medel externally generated funds forsaljningsintakter sales revenue
extraordinara intakter extra ordinary income forsaljningsomkostnad sales overhead
extraordinara kostnader extra ordinary cost (expenses) forsorjningskedja supply chain
forutbetalda intakter deferred income
faktura invoice forutbetalda kostnader prepaid expenses
fast kostnad fixed cost forvaltningsberattelse management report
fastighet real estate forvarvsmetoden (inom koncernredovisning} purchase
fastighetsskatt real estate tax accounting method
finansbolag finance company foradlingsvarde value added
finansiell intakt financial revenue forandring av rorelsekapital change of working capital

genomsnittlig skuldranta average interest on debt juridisk person legal entity

geografisk organisation geographical structure justerat eget kapital adjusted equity
god redovisningssed generally accepted accounting principles
goodwill goodwill kalkylobjekt cost unit
grundinvestering original investment kalkylranta cost of capital
(i nterest rate)
handelsbolag partnership kapitalandelsfond equity method reserve
huvudbok general ledger kapitalandelsmetoden (inom koncernredovisning) equity
havstangsformeln leverage equation method
havstangsrisk leverage risk kapitalbehov capita l requirements
kapitalbindning capital tied up
ideell forening non-profit association kapitalkostnad cost of capital (cost for financing)
inbetalning receipt, cash receipt (in) kapitalstruktur structure of equity and liabilities
inbetalningsoverskott cash receipt surplus kapitalvardemetoden net present value method
indirekt kostnad indirect cost kassa cash (in hand)
industri industry kassaflodesanalys cash flow analysis
industriell ekonomi industrial management kassalikviditet acid test ratio
informell organisation informal structure klyvningsmetoden (inom koncernredovisning) proportional
ingaende balans opening balance method
ingaende moms input VAT kommanditbolag limited partnership
inkomst income kommanditdelagare limited partner
inkurans obsolescence kommunalskattelagen municipal tax law (in Sweden)
inre effektivitet efficiency komplementar (i kommanditbolag) general partner
inriktningsinvestering strategic investment koncern group (consolidated company)
insatsvaror input goods koncernbalansrakning consolidated balance sheet
installerad bas av salda produkter installed base koncernbidrag group contribution
interimsfordran interim claim koncernredovisning consolidated financial statement
interimsskuld interim debt koncernresultatrakning consolidated income statement
internprissattning transfer pricing konsortialavtal consortium agreement
internredovisning management accounting konsortium consortium, joint venture
internranta internal rate of return konsumentprodukter consumer products
internrantemetoden internal rate of return method kontera code
internt genererade medel internally generated funds kontoplan accounting plan
internt tillforda medel internally provisioned funds kontrollspann span of control
intressent stakeholder konvertibla forlagslan convertible loan
intakt revenue konvertibler convertible instrument
intaktsenhet revenue unit kortfristiga skulder current liabilities
intaktskonto revenue account kostnad cost
investering investment kostnad expense
investeringsbedomning capital investment analysis kostnad salda varor cost of goods sold
investeringskalkyl capital investment appraisal kostnadsbarare cost unit
kostnadsdrivare cost driver

kostnadskonto cost account nationalekonomi economics

kostnadsslag type of cost nettofiirsaljning net sales
kostnadsslagsindelad resultatrakning income statement nettoomsattning net sales
classified by nature of cost nominellt varde nominal value
kostnadsstalle cost center nusumma cumulative present value
kred it credit nusummefaktor cumulative present value factor
kreditrisk credit risk nuvarde present value, net present value
kreditvardering credit rating nuvardefaktor present value factor
kritisk volym critical volume nuvardekvot net present ratio
kundfordran accounts receivable nuvardemetoden net present value method
kundorder make to order nyckeltal business ratio
kunskapsintensiv tjansteverksamhet nyemission new capital issue
knowledge intensive business service
kvartalsrapport quarterly report obeskattade reserver untaxed reserves
karnverksamhet core business obligation bond
obligationslan bond loan
lagen om ekonomiska fiireningar offert tender
Economic Association Act offertingenjor tender engineer
lagerorder make to stock omkostnad overhead cost
latent skatteskuld deferred tax liabilities omkostnadspalagg overhead charge
legotillverkare contract manufacturer omsattning sales, turnover
leverantor supplier omsattningshastighet turnover rate
leverantorsskuld accounts payable omsattningstillgangar current assets
likvida medel cash (in hand) organisationsform organization design
linje-stabsorganisation functional staff structure organisationsplan organization chart
linjechef functional manager organisationsstruktur organization structure
linjeorganisation line organization, functional structu re
laneranta loan interest pantforskrivning mortgage
langfristig skuld long-term debt passivsidan (i balansrakningen) liability side (in the financial
lagsta vardets princip lower of cost or market statement)
lonsamhet profitability pay-back-metoden payback method
lopande bokfiiring current recording of transactions periodisering allocation to a particular time period
periodiseringsfond tax allocation reserve
markanlaggningar land assets personalintensiva tjanster labor intensive services
marknadsfiiring marketing poolningsmetoden (inom koncernredovisning) pooling of
marknadsfiiringsprocessen marketing process interest method
maskiner och inventarier machinery and equipment planenlig avskrivning depreciation according to plan
materialomkostnad material overhead preferensaktier preferred stock
materialomkostnadspalagg materia l overhead charge prestationsmatning performance measurement
matrisorganisation matrix structu re producentprodukter business-to-business products
mellanlager intermediate stock produkter i arbete products in prog ress
mervardesskatt (moms) va lue added tax (VAT) produktion operations
moderbolag parent company produktionsflodet production flow

produktivitet productivity rorelseskulder operational liabilities

produktkalkyl product cost estimate rorlig kostnad variable cost
produktkalkylering product costing
produktorganisation product structure samkostnad common cost
produktutveckling product development samordning coordination
produktvariation product variety sjalvdeklaration tax return
projektorganisation project structure (organization) sjalvfinansiering internal financing
palaggsbas basis for overhead charge sjalvkostnadsmetoden full costing method
palaggskalkylering absorption costing skatt tax
skattelagstiftning tax law
rationaliseringsinvestering operational investment skatteskuld tax debt
realisationsvinst capital gain skattesubjekt tax subject, tax payer
restvarde residual value Skatteverket Swedish Tax Agency
resultat profit/loss skulder debts, liabilities
resultatdiagram break-even chart skuldkonto liability account
resultatenhet profit center skuldsattningsgrad debt/equity ratio, gearing
resultatkonto profit/loss account slutvarde terminal value
resultatmatning performance measurement slutvardefaktor terminal value factor
resultatrakning income statement sociala avgifter social security costs
revisionsberattelse auditor's report soliditet equity ratio, equity/assets ratio
revisor auditor speciella direkta forsaljningskostnader special direct sales
riktad emission private placement costs
riskbarande eget kapital owner's capital, equity stamaktier common stock
riskkapital owner's capital, equity stegkalkyl step costing
riskkapitalbolag venture capital company stordriftsfordelar economy of scale
Radet for finansiell rapportering Swedish Financial Reporting styrelse board of directors
Board staende kommitte standing committee
ramaterialforrad raw materials inventory subordinerat Ian subordinated loan
rakenskapsanalys financial analysis sakerhetsmarginal safety margin
rakenskapsenliga avskrivningar depreciation as recorded in sarintakt specific revenue
the books sarkostnad specific cost
ranta interest
rantabilitet return T-konto T-account
rantabilitet pa eget kapital return on equity teknisk livslangd technical life
rantabilitet pa sysselsatt kapital return on capital employed tidspreferens valuation of time
rantabilitet pa totalt kapital return on total capital tillfallig arbetsgrupp task force
rantebarande skulder interest-bearing liability tillforda medel funds provided
ranterisk interest rate risk tillgang asset
rorelsekapital working capital tillgangskonto asset account
rorelsekapitalbehov working capital requirement tillverkningskostnad cost of
rorelsekapitalforandring working capital change production
rorelsens kostnader operating cost tillverkningsomkostnad manufacturing overhead
rorelserisk operational risk

tillverkningsomkostnadspalagg vinst- och forlustkonto profit and loss account

manufacturing overhead charge vinstmarginal profit margin
tillaggsforsaljning additional sales vinstpalagg profit charge
tjanster services vardeerbjudande value proposition
tjansteverksamheter service business vardekedja value chain
totalt kapital total assets vardeminskning value depreciation
tvingande investering required investment vardering av anlaggningstillgangar
tackningsbidrag contribution margin valuation of fixed assets
vardering av omsattningstillgangar
underentreprenor sub-contractor valuation of current assets
underleverantor sub-supplier vardering av skulder valuation of liabilities (debts)
upphandling procurement vardering av tillgangar valuation of assets
upplupna intakter accrued revenues vardeskapande value creation
upplupna kostnader accrued costs
uppskrivningsfond revaluation reserve yttre effektivitet effectiveness
utbetalning payment, cash payment (out)
utbetalningsoverskott cash payment surplus arets vinst/forlust annual profit/loss
utdelning dividend arsbok annual accounts book
utgift expenditure arsbokslut annual financial statements
utgiftskonto expenditure account arsredovisning annual report
utgaende balans balance carried forward, closing balance arsredovisningslagen Annual Accounts Act
utgaende balans closing balance ateranskaffningsvarde replacement cost
utgaende moms output VAT aterbetalningsmetoden payback method
aterbetalningstid payback period
varor goods aterbetalningsvillkor conditions for liability (debt) payment
verifikation voucher
verksamhet operations overavskrivning additional depreciations
verksamhetsvolym operating volume overkursfond share premium reserve
verkstallande direktor (VD) chief executive officer (CEO), ovriga direkta tillverkningskostnader
managing director other direct manufacturing cost
vertikal integration vertical integration ovriga rorelseintakter other operational revenues
vinst earnings, profit ovriga rorelsekostnader other operational costs

TABLE A Future value (FV) (1+i)Y
"
-<
I
z
m
Year 0% 1% 2% 3% 4% S% 6% 7% 8% 9 % 10 % 11 % 12 % 13 % 14 % 1S % 16 % 17 % 18 % 20 % --i
>
C
m
-< ::0
I
0
1,0 1,010 1,020 1,030 1,040 1,050 1,060 1,070 1,080 1,090 1,100 1,110 1,120 1,130 1,140 1,150 1,160 1,170 1,180 1,200 m
~ V1
~
> 2 1,0 1,020 1,040 1,061 1,082 1,103 1,124 1,145 1,166 1,188 1,210 1,232 1,254 1,277 1,300 1,323 1,346 1,369 1,392 1,440 --i
z
0 --i
~
-<
3 1,0 1,030 1,061 1,093 1,125 1,158 1,191 1,225 1,260 1,295 1,331 1,368 1,405 1,443 1,482 1,521 1,561 1,602 1,643 1,728 >
a:,
C
0
m 4 1,0 1,0411,0821,126 1,170 1,216 1,262 1,3111,3601,412 1,464 1,518 1,574 1,630 1,689 1,749 1,811 1,874 1,939 2,074 r
z m
-< V1
r
5 1,0 1,051 1,104 1,159 1,217 1,276 1,338 1,403 1,469 1,539 1,611 1,685 1,762 1,842 1,925 2,011 2,100 2,192 2,288 2,488
-<
-<
~
6 1,0 1,062 1,126 1,194 1,265 1,340 1,419 1,501 1,587 1,677 1,772 1,870 1,974 2,082 2,195 2,313 2,436 2,565 2,700 2,986
>
-<
C
~ 7 1,0 1,072 1,149 1,230 1,316 1,407 1,504 1,606 1,714 1,828 1,949 2,076 2,211 2,353 2,502 2,660 2,826 3,001 3,185 3,583
8 1,0 1,083 1,172 1,267 1,369 1,477 1,594 1,718 1,851 1,993 2,144 2,305 2,476 2,658 2,853 3,059 3,278 3,511 3,759 4,300
9 1,0 1,094 1,195 1,305 1,423 1,551 1,689 1,838 1,999 2,172 2,358 2,558 2,773 3,004 3,252 3,518 3,803 4,108 4,435 5,160
10 1,0 1,105 1,219 1,344 1,480 1,629 1,791 1,967 2,159 2,367 2,594 2,839 3,106 3,395 3,707 4,046 4,411 4,807 5,234 6,192
11 1,0 1,116 1,243 1,384 1,539 1,710 1,898 2,105 2,332 2,580 2,853 3,152 3,479 3,836 4,226 4,652 5,117 5,624 6,176 7,430
12 1,0 1,127 1,268 1,426 1,601 1,796 2,012 2,252 2,518 2,813 3,138 3,498 3,896 4,335 4,818 5,350 5,936 6,580 7,288 8,916
13 1,0 1,138 1,294 1,469 1,665 1,886 2,133 2,410 2,720 3,066 3,452 3,883 4,363 4,898 5,492 6,153 6,886 7,699 8,599 10,699
14 1,0 1,149 1,319 1,513 1,732 1,980 2,261 2,579 2,937 3,342 3,797 4,310 4,887 5,535 6,261 7,076 7,988 9,007 10,147 12,839
15 1,0 1,161 1,346 1,558 1,801 2,079 2,397 2,759 3,172 3,642 4,177 4,785 5,474 6,254 7,138 8,137 9,266 10,539 11,974 15,407
16 1,0 1,173 1,373 1,605 1,873 2,183 2,540 2,952 3,426 3,970 4,595 5,311 6,130 7,067 8,137 9,358 10,748 12,330 14,129 18,488
17 1,0 1,184 1,400 1,653 1,948 2,292 2,693 3,159 3,700 4,328 5,054 5,895 6,866 7,986 9,276 10,761 12,468 14,426 16,672 22,186
18 1,0 1,196 1,428 1,702 2,026 2,407 2,854 3,380 3,996 4,717 5,560 6,544 7,690 9,024 10,575 12,375 14,463 16,879 19,673 26,623
19 1,0 1,208 1,457 1,754 2,107 2,527 3,026 3,617 4,316 5,142 6, 116 7,263 8,613 10,197 12,056 14,232 16,777 19,748 23,214 31,948
20 1,0 1,220 1,486 1,806 2,191 2,653 3,207 3,870 4,661 5,604 6,727 8,062 9,646 11,523 13,743 16,367 19,461 23,106 27,393 38,338
~
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-.J --,
0 m
:,J
m
V,
--,
~
CP
r
m
V,
TABLE 8 Present Value (PV) 1/((Hi)')
% 1% 2% 3% 4% S% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18%
1,000 0,990 0,980 0,971 0,962 0,952 0,943 0,935 0,926 0,917 0,909 0,901 0,893 0,885 0,877 0,870 0,862 0,855 0,847 0,833
2 1,000 0,980 0,961 0,943 0,925 0,907 0,890 0,873 0,857 0,842 0,826 0,812 0,797 0,783 0,769 0,756 0,743 0,731 0,718 0,694
3 1,000 0,971 0,942 0,915 0,889 0,864 0,840 0,816 0,794 0,772 0,751 0,73 1 0,712 0,693 0,675 0,658 0,641 0,624 0,609 0,579
4 1,000 0,961 0,924 0,888 0,855 0,823 0,792 0,763 0,735 0,708 0,683 0,659 0,636 0,613 0,592 0,572 0,552 0,534 0,516 0,482
5 1,000 0,951 0,906 0,863 0,822 0,784 0,747 0,713 0,681 0,650 0,621 0,593 0,567 0,543 0,519 0,497 0,476 0,456 0,437 0,402
6 1,000 0,942 0,888 0,837 0,790 0,746 0,705 0,666 0,630 0,596 0,564 0,535 0,507 0,480 0,456 0,432 0,410 0,390 0,370 0,335
7 1,000 0,933 0,871 0,813 0,760 0,711 0,665 0,623 0,583 0,547 0,513 0,482 0,452 0,425 0,400 0,376 0,354 0,333 0,314 0,279
8 1,000 0,923 0,853 0,789 0,731 0,677 0,627 0,582 0,540 0,502 0,467 0,434 0,404 0,376 0,351 0,327 0,305 0,285 0,266 0,233
9 1,000 0,914 0,837 0,766 0,703 0,645 0,592 0,544 0,500 0,460 0,424 0,391 0,361 0,333 0,308 0,284 0,263 0,243 0,225 0, 194
10 1,000 0,905 0,820 0,744 0,676 0,614 0,558 0,508 0,463 0,422 0,386 0,352 0,322 0,295 0,270 0,247 0,227 0,208 0, 191 0,162
11 1,000 0,896 0,804 0,722 0,650 0,585 0,527 0,475 0,429 0,388 0,350 0,317 0,287 0,261 0,237 0,215 0,195 0,178 0,162 0,135
12 1,000 0,887 0,788 0,701 0,625 0,557 0,497 0,444 0,397 0,356 0,319 0,286 0,257 0,231 0,208 0,187 0,168 0,152 0,137 0,112
"
---<
:i:
13 1,000 0,879 0,773 0,681 0,601 0,530 0,469 0,415 0,368 0,326 0,290 0,258 0,229 0,204 0, 182 0, 163 0, 145 0, 130 0, 116 0,093
,.m
C
---< 14 1,000 0,870 0,758 0,661 0,577 0,505 0,442 0,388 0,340 0,299 0,263 0,232 0,205 0,181 0,160 0,141 0,125 0,111 0,099 0,D78
:i:
,,
0
15 1,000 0,861 0,743 0,642 0,555 0,481 0,417 0,362 0,315 0,275 0,239 0,209 0, 183 0, 160 0, 140 0, 123 0, 108 0,Q95 0,084 0,065
,.
~
z
0 16 1,000 0,853 0,728 0,623 0,534 0,458 0,394 0,339 0,292 0,252 0,2 18 0,188 0,163 0,14 1 0, 123 0, 107 0,093 0,081 0,071 0,054
~
---<
C
0
17 1,000 0,844 0,714 0,605 0,513 0,436 0,371 0,317 0,270 0,231 0, 198 0, 170 0, 146 0, 125 0, 108 0,093 0,080 0,069 0,060 0,045
m
z
---<
r
18 1,000 0,836 0,700 0,587 0,494 0,416 0,350 0,296 0,250 0,212 0,180 0,153 0,130 0,11 1 0,Q95 0,081 0,069 0,059 0,051 0,Q38
---<
---<
,,,. 19 1,000 0,828 0,686 0,570 0,475 0,396 0,331 0,277 0,232 0, 194 0, 164 0, 138 0, 116 0,098 0,083 0,070 0,060 0,051 0,043 0,03 1
---<
,,
C 20 1,000 0,820 0,673 0,554 0,456 0,377 0,312 0,258 0,215 0, 178 0, 149 0, 124 0, 104 0,087 0,073 0,061 0,051 0,043 0,037 0,026
TABLE c Cumulative Present Value (CPV) (1-(Hi)-Y)/i
"---,
I
m
J>
Vear 0 % 1% 2% 3% 4% 5% 6% 7% 8% 9% 10 % 11 % 12 % 13 % 14 % 15 % 16 % 17 % 18 % 20 %
C
---,
I 0,990 0,980 0,971 0,962 0,952 0,943 0,935 0,926 0,917 0,909 0,901 0,893 0,885 0,877 0,870 0,862 0,855 0,847 0,833
,,
0
V,
J> 2 2 1,970 1,942 1,913 1,886 1,859 1,833 1,808 1,783 1,759 1,736 1,713 1,690 1,668 1,647 1,626 1,605 1,585 1,566 1,528
z
0
V, 3 3 2,941 2,884 2,829 2,775 2,723 2,673 2,624 2,577 2,531 2,487 2,444 2,402 2,361 2,322 2,283 2,246 2,210 2,174 2,106
---,
C
0
4 4 3,902 3,808 3,717 3,630 3,546 3,465 3,387 3,3 12 3,240 3,170 3,102 3,037 2,974 2,914 2,855 2,798 2,743 2,690 2,589
z
---,
---, 5 5 4,853 4,713 4,580 4,452 4,329 4,212 4,100 3,993 3,890 3,791 3,696 3,605 3,517 3,433 3,352 3,274 3, 199 3,127 2,991
---,
,,
m
6 6 5,795 5,601 5,417 5,242 5,076 4,917 4,767 4,623 4,486 4,355 4,231 4,111 3,998 3,889 3,784 3,685 3,589 3,498 3,326
J>
---,
,,C 7 7 6,728 6,472 6,230 6,002 5,786 5,582 5,389 5,206 5,033 4,868 4,712 4,564 4,423 4,288 4,160 4,039 3,922 3,812 3,605
8 8 7,652 7,325 7,020 6,733 6,463 6,210 5,971 5,747 5,535 5,335 5,146 4,968 4,799 4,639 4,487 4,344 4,207 4,078 3,837
9 9 8,566 8,162 7,786 7,435 7,108 6,802 6,515 6,247 5,995 5,759 5,537 5,328 5, 132 4,946 4,772 4,607 4,451 4,303 4,031
10 10 9,471 8,983 8,530 8,111 7,722 7,360 7,024 6,710 6,418 6,145 5,889 5,650 5,426 5,216 5,019 4,833 4,659 4,494 4,192
11 11 10,368 9,787 9,253 8,760 8,306 7,887 7,499 7,139 6,805 6,495 6,207 5,938 5,687 5,453 5,234 5,029 4,836 4,656 4,327
12 12 11,255 10,575 9,954 9,385 8,863 8,384 7,943 7,536 7,161 6,814 6,492 6,194 5,918 5,660 5,421 5,197 4,988 4,793 4,439
13 13 12,134 11,348 10,635 9,986 9,394 8,853 8,358 7,904 7,487 7,103 6,750 6,424 6, 122 5,842 5,583 5,342 5,118 4,910 4,533
14 14 13,004 12,106 11,296 10,563 9,899 9,295 8,745 8,244 7,786 7,367 6,982 6,628 6,302 6,002 5,724 5,468 5,229 5,008 4,61 1
15 15 13,865 12,849 11,938 11,118 10,380 9,712 9,108 8,559 8,061 7,606 7,191 6,811 6,462 6,142 5,847 5,575 5,324 5,092 4,675
16 16 14,718 13,578 12,561 11,652 10,838 10,106 9,447 8,851 8,313 7,824 7,379 6,974 6,604 6,265 5,954 5,668 5,405 5, 162 4,730
17 17 15,562 14,292 13,166 12,166 11,274 10,477 9,763 9,122 8,544 8,022 7,549 7,120 6,729 6,373 6,047 5,749 5,475 5,222 4,775
18 18 16,398 14,992 13,754 12,659 11,690 10,828 10,059 9,372 8,756 8,20 1 7,702 7,250 6,840 6,467 6, 128 5,818 5,534 5,273 4,812
19 19 17,226 15,678 14,324 13,134 12,085 11,158 10,336 9,604 8,950 8,365 7,839 7,366 6,938 6,550 6,198 5,877 5,584 5,316 4,843
20 20 18,046 16,351 14,877 13,590 12,462 11,470 10,594 9,818 9, 129 8,514 7,963 7,469 7,025 6,623 6,259 5,929 5,628 5,353 4,870
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TABLED An nuity (ANN) i/(1-(Hi)-Y)
Year 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 20%
1,00 1,010 1,020 1,030 1,040 1,050 1,060 1,070 1,080 1,090 1,100 1,110 1,120 1,130 1,140 1,150 1,160 1,170 1,180 1,200
2 0,50 0,508 0,515 0,523 0,530 0,538 0,545 0,553 0,56 1 0,568 0,576 0,584 0,592 0,599 0,607 0,615 0,623 0,631 0,639 0,655
3 0,33 0,340 0,347 0,354 0,360 0,367 0,374 0,38 1 0,388 0,395 0,402 0,409 0,416 0,424 0,431 0,438 0,445 0,453 0,460 0,475
4 0,25 0,256 0,263 0,269 0,275 0,282 0,289 0,295 0,302 0,309 0,3 15 0,322 0,329 0,336 0,343 0,350 0,357 0,365 0,372 0,386
5 0,20 0,206 0,212 0,218 0,225 0,231 0,237 0,244 0,250 0,257 0,264 0,271 0,277 0,284 0,291 0,298 0,305 0,313 0,320 0,334
6 0, 17 0, 173 0, 179 0, 185 0, 191 0,197 0,203 0,210 0,216 0,223 0,230 0,236 0,243 0,250 0,257 0,264 0,271 0,279 0,286 0,301
7 0,14 0, 149 0,155 0,161 0, 167 0, 173 0, 179 0, 186 0, 192 0, 199 0,205 0,212 0,219 0,226 0,233 0,240 0,248 0,255 0,262 0,277
8 0,13 0,131 0, 137 0, 142 0, 149 0, 155 0, 161 0,167 0,174 0,181 0, 187 0, 194 0,201 0,208 0,216 0,223 0,230 0,238 0,245 0,261
9 0, 11 0,117 0,123 0,128 0,134 0,141 0,147 0,153 0,160 0,167 0,174 0,181 0, 188 0, 195 0,202 0,210 0,217 0,225 0,232 0,248
10 0,10 0,106 0, 111 0,117 0, 123 0,130 0,136 0,142 0,149 0,156 0,163 0,170 0,177 0,184 0,192 0,199 0,207 0,215 0,223 0,239
11 0,09 0,096 0, 102 0, 108 0, 114 0, 120 0, 127 0, 133 0, 140 0, 147 0, 154 0, 161 0,168 0,176 0,183 0,191 0,199 0,207 0,215 0,231
12 0,08 0,089 0,095 0, 100 0, 107 0, 113 0, 119 0, 126 0, 133 0, 140 0, 147 0, 154 0, 161 0, 169 0, 177 0, 184 0, 192 0,200 0,209 0,225
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~ 15 O,Q? 0,072 O,Q78 0,084 0,090 0,096 0, 103 0, 110 0, 117 0, 124 0, 131 0,139 0,147 0,155 0,163 0,171 0,179 0,188 0,196 0,214
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0 16 0,06 0,068 0,074 0,080 0,086 0,092 0,099 0,106 0,113 0,120 0,128 0,136 0,143 0,151 0,160 0, 168 0,176 0,185 0,194 0,211
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17 0,06 0,064 O,Q?O 0,076 0,082 0,089 0,095 0,102 0,110 0,117 0,125 0,132 0,140 0,149 0,157 0,165 0, 174 0,183 0, 191 0,209
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18 0,06 0,061 0,067 0,073 0,079 0,086 0,092 0,099 0,107 0,114 0,122 0,130 0,138 0,146 0, 155 0,163 0,172 0,18 1 0, 190 0,208
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-< 19 0,05 0,058 0,064 0,070 0,076 0,083 0,090 0,097 0, 104 0, 112 0, 120 0, 128 0, 136 0, 144 0, 153 0, 16 1 0, 170 0, 179 0, 188 0,206
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-< 20 0,05 0,055 0,061 0,067 0,074 0,080 0,087 0,094 0,102 0,110 0,117 0,126 0,134 0,1 42 0,151 0,160 0,169 0,178 0,187 0,205
,,
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INDEX
4V 56 administrative overhead (AO) 201 annuity 225

5S 152 advance payment 262 annuity factor 226
5 Why? 153 advance payment from customers 262 annuity method 225
20 % rule 277 advertising 104, 106 annuity ratio 228
30 % rule 277 affiliated marketing 63 Ansoff, Igor 337
2030-secretariat 451 after sales (aftermarket) 62, 106 Ansoff Matrix 337
agency 103 appropriation 265, 275
ABC - Activity-based costing 203 agile product development 173 assembly line 20
absorption costing 200 AGM (Annual General Meeting) 269 asset 244, 260, 262
academic field of Industrial agreement 111 - account 244
Management 15 - breach of 113 - current 261,274
acceptance 112 agriculture and forestry 37 - fixed 260,272
accounting 239 AIDA (Attention, Interest, Desire, - valuation 271
accounts payable 262 Action) 109 association 390
accounts receivable 261, 274 alienation 369 Atlas Copco 54, 341, 401
accrued expense 270 allocation auditor 268, 389
accrued income 270 - of expenses 270 auditor's report 257, 268
accumulated additional depreci- - of income 270 authority 397, 399
ation 275, 277 - to relevant time period 188, 270 authority over project members 424
accumulated depreciation 273, 278 Amara, Roy 89 authorized public accountant 269
acid test ratio 283, 301, 313 Amara's law 89 average credit time from
activities 204 ambidextrous 88 suppliers 297
Activity Based Costing (ABC) 203 amortization 304 average credit time to clients 297
Actual Cost Work Performed Annual Accounts Act 258
(ACWP) 431 Annual Accounts Book 251 back office 138
additional depreciation 265, 275, 277 annual financial statement 25, 259 balanced scorecard 324
additional depreciation rule 277 Annual General Meeting (AGM) 269, balance sheet 247, 257, 259, 260
additional sales 62 388 - account 244
adjusted equity 298 Annual Leave Act 362 bank balance 274
administration report (management annual profit 261, 262 BAS 2017 (chart of accounts) 250
report) 257, 268 annual report 257 bases for overhead 201

I N DE X
batch size 148 business market 96 cash and bank assets over total
benchmarking 108 Business Model Canvas 353 turnover (ratio) 284
big data 46 business products 95 cash and carry 113
bill of material 323 business ratio 280 cash cow 347
blue ocean strategy 341 business services 41 cash flow 214, 328
board of directors 389 business-to-business (B2B) 50, 95 cash flow analysis 268, 305, 307
bond 304 business-to-business products 105 cash flow analysis report 268
bond issue (bond loan) 304 business-to-consumer (B2C) 50, 96 cash flow chart 214
bookkeeping 239 business-to-consumer products 105 cash in 187
- credit 244 cash on hand 261, 274
- debit 244 CAD systems (Computer Aided cash out 187
- double-entry 247 Design) 179 cash surplus
- making corrections 247 capacity 128 - over or under 215
Bookkeeping Act 258 - level of 129 category management 131
bookkeeping requirements 240 capital certification body 450
Boston Consulting Group 346 - cost 298 Chandler, Alfred D. 356
Boston Matrix 346 - cost of 235 chart of accounts (BAS 2017) 250
bottleneck 128 - fixed asset 292 checking account 304
brand 98 - fixed asset requirement 292, 305 Chief Executive Officer 388
break-even chart 190 - gain 278 Chief Financial Officer (CFO) 313
bribery 444 - generating 301 circular economy 443
Brown, Lester 437 - loss 278 civil law 259, 271
Brundtland Commission 437 - outlay 214 climate change, issue of 442
Brundtland, Gro Harlem 442 - rationalization 294 closing the books 248
budget 319, 325 - requirement 291, 292 collusion 446
Budgeted Cost for Work Performed - return on employed 283 column diary 251
(BCWP) 431 - return on total 282, 309, 311 commerce (industry) 44
Budgeted Cost for Work Scheduled - risk 298 common cost 102, 193, 195
(BCWS) 431 - safety 292 common share 299
budget period 326 - share 388 Companies Act 258
budget work 328 - structural 159 companies in Sweden 33
built environment 40 - structure 298 competitive forces 349
business tied up 121, 147, 293, 295 competitiveness
- concept 52 - turnover rate 297 - by customer intimacy 53
- ecosystem 129 - utilization 294 - by operational excellence 53
- idea 335 - working 292 - by product leadership 52
- ideal 52 - working/requirement 147, 292, competitive situation 349
- model 64, 86 293,295,296,305,307 competitive strategies 52
- organization 391 capital investment 24 competitor analysis 108
- risk 309 - analysis 24 concurrent engineering (simultaneous
- strategy (generic) 339 Carson, Rachel 441 engineering) 171
business administration 17 cartel 444, 446 conflict of objectives 410
business angels 304 cash 305 consolidated balance sheet 287
474 0:, THE AUTHORS ANO STUDENTLITTERATUR

INDEX
consolidated income statement 287 - direct 192, 198, 203 - variable 189, 190
consolidations accounting 287 - direct labor (dL) 200 costing
consortium 387, 391 - direct material (dM) 200 - absorption 200
construction industry 40 - driver 204 - activity-based (ABC) 203
consultancy industry 42 - employers' social costs for - contribution 194
consumables 273 labor 279 - follow-up 209
consumer market 96 - estimate 209 - full 198
consumer product 50, 96, 105 - extraordinary 265 - process 198
consumption 214 - financial 265 - product 194
continuous replacement 228 - fixed 189 - step 196
Contract Act 112 - full 101, 200 creative industries 45
contract (in construction - indirect 198, 203 creditor 388
industry) 40 - indirect administrative (AO) 201 credit time from suppliers 297
contract manufacturer 39, 130 - indirect manufacturing credit time to clients 297
contribution costing 194 (MgO) 200, 201 critical machine 136
contribution margin 102, 194 - indirect material (MO) 200 critical path 428
controller 326 - indirect (overhead) 192 Critical Path Method (CPM) 428
convertible loan 300 - indirect sales 200 critical volume 191
coordination 395, 396, 404 - irrelevant 193 cumulative present value (CPV) 221
core business 66 - manufacturing overhead cumulative present value factor
core competence 163 (MgO) 200 formula 221
corporate finance company 304 - materials overhead (MO) 200 currency hedge 314
Corporate Social Responsibility - of capital 217, 220, 235, 298 currency risk 314
(CSR) 436, 437 - of capital interest rate 218, 220, current asset 261, 274
- Corporate Citizenship 437 232 current liability 262
- Corporate Responsibility 437 - of goods sold 188, 321 current market value 274
- Corporate Societal - of production (CoP) 200 current ratio 284
Responsibility 437 - other direct manufacturing 200 current recording of transaction 240,
- Creating Shared Value (CSV) 437 - other operating 265 258
- Environmental and Social - progressive (increasing) 189 - rules 245
Governance (ESG) 437 - regressive (declining) 189 customer
corporate tax 279, 447 - relevant 193 - adaptation 120
corruption 444 - sales and administrative - involved 58
Corruption Perceptions Index 445 overhead (S&A) 201 - order decoupling point 140
cost 24, 187, 260, 263, 264 - sales overhead (SO) 200 - segmentation 97
- account 244 - social security 279 - structure (organizational) 401
- acquisition, of 274, 278 - special direct sales 201 - visit 108
- administrative overhead - specific 102,193
(AO) 201 - step 189 debit 244
- allocation 201, 202 - tied up 430 debt/equity ratio 285, 311
- budget 326 - total 190 debt-maturity principle 313
- center 192, 201, 203, 318 - type 191 decision level 403
- common 102, 193, 195 - unit 192, 193, 200, 203 de facto standard 82

INDEX
deferred income 270 DMAIC (Define, Measure, Analyze, - restricted 262, 303
deferred tax liability 262 Improve, Control) 153 - return on 282, 311
delegate 399 dominant design 82 - risk-bearing 285, 298
delivery service 113 double-entry bookkeeping 244 equity method reserve 263
demand 95 double taxation 298 ex-ante estimate 322
- dependent 119 DuPont Chart 309 expenditure 187, 245
- independent 119 expenditure account 244
- variation in 137 Earned Value Technique 431 expense 187
demand-control model 373 earning capacity 282 - accrued 270
demand pull 74 EBIT 264 - allocation of 270
Deming, Edwards 154 EBITDA 264 - operating 265
dependability (to deliver) 121 Ecolabel - prepaid 270
depreciation 260 - EU 450 ex-post estimate 322
- according to plan 265, 272, 275 - Nordic 450 extraction of raw materials 37
- accumulated 273, 278 e-commerce 104 extraordinary cost 265
- accumulated additional 276, 277 economic association 387, 390 extraordinary revenue 265
- additional 265, 275, 277 Economic Associations Act 258
- as recorded in the books 275 economic cycle 23, 26 facility management 43
derivative 165 economic life 215 factoring 305
Design for Manufacturing and economics 17 Failure Mode and Effect Analysis,
Assembly (DFMA) 180 economic structure (of Sweden) 31 FMEA 181
development funnel 168 economic theory 94 fairs 107
development pair 74 economies of scale 56, 122 Fairtrade Sverige 450
digitalization 46 ecosystem 69 fair value reserve 263
dimensioning factor 204 effectiveness 69 FAR (Swedish Institute of Authorized
direct cost 192, 198, 203 efficiency 69 Public Accountants) 258, 306
direct material (dM) 200 Elmo Lewis, E. St. 109 feasibility study (pre-study) 168
direct supervision 396 employers' social costs for labor 279 financial
discounting (of receipts and employment agencies 66 - accounting 251, 257, 258, 319, 320
payments) 218 Employment (Codetermination in the - analysis 280
discrepancy (between ex-post and Workplace) Act 362 - balance 301
ex-ante estimates) 322 Employment Protection Act 361 - control 317
Discrimination Act 362, 365 enterprise resource planning systems - cost 265
dismissal 362, 363 (ERP) 322 - forecasts 306
disposable (non-restricetd) equity 262 environmental issue 441 - ratio 280
disposition accounting 430 environmental management 450 - revenue 265
distribution channel 102 equal treatment 365 - risk 310
distribution sector 43 equilibrium price 95 - transactions 239
diversification 338 equity 23, 26, 261, 298 financiers 23
dividend 23, 262 - adjusted 282, 298 finished goods inventory 261, 274
division 319 - non-restricted 262, 303 FIRO model 378
division of labor 395 - ratio 1 285 first tier supplier 131
- ratio 2 285
476 IC THE AUTHORS AND STUDENTLITTERATUR

INDEX
fishbone diagram (Ishikawa goal 414 idea sales 106

diagram) 153 - conflict 410 income 187, 244, 245
fixed asset 260, 272 - impact 415 - accrued 270
fixed asset capital 292, 305 good 25, 49 - allocation of 270
fixed assets register 278 good accounting practice 258 - deferred 270
fixed cost 189 Good Environmental Choice 450 - tax 448
flexibility 121 goods manufacturing industry 31 income statement 247, 257, 259, 263
flow chart 133 goodwill 273 - account 244
flow shop 136 GRI (Global Reporting Initiative) 449 - budgeted 326
follow-up costing 209 Gross Domestic Product (GDP) 31 - classified by the function of
Ford, Henry 20 group 286 expense 264
Ford Motor Company 19 - dynamics 376 - classified by the nature of
formal leader 380 - formal 376 expense 264
formal means of control 317 - informal 376 - consolidated 287
formal organization 398 - managed by objectives 375 incremental innovation 76
Forsberg, Erik 22 - pressure 377 increments 177
freemium 63 - reference 423 indirect cost (overhead) 192, 198
front office 58, 138 - self-governing 375 industrialized 20, 21
full cost 101 - thinking 378 industrial management 15, 17, 22
full costing 198 - working 376 industrial transformation 45
functional organization 406 group (consolidated company) 286 industry 20, 35
functional organizational - contribution 287, 288 - the concept 45
structure 400 growth under financial balance 301 industry structure 36
functional strategy 344 guarantee certificate 112 informal leaders 380
functional work supervision 406 informal means of control 317
function of expense (organization of Haga Initiative 451 informal organizational 398
income statement) 264 Hawthorne effect 370 innovation 29, 75
funds provided 307 Hawthorne Works 369 - diffusion 77
funds utilized 307 Herzberg, Frederick 371 - incremental 76, 159
future value factor formula 220 hierarchy 397, 404 - radical 76, 159
future value (FV) 220 hierarchy of needs (Maslow's) 370 innovation strategy 161
high-level (master) budget 326 input market 24
Gantt chart 428 homosociality 365 input VAT 253
Gartner Group 80 horizontal integration 65 insourcing 66
Gartner Hype Cycle 80 horizontal relationship/ installed base 67
GDP (Gross Domestic Product) 31 integration 400 instructions 396
GE-McKinsey Matrix 348 horizontal specialization 399 integration
gender equality 366 human relations movement 370 - forward 103
General Electric 348 Human Resource Management - horizontal 65
General Ledger 251 (HRM) 361, 383 - vertical 65, 130
general partner 390 hygiene factors 371 interest 23
geographic organization 402 interest-bearing liability 300
Global Compact 451 interest rate risk 313

INDEX
interest rates provided by alternative journal 251 - interest-bearing 300

investment options 234 Juran, Joseph 154 - interim 271
interim claim 271 Just in Time (JIT) 142, 150, 294 - non-current 262
interim liability 271 - operational 300
interim report 269 kaizen 142, 153 - side (of balance sheet) 260
internal charge 320 kanban 142, 144 - subordinated 300
internally generated funds (cash) 305, Kennedy, John F. 357 - tax 262, 280
307 key account manager 111, 402 - valuation 271
internal rate of return 225, 229 key performance indicator (KPI) 323 liaison role 407
internal rate of return method 229 knowledge-intensive consulting 41 licensing 63
Internet of Things 80 knowledge-intensive service lifecycle 418
inventory 145 operations 21 lifecycle analysis 348
- level 146 Kotler, Philip 107 Lima-Paris Action Agenda
- safety 146 Kraljic's matrix 131 (LPAA) 451
- turnover rate 297 KRAY 450 limited liability company 259, 387
investment (capital) 24, 213, 214 Kreuger crash 287 limited partner 390
- adaptation 233 Kreuger, Ivar 287 limited partnership 387, 390
- analysis 24 line manager 406
- appraisal 214 labor-intensive business 43 line of command 404
- calculation 214, 217 labor-intensive services 21, 41 line organization 404
- evaluation 216 labor laws 361 line-staff organization 405
- mandatory 234 land (asset) 273 liquid asset 307
- original 214 layout 133 liquidity 231, 280, 283, 313
- rationalization 233 - fixed-position 134 liquidity risk 310, 313
- strategic 233 - flow 135 loan
invoice 240 - functional 134, 148 - interest rate 304
- approving of 246 - line-based 135 logic
- questioning of 246 - product-oriented 135 - back office-dominant 59
Irvin, Janis 378 leadership style - front office-dominant 59
Ishikawa diagram (fishbone diagram) - authoritarian 380 - goods-dominant 59
153 - democratic 381 logistics 145
ISO 9000 153 - laissez-faire 381 - cost 145
ISO 14001 450 Lean Production 142, 154 - external 145
ISO 26000 450 leasing 305 - internal 145
ISO (International Standardisation legal entity 389
Organisation) 450 leverage equation 311 machinery and equipment 273
issue for non-cash consideration 303 leverage risk 310 mailbox company 448
liability (debt) 23, 245, 261 main depreciation rule 277
job - account 244 management accounting 251, 319
- description 398 - average interest rate 311 management report (administration
- enrichment 374 - current 262 report) 257, 268
- extension 374 - deferred tax 262 manager 380, 397, 404
- rotation 374 - discharge from 269 managerial grid 381
478 © THE AU T HO RS AND ST U DEN TL ITTERA TUR

INDEX
manufacturing industry 38 nature of expense (organization of order 397

manufacturing overhead (MgO) income statement) 264 ordering principles 144
(indirect manufacturing cost) 200 net present ratio 224 - pull control 144
market net present value method 218 - push control 144
- development 338 net sales (turnover) 265 order point 146
- penetration 338 network 69, 409 order winner 121
- research 108 network techniques (project organic growth 301
- segmentation 97 planning) 428 organization 391
marketing 60, 93, 118, 164 nominal value 299 - customer 401
- components 107 non-current liability 262 - flat(broad) 403
- organization 110 non-profit association 387, 390 - formal 398
- plan 108 non-restricted (disposable) - functional 406
marketing mix (4P = product, price, equity 262, 303 - functional structure 400
place, promotion) 107 Non-state Action Zone for Climate - geographic 402
Maslow, Abraham 370 Action (NAZCA) 451 - informal 398
Maslow's hierarchy of needs 370 norms 376, 396 - line 404
master (high-level) budget 326 notice of termination 362 - matrix 403, 408, 424
materials overhead (MO) (indirect - product 401
material cost) obeya 176 - project 408, 414, 422, 424
200 objective 357 - rules 396
matrix organizational structure 403, - changes to project 417 - tall (narrow) 403
408,424 - interim 426 - theory 391
maturity date (in financing) 298, 301, - project 415, 425 organizational
304,313 - SMART 357, 425 - chart (organogram) 397
Mayo, Elton 369 - triangle 416 - form 399
McCarthy, Jerome 107 - VACT 357 - roles 396
McKinsey 348 obsolescence 274 - structure 395, 397, 398, 402
member organization 391 offer 112 - values 396
methods study 151 offshoring 30, 68 Original Equipment Manufacturers
Methods-Time-Measurement off the balance sheet financing 305 (OEM) 159
(MTM) 151 oligopoly 94 original investment (OI) 214
MgO charge 202 oligopsony 94 OSH (Occupational Safety and
mission statement 335 on the job training 367 Health) 449
MO charge 201 OPEC (Organization of Osterwalder, Alexander 353
modularized product 127 Petroleum Exporting Countries) 447 other direct manufacturing costs 200
monopoly 94 opening balance 248 other operating costs 265
Montreal Protocol 442 open innovation 167 other operating revenues 265
motion time system 151 operating cost 265 other operating revenues and
motivation 370 operational excellence 56 costs 265
motivational factors 371 operational liability 300 output VAT 253
muda 142 operation card 323 outsourcing 32, 42, 66, 305
Municipal Tax Law 258 operations management 117 overhead charge (percentage rate) 201
mutual adjustment 396 operations that require a permit 449 overhead (indirect cost) 192, 203

IN DEX
- administrative (AO) 201 principal payment conditions (of - divergent 38, 126
- manufacturing (MgO) 200 loan) 304 - engineering 150
- materials (MO) 200 principle oflower of cost or - hourglass-shaped 126
- sales and administrative market 274 - in projects 134
(S&A) 201 principle of unity of command 405 - make (produce) to order 139
- sales (SO) 200 private placement 303 - make (produce) to stock 139
over the wall engineering 170 process costing 198 - management 133
process innovation 83 - planning 143
parent company 286 process production 37 - system 117
partnership 387, 389 process (relating to project) 413 - T-shaped 126
payback method 231 procurement 111 - volume 122, 123
payback period 217, 231 producer product 50, 105 production of goods 37
- determination of 232 product 49 production process
payment (cash out) 187, 214 - costing 24, 194 - batch production 124
PDCA (Plan, Do, Check, Act) 153 - family 166 - continuous production 124
penalty interest 113 - innovation 83 - jobbing (one-of-a-kind
people in employment (in Sweden) 32 - in process 261, 274 production) 123, 134
perfect competition 94 - in progress 147 - mass production 124, 135
performance measurement 318 - lifecycle 159, 346 - projects 123
permanent job or position 362 - maintenance 159 - small batch production 134
PERT (Program Evaluation and - manager 110, 158 production strategy 120
Review Technique) 428 - organization 401 - competitive factors 120
PESTLE (political, economic, social, - portfolio 97 productivity 70
technological, legal, environmental) - variety 56 product lifecycle 346
model 351 Product Breakdown Structure product manager 110
pharmaceutical industry 40 (PBS) 427 product/market matrix 337
physical count 274 product development 24, 60, 157, 164, professional code 452
pioneer (technology enthusiast) 78 338 professional service 125
pledge 304 - agile 173 profit 25,70,189,249,262, 271,305
Porter, Michael 339, 349 - in mass production 158 - margin 101,283
Porter's Five Forces 349 - in process (continuous) profitability 70, 282
position 399 production 158 profitability center 319
Power by the Hour 19 - in service production 158 profit brought forward 261, 262
pre-development 168 - in small batch and unit profit center 319
preferred shares 299 production 158 profit/loss from financial items 265
prepaid expenses 270 product development process 169 profit margin 283
present value factor formula 221 product development projects 168 progressive (increasing) cost 189
present value (PV) 220 productifying 159 project 40, 413
pre-series production 169 production 24, 60, 117 - administrative staff 423
pre-study (feasibility study) 168 - cell 136 - budget 430
pricing 101 continuous 135 - lifecycle 419
- value-based 101 - control 143 - model, standardized 426
- convergent 126 - objectives 425

INDEX
- organization 408, 414, 422, 424 regressive (declining) cost 189 Rhenman, Eric 350
- process 418 relationship marketing 104 rights of the employee 363
- project owner (sponsor) 424 replacement cost 274 rights of the employer 363
- reference group 423 replenishment volume 146 right to stop operations 364
- steering committee 423 required rate of return 217, 232 risk 308
- sub 422, 426 requirement specification 158 - business 309
- team 422 research 73 - capital 298
projectification 432 reserve - credit 313
project management 413 - equity method 263 - currency 314
project management knowledge - fair value 263 - financial 310
paradox 418 - revaluation 263 - interest rate 313
project manager 414, 423 - share premium 263 - leverage 310
- assistant 423 - statutory (legal) 263 - liquidity 310, 313
promotion 104 - tax allocation 265, 275, 278 - operational 309
property (real estate) fee 448 re-shoring 68 risk-bearing equity 285, 298
property (real estate) tax 279, 448 residual value (RV) 215 routines 396
proposition 123 resource-based view 342 Rumsfeld, Donald 355
proprietorship 389 resource consumption 321
prototype 178 - accumulated 421 S&A charge 202
public procurement no resources 24 safety capital 292
public sector 31 resource transformation 55 safety margin 191
resource utilization 121 safety officer 364
QFD matrix (the house of quality) 179 responsibility 399 sale/leaseback 305
qualifier 121 - distribution of 318 sales and administrative overhead
quality 152 restricted equity 262, 303 (S&A) 201
Quality Function Deployment restricted share 299 sales office 103
(QFD) 179 retailer 44, 96, 102 sales overhead (SO) (indirect sales
quality management 152 return cost) 200
quality management system 450 - on capital employed (ROCE) 283 sales promotion 105
quarterly report 268 - on equity (ROE) 282, 3n sales revenue 265
quota value 299 - on total capital (ROT) 282, 3n scalar principle 404
revaluation reserve 263 Scania 127
radical innovation 76 revenue 25, 187, 260, 263 scenario technique 352
raw materials inventory 261, 274 - account 244 scope creep 421
Razors and Blades 62 - budget 326 scrum 177
real estate industry 41 - center 319 S-curve 75,80,420,421
real estate (property) fee 448 - extraordinary 265 second tier supplier 131
real estate (property) tax 279, 448 - financial 265 self-financing 301
real estate, valuation of 273 - model 62 self-governing groups 375
receipt (cash in) 187, 214 - other operating 265 sequential development process 170
recording of transactions 243 - sales 265 service 25, 49, 66
recruitment 366 - specific 193 - business 21
reference group 423 - total 190 - innovation 86

INDEX
- organization 391 specialization 56, 395 - economic 437

- production 32 specific cost 102, 193 - environmental 437
- sales 106 specific revenue 193 - social 437
- sector 32 split 303 sustainability report 449
- shops 125 sprint 177 sustainability reporting
- that complements physical sprint backlog 177 guidelines 450
product 51 staff 404 sustainable business development 439
- that replaces physical product 51 staffing agency 42 sustainable development 437, 442
set-based design (set-based staff management 383 Swedish Accounting Standards Board
concurrent engineering) 178 stage-gate model 174, 426 (BFN) 258
setup time 148 stakeholder 410 Swedish Anti-corruption Institute
- reduction 150 stakeholder model 350 (IMM) 446
setup work, external 150 - strategies of stakeholder Swedish Association of Graduate
setup work, internal 150 management 351 Engineers' code of honor 452
severance payment 367 standard agreement 112 Swedish Bookkeeping Act 240, 243
share 298 standardization 20, 56, 120 Swedish Companies Registration
- capital 259, 261, 298, 388 - of knowledge and skills 397 Office 388
- class A 299 - of output 397 Swedish Financial Reporting
- class B 299 - of work processes 397 Board 258
- dividend 303 standardized services 125 Swedish Forest Agency 402
- issue 302 standard terms and conditions 112 Swedish industry 35
- preference during dividends 299 standing committees 407 - structure 36
- restricted 299 statutory (legal) reserve 263 Swedish Institute of Authorized
- shareholders' register 298 step cost 189 Public Accountants (FAR) 258,306
- transfer 299 step costing 196 SWOT analysis 345
- unrestricted 299 stock dividend 303 systematic work environment
- voting rights 299 strategic planning process 343 work 364, 449
share issue 302 strategic product planning 164 system sales 106
- premium 303 strategy 52, 337, 355 systems integrator 66
share preminum reserve 263 stress 372 Siillfors, Tarras 22
shell company 448 structural capital 159
simultaneous engineering 171 structural change of society 31 T-account 244
Six Sigma 153 sub-budget 326 talent management 366, 367
SMED (Single digit Minute Exchange subordinated liability 300, 304 tax 265,447
of Die) 150 subsidiary 103, 286, 402 - allocation reserve 265, 275, 278
social security contribution 448 substitute 350 - deducted at source 448
social security costs 279 supplier 39 - law 259, 272
societal organization 391 supply 95 - liability 262, 280
societal responsibilities (of - variation in 138 - planning 448
companies) 435 supply chain 130, 131 - return 279
sole proprietorship 387, 389 - management 130 taxable entity 389
sourcing 131 supporting voucher 242 Tax Evasion Act 448
span of control 403 sustainability 437 Taylor, Frederick W. 406
482 <i:> THE AU T HORS AND STUDENTLITTERATUR

INDEX
team untaxed reserves 261, 275 Work Breakdown Structure

- organization 374 utility company 37 (WBS) 427
- project 422 work element 151
- sub-project 422 valuation work environment 364
- temporary 408 - of assets 271 - physical 364
technical infrastructure 37 - of current assets 274 - psychosocial 364
technical life 215 - of fixed assets 272 Work Environment Act 361
technological development 73 - ofliabilities (debts) 271 working capital 147, 292, 307
technological platform 165 value 70 - change in 307
technological trajectory 75 - capture 62 working capital requirement 295, 305
technology - chain 64 - balance method 297
- adoption lifecycle 78 - creation 16, 55 - time method 297
- complementary 164 - decrease in 265 working group 376
- core 164 - network 69 - formal 376
- development process 167 - proposition 30, 49, 50, 52, 97, 99 - informal 376
- emerging 164 - stream mapping 142 work in progress (WIP) 293, 321
- intensive operations 22 value added 55, 67
- peripheral 164 value-based pricing 101 year-end closing 248
- push 74 variable cost 189
- shift 84 variation in demand 57 zero-defect philosophy 142, 152
- strategy 163 VAT (value added tax) 253,279,448
temporary team 408 - input 253
tender 110, 112 - output 253
tender engineer 110 vertical integration 65, 130, 400
throughput time 148 vertical relationship 400, 404
time-limited position 363 vertical specialization 399
time preference 218 vision 336
time to market 171 visual planning 176
total cost of ownership 161 voting right 299
tourism industry 45 voucher 242
Toyota Motor Company 142
trading partnership 389 war room 176
transfer pricing 287, 320 waterfall model 170
Transparency International 445 welfare service 45
trial period (employment) 363 Western Electric 369
two-factor theory 371 wholesaler 44, 96, 102
WIP (work in progress) 321
United Nations Framework work
Convention on Climate - conditions 375
Change 442 - measurement 151
unit sales 62 - organization 374
unity of command 405 - shortage of 362
unrestricted share 299 - study 151

Industrial Management

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Industrial Management

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Modern Industrial

MATS ENGWALL ANNA JERBRANT BO KARLSON PER STORM

Modern Industrial Management

Translation: Ida Stefansson

This book is protected by the Swedish Copyright Act. Apart from

Should this book be published as an e-book, thee-book is protected

Anyone who violates the Copyright Act may be prosecuted by a

Studentlitteratur publishes digitally as well as in print formats.

© The authors and Studentlitteratur 2018

Translation: Ida Stefansson

Printed by Interak, Poland 2018

Part I Industrial Management

2 SWEDISH TRADE AND INDUSTRY 29

2.2 The economic structure of Sweden 31

3 BUSINESS OPERATIONS AS PO I NT OF DEPARTURE 49

© THE AU T HORS AND STUDENTLITTERATUR 3

4.1 Sources of innovation and technological development 73

Part II The value creation system

7 PRODUCT DEVELOPMENT 157

7.1 Product development in different types of businesses 157

Part Ill The financial system

8 PRODUCT COSTING AND ANALYSIS 187

9 CAPITAL INVESTMENTS AND INVESTMENT ANALYSIS 213

9.1 What is a capital investment? 213

11 FINANCIAL ACCOUNTING 257

0 THE AUTHORS AND STUDENTLITTERATUR 5

11.4 Preparation of the financial statements 269

12 CORPORATE FINANCE 291

12.1 Capital requirements 291

13 MANAGEMENT ACCOUNTING AND FINANCIAL CONTROL 317

13.1 Financial control 317

Part IV Management and organizing

14 BUSINESS STRATEGY AND STRATEGY MODELS 335

14.1 There needs to be a business idea 335

6 0 THE AUTHORS AND STUDENTLITTERATUR

15 LEADERSHIP AND HUMAN RESOURCE MANAGEMENT (HRM) 361

16 ORGANIZING THE BUSINESS OPERATIONS 387

17 PROJECT MANAGEMENT 413

18 CSR AND SUSTAINABLE OPERATIONS 435

© THE AUTHORS AND STUDENTLITTERATUR 7

Glossary: English-Swedish 457

0 THE AUTHORS AND STUDENTLITTERATUR

e THE AUTHORS AND STUDENTLITTERATUR 9

Stockholm, June 2018

10 0 THE AUTHORS AND STUDENTLITTERATUR

Mats Engwall is a Professor of Industrial Management at KTH Royal Institute of

Anna Jerbrant is an Associate Professor and Head of Division at the Department

Bo Karlson is a Senior Lecturer and Director of Studies at the Department oflndustrial

C> THE AUTHORS AND STUDENTLITTERATUR 11

12 0 THE AUTHORS AND STUDENTL ITTERATUR

1.1 Industrial Management as an academic field

0 THE AUTHORS AND STUDENTLITTERATUR 15

16 0 THE AUTHORS AND STUDENTLITTERATUR

Three related fields

Economics - in Swedish, nationalekonomi:

Business Administration, sometimes also Business Studies or Management Studies - in Swedish,

Industrial Management, sometimes also Technology Management or Industrial Engineering

C THE AUTHORS AND STUDENTLITTERAT U R 17

1.2 Industrial Management - yesterday, today, tomorrow ...

18 <i:> THE A U THORS AND STUDENTL ITT ERATUR

advanced technical equipment in the manufacturing and employed technically trained

C> TH E A UTH O RS A N D STU D ENTLITTE RA T UR 19

Ford Motor Company and the Ford Model T

FIGURE 1.2 The first moving