ASAL Business Coursebook Answers PDF

CAMBRIDGE INTERNATIONAL AS & A LEVEL BUSINESS: TEACHER’S RESOURCE
Exam-style questions and sample answers have been written by the authors. In examinations, the way marks are awarded may
be different.
Coursebook answers
Most of the answers are in ‘outline’ form indicating the appropriate points and skills that learners need
to include in their answers. They provide the necessary guidance to allow learners to develop and extend
the points for a fuller answer that contains the relevant skills. In many instances, there may be other valid
approaches to answering the question.
Chapter 1
Business in context
Learners’ discussion might include:
• Less competition for customers; differentiation from competitors; unique selling points.
• However, the presence of a gap in the market may be evidence that there is no demand.
• Business knowledge will help a business: plan and manage the use of resources, apply for business
finance, avoid cash flow problems, conduct market research, develop appropriate marketing strategies,
maintain accounts, recruit employees and manage employees effectively.
• Ambition is important to provide the determination to succeed, inspire others, set challenging goals
and attract finance.
Activities
Activity 1.1
1 a Taking raw ingredients such as locally grown foods and turning them into a high-quality evening
meal. The meal would have a much higher value than the total cost of the individual ingredients.
OR
Offering high-quality customer service to guests: combination of bedrooms, 24-hour reception, a
concierge to provide information to customers, leisure facilities and a restaurant will increase the
difference between the cost of purchasing materials and the price at which the hotel room is sold.
b Purchase second-hand cars at one price and sell them on to the customer at a higher price by
improving the appearance and condition of the original car (e.g. repairs to bodywork, mechanical
repairs, valeting).
OR
Offering a package of after-sales care including a guarantee or service agreement.
c Taking materials such as cloth, sewing materials, dyes and accessories, and turning these into a
finished product (e.g. a dress or trousers).
OR
Developing a brand image through advertising as customers will be willing to pay a higher price
for branded designer goods.
d Taking basic food ingredients such as meats, vegetables, breads and grains and turning these into a
meal or snack that can be sold to customers.
OR
1 Cambridge International AS & A Level Business – Stimpson & Farquharson © Cambridge University Press 2021
Training employees to offer a high standard of customer service, including meeting customer
orders quickly.
Activity 1.2
1 An entrepreneur is someone who takes the financial risk of starting and managing a new venture.
• Willingness to take risks. Businesses are unlikely to develop if risks are not taken. In this case
Pedro risked his own savings to start up his business, having identified a gap in the market.
He also took a risk when purchasing the African rose-growing business.
• Motivation and hard work. Establishing a business often demands single-minded commitment and
determination. Pedro was prepared to work long hours to make his business a success.
• Self-confidence. Pedro’s confidence in his business venture encouraged other investors to back
him. Without other investors Pedro may not have been able to expand the business due to
insufficient capital.
• Multi-skilled. All-round business skills helped in setting up the business, exporting flowers and
growing the business rapidly.
Activity 1.3
1 Learners’ answers might include:
• Securing finance to set the business up. Although Farah has savings and her mother is willing to
invest, it is evident that her finances are limited as she needs to get a bank loan to raise the rest of
the $15 000 she estimates is necessary.
• Finding suitable premises. With limited capital, she believes that a city-centre location is too
expensive and has to consider less desirable out-of-town locations.
• Acquiring the necessary skills to run her business. She lacks the financial skills to keep the
accounts for the business. Therefore, she either has to pay for an accountant or attend classes at a
local college in the evening. A college course would be time-consuming and add to the burden of
work likely to result from setting up her business.
• Identifying a good business opportunity. Farah recognises the importance of differentiating herself
from the competition. Her intention to offer dressmaking lessons as well as selling finished dresses
is an effective way of providing something different and is based on her knowledge of the market
acquired in her previous job.
• A range of skills. Although Farah clearly has good dressmaking skills, she appears to lack other
business skills such as accounting and awareness of the business environment (e.g. she was
surprised how expensive the city-centre locations were). She was also unaware of the amount of
paperwork involved in setting up a business. However, she is determined and is not put off by her
lack of experience, showing a willingness to go to college to learn accounting skills.
• Leadership skills. The case indicates little about her possible leadership skills; however, she has
argued with her previous manager. This may suggest that she finds it difficult to get on with others
or it may be an indication of her enthusiasm for dressmaking.
• Determination. It appears that, although she has been surprised and disappointed at discovering
that setting up a business is difficult, she is undaunted by the setbacks and remains determined to
proceed.
Evaluation may focus on:
• If her idea is a good one and there is enough demand, Farah’s dressmaking skills certainly provide
the foundation for success.
• Success also depends on external factors outside her control, and whether she can secure
sufficient finance.
Activity 1.4
• Employment creation. Set up a factory to produce the sauce, created jobs for people to work in
the factory.
• Exports. In talks with a company to export the UK-produced sauces to the Caribbean, increasing
the value of the UK’s exports and the country’s international competitiveness.
• Finance. Banks rejected Levi’s applications for a loan. Without finance, he could not expand
the business.
• Securing a customer base. Having invested in production facilities, Levi needed to develop his
customer base so that there would be sufficient cash inflows to pay for costs and prevent liquidity
problems. Distributing his product to a supermarket brought his product to a wider customer base,
enabling an increase in sales.
3 These (or other relevant points) should be analysed and judgements made about their relative
importance:
• Having a good product. Levi has a ‘unique’-tasting sauce which had been tested on the public at
music festivals and was sufficiently good to attract a large supermarket.
• Personality. Levi’s enthusiasm and confidence in his product were central to persuading the
businessman to invest £100 000. Securing finance enabled large-scale production to be set up.
These same qualities were essential in securing a contract with a leading UK supermarket.
With the backing of a national supermarket, Levi was able to bring Reggae Reggae Sauce to a
national audience.
• Media publicity. Levi had failed to secure backing from high-street banks so his appearance on
Dragon’s Den was critical to the success of his business. Without sufficient finance, the growth of
his business would have been severely constrained in the short term. His appearance on British TV
also provided an ideal opportunity to promote his business to a much wider public; his personality
was, again, important in making an impact on the British public.
• Commitment and determination. Levi did not give up on his dream despite the setback of banks
refusing to give him a loan. Being able to bounce back in the face of adversity is an important
characteristic of many successful entrepreneurs.
Activity 1.5
Learners’ own answers based on the main features outlined in Section 1.3.
Exam-style questions
Short answer questions
1 Selling goods and services for a higher price than the cost of bought-in materials.
2 Someone who takes the financial risk of starting and managing a new venture, and combines factors of
production to turn inputs into outputs.
3 Learners’ answers will vary, e.g. successful entrepreneurs are self-motivated so willing to work long hours
to make the business a success, despite the fact that income or profits might be low, at least initially;
multi-skilled so able to undertake a range of tasks from marketing to accounting, which means that the
business does not have the cost of appointing specialist managers.
4 Learners’ answers will vary, e.g. building a customer base quickly to earn enough revenue to allow the
business to survive.
5 Opportunity cost is the cost of one decision in terms of the next best alternative, e.g. paid employment
versus the setting up of a new business.
6 Learners’ answers will vary, e.g. increase in economic output (GDP) leading to rising living standards;
exporting goods to earn foreign currency to pay for imports; higher tax revenues to spend on
government priorities such as infrastructure.
7 An intrapreneur provides creative ideas to innovate products and processes, which can result in
improved business competitiveness and differentiation.
8 Learners’ answers will vary, e.g. business plan will contain a marketing strategy such as details of why
the entrepreneur thinks customers will buy the product and how the business will sell to customers,
including details on pricing and promotion.
9 Learners’ answers will vary, e.g.:
• Financial forecasts are based on estimates of future costs and sales. For a new business it is
difficult to make estimates as there is no past data to use.
• Entrepreneurs may become inflexible if they try to follow the business plan too closely. This is
a problem as the business environment is dynamic and businesses should be able to respond to
threats and take advantage of opportunities.
10 Learners’ answers will vary, e.g. the business will need labour – hairdresser; capital – fixtures and
equipment; enterprise – idea.
11 Learners’ answers will vary, e.g. finance to pay for premises from which to trade.
12 Learners’ answers will vary, e.g. food packaged into convenient packs; establish a brand name that
customers can identify with, which might make them more prepared to pay higher prices.
13 Learners’ answers will vary, e.g. they provide a personal service that gives competitive advantage to
small businesses in which the owner is in direct contact with customers; businesses can start small and
the finance required when starting up is relatively little.
14 Learners’ answers will vary, e.g. external sources of finance through a bank loan as a result of
providing a detailed business plan to the manager; crowd funding.
15 Learners’ answers will vary, e.g. it helps economic growth, so national output increases, which helps to
raise living standards.
Essay questions
1 a Added value comes from processing materials, aspects of customer service, advertising and
branding and convenient opening times. It allows goods and services to be sold for a higher price
than the cost of bought-in materials.
Learners’ answers will vary, e.g. reduce material costs, including purchasing lower-cost flour, sugar,
salt etc.; offer a paid-for delivery service to customers; make takeaway sandwiches; decorate cakes;
provide a seating area for customers to eat in.
For the two suggestions made, explain how each one could increase the difference between selling
prices and the cost of material bought in by the bakery.
b The typical qualities of a successful entrepreneur include:
• Leadership skills, including finding and motivating people.
• The ability to take risks.
• Innovation, self-confidence and the ability to learn from mistakes.
• Commitment and self-motivation. Hard work usually plays a significant part in business
success. Entrepreneurs are often highly focused and determined.
• Marketing and communication skills.
However, in evaluation, luck is often very important: attracting media attention or celebrity
patronage; being in the right place at the right time; lack of competition; support of friends and
family. Develop the point that, perhaps with the aid of an example, luck might influence the
success of an entrepreneur’s new business.
2 a Any two of the following applied to new business start-ups and explained in detail:
• Economic growth, increasing GDP, which raises living standards.
• Jobs, which increase spending power, leading to greater demand.
• Reduction in government expenditure on welfare.
• Increase in export earnings to pay for imports.
• Greater social cohesion, as unemployment can lead to higher crime and personal problems.
b Barriers include:
• Access to finance. This may be a particular problem in developing countries where financial
institutions may be less developed.
• Bureaucracy, e.g. complex paperwork that has to be completed in order to trade.
• Insufficient protection of property rights, increasing the risks of investment.
• Corruption requiring bribes or preventing access to public-sector contracts.
• Geographically dispersed markets increasing the costs of distribution.
• Poor infrastructure, from roads to education and health. This will increase business costs and
affect labour recruitment.
• High rates of taxation, which reduce retained profits and capital available for investment to
grow the business.
Evaluation will use the country context to identify which are the most significant barriers to
business activity.
Data response questions

1 Rivelino
a i Commitment.
ii Costs of a decision in terms of the next best alternative that has been given up.
b Any two points from: Rivelino is self-motivated, has spotted more than one business opportunity
and is willing to take risks to set these up. He has a desire to succeed and belief in his business
ideas. He is willing to work hard, giving up his time to ensure that the business is a success.
He shows enterprise and initiative. He is passionate and knowledgeable.
c Any two points from: Rivelino may have lacked the relevant knowledge and skills to make
a success of the business opportunity by himself. By forming a partnership he was able to
complement his own marketing skills and business contacts with those of the other two partners.
The second partner was trained in marketing and had many business contacts. The third partner
had financial skills and software design experience. Therefore, the three partners had the potential
to identify market opportunities, manage the development of software applications and develop
appropriate marketing strategies whilst ensuring that the business had sufficient finance. TFS
would also benefit from the start-up capital available from the three partners, thus reducing the
need for debt finance.
d TFS operates in a dynamic business environment. The technology industry is fast moving,
with new innovations coming out regularly. This will affect both new and repeat customers.
As technology develops, businesses will be looking for more sophisticated e-commerce and e-trade
facilities. It is a competitive market that will attract other entrepreneurs with similar skills.
This can pose a threat to TFS, although patents could protect their own software designs.
However, TFS cannot stop competitors from entering the market with potentially better software.
Evaluation could include: TFS will succeed in a changing business environment if Rivelino and his
partners and intrapreneurs continue to be creative and show a willingness to change in response to
IT developments and competitive pressures.
2 Wesley’s laundry
a i Capital.
ii The individual consumers or businesses that a company sells its goods or services to.
b Learners’ answers might include:
• Financial management. Keeping accounting records, predicting cash flow, efficient
management of debtors. Wesley has allowed his accounting records to become out of date
and consequently he has failed to collect payments from debtors, which has contributed to his
cash flow problems.
• Managing operations. Ensuring that service commitments are maintained. The failure of the
business to return laundry to customers the next day will be expensive in terms of lost revenue.
c Learners’ answers might include:
• Wesley has limited finances and time available so the decision to purchase a computer-based
accounting system will mean the business cannot spend that money on something else (e.g. a
new marketing campaign).
• When making decisions, Wesley must take into account the opportunity cost so as to consider
alternatives and ensure that he is making the best decision for his business.
d Benefits
• Without being provided with a detailed business plan, the bank would not have been willing to
lend Wesley the capital he needed to start his business.
• Wesley’s business plan forecast that there would not be many customers at first. This
highlighted that the business needed to secure other sources of cash inflows to meet its needs.
Limitations
• Forecasts were inaccurate, possibly as a result of a lack of previous data. This resulted in the
business quickly reaching capacity and being unprepared for the level of demand.
• Due to Wesley’s lack of accounting expertise, the plan did not prevent the business running
short of cash and reaching the overdraft limit by the end of month four.
Evaluation: A business plan does not guarantee success, as markets are dynamic and the
entrepreneur may lack all of the skills necessary for running a business. Wesley did not identify the
right labour resources to employ and consequently customers were dissatisfied by late deliveries.
Wesley also lacked the leadership qualities to prevent employees arguing and he failed to allocate
jobs effectively. Therefore, the plan failed due to Wesley’s weaknesses.
be different.
Coursebook answers
Chapter 2
Business in context
• It is expensive to become a public limited company so this is only suitable for large businesses. Private
limited companies offer limited liability, which is an essential protection that enables a business to grow
without exposing owners to too much risk. Many businesses in India are still family-owned and the
private limited company status means that families can retain control over their businesses.
• Going public gives access to substantial finance. This can be used for expansion and to reduce the
debts of the business. This will reduce Century Metal Recycling’s interest payments and therefore
increase profits.
• A share issue will raise the profile of the business and increase interest in its activities.
• Century Metal Recycling may need to grow to be competitive in the market.
Activities
Activity 2.1
• Significant personal financial rewards. The two founders became multimillionaires instantly on the
sale of shares.
• Access to the substantial capital required to expand the business through takeover of other
internet businesses. This would consolidate Twitter’s place in the market.
• Risk of hostile takeover bid. As a public limited company, other firms can purchase shares in
Twitter and there is the threat of another business gaining control of Twitter.
• Disclosure of information to the public, including competitors. A public limited company has to
publish financial accounts, giving competitors access to sensitive financial data about Twitter and
its operations.
Activity 2.2
1 The private sector. Footie Ltd is a private limited company and therefore owned by shareholders rather
than the government. Public-sector businesses are owned by the government.
2 To maintain current shareholder control of the business. Footie Ltd is a long-established family
business. It is likely that the directors are shareholders and decided that, along with the other
shareholders, they wished to retain control of the future direction of the business. In a public limited
company (plc), there is a greater division between ownership and control. If Footie Ltd became a plc,
then the threat of takeover would be greater than it currently is.
No need to raise finance. As profits have increased by $18 million, the company has ‘no need of
further capital to fund further expansion’. There is little incentive to pursue a public flotation with its
associated costs. A public flotation is usually motivated by a need to raise capital.
3 Benefits to the business
• Raise more capital. This could be used to expand the firm more rapidly and consolidate its
position as the largest conventional shoe brand in the world.
• Will not have to use debt finance for expansion. Borrowing increases gearing and means that the
business has more debt to service (pay interest on). This increases the risk to the business if there is
an economic downturn as the interest will still have to be paid.
Benefits to existing shareholders
• Easier to sell shares that are held and realise a capital gain. This would enable shareholders to
release their wealth into a more liquid form.
• If shareholders held on to their shares then they could benefit from a rapidly increasing share
value if Footie plc used the capital effectively.
Activity 2.3
• Pizza Delight is an established brand with 100 restaurants in other countries. This could save
Harry from having to spend heavily on marketing as the brand is already known. The case study
suggests that Pizza Delight will be providing national advertising of the business.
• Harry has no business experience so the advice and help that Pizza Delight provides will be useful
and help prevent mistakes being made.
• He has to pay a percentage of total revenue each year to Pizza Delight. Therefore, if he has a poor
year’s trading, when profit is low or non-existent, he will still have to make payments to Pizza Delight.
• The franchise contract restricts Harry’s decision-making within the business. Thus, Harry will
not fully achieve his desire to be free from taking orders from others and is restricted in using his
talents to prepare food.
3 In favour of a franchise
• The franchise is supported by national advertising.
• It is an established brand name in the market.
• It partially meets Harry’s objective to be in control of his work but reduces the burden and risk of
opening an entirely new business. The text refers to Harry’s lack of business experience as being his
main problem.
Against a franchise
• Pizza Delight is well established in other countries. If it is relatively unknown in Harry’s country
then the benefit of being a franchisee is significantly reduced.
• The franchise has a high cost of $100 000 and a percentage of profits has to be paid for it each year.
• Restrictions on the design of restaurant and sourcing of supplies limit the control that Harry
would have.
• The cost of the franchise might mean that Harry has to take out a large loan with interest costs to
pay, adding to annual expenses.
• Harry would still have to find premises and recruit and motivate staff.
Evaluation: If Harry is concerned about his lack of business expertise then clearly the franchise offers a
significant advantage. However, taking the franchise will severely restrict how the business is run and Harry
will not even control what is sold. His experience as the second chef at an upmarket hotel and his desire to
prepare food for his own customers suggest that Harry might be dissatisfied with having to prepare pizzas
to Pizza Delight’s recipe. Therefore, Harry should set up his own restaurant rather than take out a franchise.
Activity 2.4
1 Learners’ answers should consider the benefits of different forms of business structure with reference
to information provided in the case. Some key issues include:
Sole trader
• Salman retains complete control of the garage.
• Unlimited liability is an issue. Expansion may expose Salman to greater risk due to the increased
level of finance required within the business.
Partnership with sons and daughter
• Appropriate in achieving his goal to involve his children in the business.
• Deed of partnership should be drawn up.
• It could be a source of finance if his children have savings to invest. However, for his children
investment exposes them to the risk of unlimited liability.
Private limited company
• It is not expensive to form a private limited company.
• Incorporation provides the major benefit of limited liability. If Salman has savings to invest
then he can remain in complete control by being the only shareholder or he could offer shares
to his children.
• This would be considered a more suitable form if the business is to continue to expand.
Salman’s decision will be influenced by his attitude to risk, desire to retain control and the amount of
finance needed to expand the business.
Activity 2.5
• Nestlé will benefit from Fonterra’s existing production facilities in Trinidad and Tobago. Therefore,
Nestlé will benefit from the economies of scale linked to the increased purchasing power of the
joint venture when purchasing milk and other ingredients. This will result in lower unit costs and
therefore a higher profit margin.
• Nestlé will not have to concern itself with production and can focus on the higher-margin marketing
of the finished brands rather than the low-margin transformation process within a production and
processing facility. This will reduce the investment needed to expand sales in the Caribbean.
• The complementary strengths that the two firms bring to the joint venture will increase the chances
of success. Nestlé is a leading marketer of branded dairy products so has particular strength as
a marketing organisation. Nestlé’s expertise will be in recognising customer needs and building
brand value within the market. In contrast, Fonterra has production and processing facilities so
will be able to produce high-quality chocolate products.
• The two companies will be able to take advantage of economies of scale by operating together.
For example, there may be increased opportunities for bulk-buying milk, sugar and cocoa.
Through bulk buying, the joint venture may be able to negotiate lower unit costs, leading to
improved price competitiveness or higher profit margins for the end product. This therefore
increases the chances of success.
• Employees are expected to work together. There may be rivalry between employees and the
existing cultures of the two businesses may not be compatible, resulting in conflict and slowing
down decision-making.
• Evaluation: chances of success will depend on the ability of the two groups of managers to work
together and whether the potential cost savings exceed the costs of setting up the joint venture.
Activity 2.6
Learners’ own answers.
1 Private sector – owned by private individuals and groups; public sector – government-owned
and -controlled.
2 Sole trader has unlimited liability but the owners of a limited company (shareholders) have
limited liability.
3 Owned by shareholders, controlled by board of directors. Most public limited companies have
thousands of shareholders, who cannot also be the directors of the business. Conflict may arise
because shareholders are primarily interested in short-term gains in share price and payment of
dividends whereas directors may have other goals, including long-term growth and investment.
4 Learners’ answers will vary, e.g. the two businesses might have different areas of expertise, as one might
have local, cultural knowledge which is useful for marketing in another country and the other might
have expertise in manufacturing.
5 To regain full control of strategic decision-making and the aims set for the business. This will allow
directors to focus on the long-term success of the business rather than short-term profit to pay
dividends to shareholders.
6 Legal identity allows a business to own assets and provides owners with limited liability. Therefore, it
is easier for the business to plan for the future and raise finance. If owners die or wish to sell shares,
this does not affect the existence of the business but only results in a change of ownership. Day-to-day
operations therefore continue unaffected.
7 By reducing the risk of investment, it makes ownership more attractive and therefore increases
the ability of a business to raise finance. Shareholder liability is limited to the amount invested in
buying shares.
8 Sole trader – the owner is the sole decision-maker, therefore ownership and control lie with the same
person. Public limited company owners are shareholders with voting rights but day-to-day control is
with directors; therefore, there is division between ownership and control.
9 Learners’ answers will vary, e.g. a partnership can raise finance from partners whereas a public limited
company (plc) sells shares to the public. Therefore, a plc has greater availability of potential finance. In
a partnership, there is unlimited liability so there is increased risk for partners if the business fails with
significant debts. Shareholders in a plc have limited liability so there is less risk.
10 Learners’ answers will vary, e.g. the entrepreneur may wish to have control over all marketing decisions,
such as pricing and products to be sold. A franchisee has to buy supplies from the franchiser and
follow guidelines about how the business prices and markets its products.
11 Private limited company – shares cannot be sold to the public and are not listed on a stock market so
there is much less potential to raise large sums of finance from selling shares. A public limited company
(plc) can issue more shares at any time. Therefore, a plc has greater access to finance but there is a
greater risk of takeover.
12 A business with social objectives that re-invests profits to benefit society rather than maximising
returns to owners. Profits are necessary for social enterprises to survive.
13 The owners may have ethical standards that lead them to want to contribute to society and avoid
damaging the environment.
14 Jointly owned businesses operated by members for their mutual benefit to produce or distribute goods
or services, as in consumers’ cooperatives or farmers’ cooperatives.
15 Primary industries extract minerals from the earth (for example) but tertiary-sector businesses provide
services to all types of businesses and consumers.
16 Learners’ answers will vary, e.g. increased sales are likely due to the recognised name and brand of the
franchiser. National advertising will promote the brand and increase demand for the franchisee.
Essay questions
1 a Learners’ answers will vary, e.g.
• Limited companies are owned by shareholders. Private limited companies have at least one
shareholder and cannot sell shares to the general public. A public limited company (plc) has
at least two shareholders. Sole traders are owned by just one person with access to much less
capital as they cannot sell shares.
• Shareholders in limited companies have limited liability. This means that the liability of
owners for the debts of the business is limited to their investment in the business. Sole traders
do not have limited liability, and the answer should explain why this is important.
b A rapidly expanding private limited company may be attracted to converting to a plc because of
increased access to finance. A public share issue can raise substantial funds to finance expansion
and avoid the need for debt finance, which carries the disadvantage of interest having to be
paid whatever the economic conditions. Explain why other sources of finance have possible
disadvantages.
Factors to consider include:
• Level of debt finance already obtained. If borrowing from financial institutions is relatively
low, a business may prefer to take further loans rather than face the transition to plc.
• Need for further finance to expand. Making a share issue is expensive due to the costs of
preparing a prospectus, hiring a merchant bank, advertising and legal costs. The business
would need to raise a substantial sum of money for the conversion to be worthwhile.
• State of the economy and the stock market. A successful share issue may depend on the funds
available on the stock market. During the financial crisis of 2008, with volatile stock markets,
issuing shares was a potentially risky strategy.
• Objectives of owners. If owners wish to retain control of the business, becoming a plc will be
an unattractive option. Assess the impact of this objective on the plc decision.
• Once a business is a plc, there is increased risk of takeover as shares are traded on the
stock market.
• Financial disclosure is greater as a plc.
Evaluation: the attitude of current shareholders towards controlling the business needs to be
weighed against the need to raise finance for further expansion.
2 a Learners’ answers will vary, e.g.
• Support and advice to the franchisee reduces mistakes (e.g. over the location of a suitable site),
reducing the risk of the new business failing.
• The franchiser’s recognised brand, supported by national advertising, makes it easier for the
new franchised business to build a customer base and increase sales when it starts trading.
• A joint venture gives local knowledge and expertise (e.g. tastes can vary significantly between
countries), reducing risk for the business that is new to the country.
• Shared financial investment reduces the cost of expanding sales.
• Distribution networks to retailers are already established, enabling food products to be placed
effectively to increase sales.
• There is a potential conflict of culture or leadership styles which may result in decision-
making difficulties.
• Joint venture businesses will share profits.
• Evaluation should include a conclusion/judgement about whether the use of joint ventures is
the best way to increase sales in other countries for businesses in this industry.

1 Joe to expand his business
a i Able to take own decisions.
ii A business formed by two or more people with shared investment and responsibilities.
b i Secondary. He buys in raw materials (e.g. coffee beans) and processes them into finished products.
ii Tertiary. Cafés offer customer services and are not involved in extraction or manufacturing.
c Joe’s business is currently in the secondary sector. He understands the need to buy in raw materials
and transform them into finished products. A café is in the tertiary sector and Joe and his
employees may have no experience in offering services directly to consumers. This may reduce the
chance of the cafés being a success.
Joe needs to make the location decision very carefully. The best sites for secondary manufacturing
activity are unlikely to be the best sites for a café. Joe will need to use different factors when choosing
café locations. An inappropriate café location will mean insufficient customers to make a profit.
d Partnership
• Unlimited liability will remain. Joe’s personal assets will be at risk if the partnership incurs
significant debt.
• Profits will have to be shared.
• A deed of partnership will be necessary to clearly identify how profits are to be shared.
• There may be disputes between Joe and his new partner(s) about the future direction of the
business.
• Partners will bring capital into the business and potentially valuable skills to complement
Joe’s.
• It is a simple legal structure to set up.
• Taxation will be different to a private limited company. Partners will pay income tax on profits
rather than corporation tax.
Private limited company
• Joe will benefit from limited liability. If the new cafés are not successful, Joe’s liability for debts
will be limited to the money he has invested in the business.
• Joe can invite a number of investors to buy shares in the business to raise the necessary capital.
It may be easier to attract investors because liability is limited. A partnership is more limited
in its ability to raise capital as there is a limit on the number of partners.
• There are more legal formalities to complete when establishing a limited company. For
example, a Memorandum of Association and Articles of Association must be submitted to the
relevant authorities.
• Financial disclosure is greater for a limited company. The public and competitors will be able
to access financial documents.
• The business will have legal personality. Thus, in case of injury to a customer, it is the business
rather than the owners that is sued.
Evaluation may focus on a number of issues:
• The degree to which Joe wishes to retain control of the business. Although both legal
structures will dilute his control over the business, if he chooses a limited company then he can
retain overall control by ensuring he has a majority of the shares.
• The risk involved in his plans. If purchasing the cafés is risky then he may prefer to benefit
from limited liability.
• The amount of capital needed. It may be easier to attract investors to a limited company.
• The requirements of potential investors. What do they wish to invest in?
2 Capital Waste Disposal Ltd (CWD)

a i Able to raise capital from the sale of shares (not to the public).
ii The first offer of a company’s shares to the public allowing capital to be raised for investment.
An IPO is part of the process of a private limited company transitioning to become a public
limited company.
b Initially, Rajesh started the business as a sole trader. This is a simple business structure and easy to
set up. However, Rajesh would have had unlimited liability. As a business grows, there is increased
risk from unlimited liability as debts could become substantial. Rajesh converted his business to
a private limited company to gain finance for expansion and to benefit from limited liability.
The success and further growth of the business made conversion to a public limited company
possible. This raised more finance for expansion and also made Rajesh wealthy.
c Advantage: Raises significant amounts of capital to enable growth of the business. This may have
been critical in CWD gaining 56% of the waste disposal market.
Disadvantage: Potential loss of control for Rajesh. He is no longer able to make decisions without
considering how shareholders are affected.
d As it is a large business, CWD should either be a private or a public limited company to protect
owners’ personal wealth. The main differences relate to finance, control and the need to publish
financial data. In this case, Rajesh has remained as the CEO but major shareholders could replace
him if they control a sufficient proportion of the shares. Rajesh does not like interference from
shareholders. This suggests he would prefer to have kept the business as a private limited company.
However, that would have constrained its growth in the market. Rajesh is recommending that
shareholders accept the bid from the multinational. This would enable CWD to continue as part
of a much larger corporation. However, this highlights a major disadvantage of becoming a public
limited company – the threat of takeover.
Evaluation/conclusion will vary: learners need to make a decision about the most appropriate form
of business and support the conclusion with an overall argument based on this business.
be different.
Coursebook answers
Chapter 3
Business in context
• The benefits and costs to governments and the economy of supporting small businesses. It is possible
that the finance could be used more effectively supporting larger and more established businesses.
• Business size can be compared in several different ways. Learners should suggest and start to explain
some of the more obvious ones, such as the number of employees and the level of sales or revenue.
Activities
Activity 3.1
1 Largest businesses by: number of employees – Z; capital employed – Y; revenue – X; selling space – Y;
number of outlets – Z.
2 There is no single measure of business size and the measures can give different rank orders of business size.
It is important to select the measure of size most appropriate to the use that the data is going to be put.
3 There is no definitive answer. Learners should aim to achieve a justification when choosing between
different measures.
a The government might focus on sales turnover in assessing monopoly power. Competition
legislation usually defines monopoly in terms of market share; this is best measured by revenue.
b Capital employed gives an indication of the capital of a business. Capital employed measures the
total value of all the long-term finance invested in the business. It is the sum of shareholder capital
and non-current liabilities.
c Selling space will be particularly relevant in determining sales potential, as this determines the
amount of stock that can be displayed for customers to purchase and the number of different
product lines that can be sold.
Activity 3.2
Activity 3.3
• As a result of rising incomes in China, the demand for meat is increasing. Therefore, Shuanghui
must secure supplies of meat to process in its factories in China. Taking over Smithfield will enable
Shuanghui to control supplies of meat to other meat processors.
• Smithfield is a large meat producer in the USA. The takeover will increase Shuanghui’s potential
revenue and profits.
• Chinese businesses are now sufficiently profitable that they can expand externally. Shuanghui has
the capital available to take over Smithfield rather than just forming a strategic alliance. This gives
Shuanghui more control.
Employees
• Protection of jobs. Shuanghui’s resources will provide greater financial stability for Smithfield and
therefore protect jobs. However, in the long run, Shuanghui may decide to close the US factories
and move production abroad.
• Pay levels are currently protected. However, pay levels cannot be guaranteed in the future.
• Shuanghui provides demand for Smithfield as a meat producer. This will benefit employees
working on farms producing the meat. However, Shuanghui may change working conditions to
reduce costs in the future.
Smithfield shareholders
• It is likely that the US$34 Shuanghui paid per share is well above the market price. Therefore,
shareholders will receive a capital gain from selling shares. However, once shares have been sold,
there will be no future dividends.
Government in USA
• Closer trading relationship will benefit the US government as there will be an increase in exports
to China. This will benefit the US trade balance.
• Injection of foreign direct investment into the USA will boost economic activity. Shuanghui may expand
operations in the USA, increasing employment and output. However, profits will flow back to China.
Activity 3.4
1 Starbucks operates cafés around the world whereas Nestlé is one of the world’s largest food and
beverage companies. Starbucks will benefit from Nestlé’s established distribution network and global
reach. This will reduce costs to Starbucks of selling its products in the booming drink-at-home coffee
market. Nestlé will benefit from an increase in sales, strengthening its position in the coffee market.
The alliance will also capitalise on the experience and capabilities of both companies. This could
increase innovation and enhance the products offered to customers.
These benefits will deliver long-term value for shareholders.
• To take advantage of economies of scale, which will reduce unit costs and therefore potentially
increase profit margins.
• China has a rapidly growing middle class, with high-income consumers set to double within
four years. Therefore, Starbucks may benefit from increasing sales and profit.
• Rapid growth will enable Starbucks to gain first-mover advantage in the Chinese market and prevent
competitors from developing brand loyalty. Therefore, Starbucks can capture a high market share.
• To gain market leadership through achieving high market share.
• The cost of opening new cafés in China may increase significantly in the future due to rapid
economic growth. Slower expansion may allow other firms the opportunity to dominate the
Chinese market.
3 Organic growth is internal growth rather than growth through merger or takeover of a chain of
Chinese cafés.
Advantages
• Control over quality to protect the brand image of Starbucks.
• Chinese consumers are demanding Western products and culture so will be attracted to the
Starbucks brand. Integration with a chain of Chinese cafés could dilute the brand and result in
lower sales and profit.
• Difficulty of integrating Chinese cafés into the Starbucks group. A culture clash could prevent
change being introduced successfully.
Disadvantages
• Increased capital cost of expansion. Investment costs are high.
• Slower growth of sales for Starbucks.
• Difficulty of controlling the expansion. For example, the ‘time-saving policy of designing stores
uniformly’ has been criticised. In the long term, this may affect Starbucks’ brand image negatively
as store designs may not meet local needs. There has also been a problem with product quality;
Consumer Reports magazine has ranked McDonald’s coffee ahead of Starbucks.
Evaluation: An overall assessment may consider the availability and cost of finance for expansion to
be a critical factor. Ten thousand new cafés represents nearly seven cafés being opened every day for
the next four years.
Activity 3.5
• Raw material prices have also risen. This will reduce the gross profit margin of the company.
• Retail mergers have increased the bargaining power of TC’s customers. Therefore, retailers can
force TC to accept lower prices.
2 Learners’ answers might include an evaluation of at least two of the following methods of expansion:
• Takeover of suppliers is backward vertical integration: absorb profit margins of cloth
manufacturers; control price paid for cloth and therefore perhaps reduce price to customers;
greater control of the quality of cloth and therefore the clothes produced.
• As TC is a manufacturer, it has production experience that could transfer to the production
of cloth.
• Takeover of retailers is forward vertical integration: absorb profit margin of retailers; greater
control over marketing of the finished product to ensure meeting customer needs; choose which
clothes of other manufacturers to stock or not, which could reduce distribution for competitors.
• TC does not have retailing experience so may lack understanding of the market and operations.
There has been consolidation in the retail market with mergers between clothes retailers. This
suggests that the market is competitive and TC would need to be sure that any retailer it wishes to
take over is able to survive in the market.
• TC would need to consider the cost of a takeover; availability of finance; suitability of any
takeover target.
• A hostile takeover may require TC to pay a premium well above the market capitalisation of the
business it takes over.
• A final recommendation for this business is required based on the learner’s analysis of the methods
of expansion.
1 Learners’ answers will vary, e.g. shareholders might want to compare business size if they only want to
buy shares in large companies, believing that they might be better investments.
2 Some businesses have many employees with low levels of capital equipment, so they are large
businesses by the employee measure but small businesses by the capital employed measure. Other
businesses have a few highly skilled employees using capital equipment costing millions of dollars.
It is difficult to compare the size of these businesses using capital employed.
3 The problem with using number of employees is that some firms are capital intensive whilst others are
labour intensive. For example, a firm with a highly automated production line will have relatively few
employees.
4 This is the total value of a company’s issued shares. In a stock market crash, market capitalisation will
decrease. For example, as a result of COVID-19, Apple’s market capitalisation declined by more than
$142bn during one week in 2020.
5 Employees: a merger or takeover of two businesses in the same industry at same stage of production
might lead to job losses due to rationalisation as there will be no need for duplication of job roles.
6 Shareholders: a merger with or takeover of a business operating closer to the market and consumer
(e.g. a shop) means that a business can absorb the profit margin of the shop so as to increase
profitability. Therefore, dividends to shareholders may increase.
7 Strength: continuity of policy and decision-making if the children have worked in the business
previously, as it is likely that they will be more committed to the long-term success of the business.
8 Increase in economic activity and employment resulting in higher living standards, particularly as
many small firms do not use very much capital to produce output but depend on more employees per
unit of capital than larger businesses.
9 Problem: lack of economies of scale, which are the cost benefits of being a large business. Relatively
high costs might lead to a small business being uncompetitive within its industry, especially if it is
dominated by large businesses.
10 Organic growth is internal growth so would involve increasing the size of the existing factory or
building a new factory. External growth is through merger or takeover. For example, one computer
manufacturer might merge with another.
11 Advantage: no interest repayments on borrowed money as would be necessary if the expansion was
financed with loans.
Essay questions
1 a Learners’ answers might include two of the following:
Number of employees. This very simple measure is easy to understand and use to make
comparisons. The problem with using number of employees is that some firms are capital intensive
whilst others are labour intensive. Explain one business example to illustrate this.
Revenue or sales turnover. This is the total value of sales made by a business over a given
time period. It is a common measure of size when comparing businesses in the same industry.
A potential weakness is that some firms may have high turnover but add relatively little value to
the production process.
Market capitalisation. This is the total value of a company’s issued shares: market capitalisation
= current share price × total number of shares issued. It is only relevant for businesses quoted on
a stock exchange where shares can be traded. Share prices can be very volatile and thus the market
capitalisation of a business may change rapidly despite no significant change within the business.
b Advantages of internal growth
• It avoids overtrading, which would place a strain on finances.
• It maintains control over the quality of production.
• It avoids the problems of culture clashes which often occur with external growth. Culture clashes
can be very damaging and result in mergers and takeovers failing to achieve corporate objectives.
Disadvantages of internal growth
• Market share may grow more slowly.
• External growth can bring new ideas and innovation into the business. It gains access to
patents to improve products.
• There may be synergy from external growth between two companies, where the whole is
greater than the sum of the parts. Synergy will not result from internal growth.
2 a Servicing the needs of larger businesses such as providing specialist engineering services or
machine maintenance to a large car manufacturing business. This helps the larger business to keep
control over costs as it does not have to employ its own specialist engineers.
Providing business functions that the car manufacturer does not want to retain itself because the
functions are not required all the time, e.g. recruitment and selection of production line workers in
a car manufacturing factory.
b Strengths: commitment of family members; strong culture and identity; continuity of policies.
Weaknesses: the business may be too large for one family to manage, especially if it has no
professional managers or if family members have not been promoted on merit.
Evaluation: for example, the most crucial factor could be that customers prefer dealing with the
same family members over a period of years.
3 a Learners’ answers will vary, e.g. shareholders – opportunity for greater profit by reducing costs;
employees – opportunity for careers in different sectors of the industry; customers – this type
of integration can lead to higher prices (by the business controlling supplies of materials or
components to competitors) or lower prices (by reducing costs).
b Organic: slower and more manageable; able to keep the culture of the business the same (a culture
of creativity might be important for this type of business); more likely to be able to finance growth
without increasing loans.
External: Reduces competition and this is a very competitive industry; acquires highly skilled
employees who may be in short supply; acquires an established customer base.
Evaluation needs to focus on the context of a web design business.

1 Chai Wei’s restaurant
a i Sales level.
ii Integration with a business in the same industry and at the same stage of production.
• Greater flexibility. The restaurants are more likely to be responsive to customer needs. Chai
Wei can take decisions quickly as the market changes. For example, he was able to change the
menu within two days. This will result in customer satisfaction and repeat sales.
• Personal service can be provided to customers. This improves customer loyalty and sales.
c Learners’ answers will vary, developing and applying one advantage and one disadvantage to Chai
Wei’s business, e.g.:
Advantages: commitment, motivation and reliability; pride and family reputation; knowledge
continuity.
Disadvantages: continuity problems; promoted to management too early; informality, lack of
procedures and policies; traditional, failure to adapt to change.
d Chai Wei and family (owners)
• External growth will result in increased sales and potentially greater profit which goes to the
family. However, there is risk of expansion causing cash flow problems and failure.
• Time and effort to ensure that the restaurants meet the standards set by Chai Wei. If they do not,
there is a danger that the reputation of all the restaurants is damaged, decreasing sales.
Employees
• Adapting to possible change in management style.
• Possible rationalisation of the enlarged business resulting in job losses. If Chai Wei gives
management roles to his family, other managers’ jobs may be at risk.
Suppliers
• Increase in demand for the local specialist suppliers. However, the existing suppliers of the
restaurants taken over may lose sales.
Customers
• Reduced contact with the restaurant owner resulting in less responsiveness to customer
demands.
• Chai Wei charges low prices so this will benefit customers of the taken-over restaurants.
• Economies of scale are possible. This could enable even lower prices for meals. However, cost
savings may not be passed on to customers.
Evaluation could be shown by assessing which stakeholder groups are likely to be most positively
or negatively affected.
2 Machine Elec (ME)
a i Takeover.
ii Business expansion by merging with or taking over another business.
b Diseconomies of scale with higher unit costs and therefore lower profit margins. This will reduce
ME’s competitiveness in the market.
More employees and more locations are more difficult to manage. Growing businesses can have
problems in coordinating the activities of employees and branches.
c Small businesses provide supplies to the industry. As they specialise, they may be able to produce
more efficiently than the washing machine manufacturers. This will reduce the cost of components.
ME provides this benefit and has used its expertise to produce better-quality components with the
potential to give greater satisfaction to customers.
Washing machine manufacturers can focus on their core activities to meet customer expectations
more effectively.
d Customers
• Greater innovation from ME and therefore better components for the manufacturers of
washing machines. This will improve the quality of output and therefore increase sales
to consumers.
Employees
• Job security for existing employees as ME will produce improved components and demand
may increase.
• New jobs for electrical engineers.
• As the owner of the other business is planning on retiring, this could have resulted in job
losses without ME’s decision to merge.
Local community
• Merger will provide new jobs.
Evaluation might focus on which stakeholder group is most affected or on identifying the factors
that could influence the impact on each stakeholder group.
be different.
Coursebook answers
Chapter 4
Business in context
Environmental objectives
• Might reduce the focus of the business on profits.
• Could make the business and its products more appealing to customers, e.g. ‘green’ consumers.
Profit objectives
• Having a profit objective helps to create strategy because only those decisions that are likely to increase
profit will be taken by the management.
• Focusing on profit might mean that decisions are made that do not meet other objectives.
Activities
Activity 4.1
Activity 4.2
• Managers and employees will know what is expected of them. This will avoid confusion and may
help to ensure that they are working towards the objectives which have been set. If all employees
are pulling in the same direction, it is more likely that the business will achieve its objectives.
Employees will better understand what the business is seeking to achieve.
• Clear corporate aims and objectives will provide a basis for setting strategic departmental targets
and individual targets for managers and employees. These objectives provide a clear guide for
management action. Management by objectives may be implemented to provide individual targets
for all employees which will contribute to achieving the overall objectives of the business.
• A focus on shareholder value may mean that short-term profit is pursued at the expense of longer-
term growth of the business.
• Rather than re-investing profits, the business may pay higher dividends to shareholders. A firm
which does not distribute profits to shareholders may face a declining share value.
• As a news agency, Reuters may have objectives related to corporate social responsibility (e.g. a
commitment to reporting the truth). This may conflict with the objective of profit. This could
arise in its activities in countries where the business may come into conflict with state authorities.
Reuters, to maintain its reputation, will report the truth about events in a country. If these news
reports upset the government, Reuters could lose contracts to provide news stories to a state-
owned TV company, reducing profits.
Activity 4.3
1 The mission statement is useful as it identifies what the company is seeking to achieve. If
communicated with employees, the statement will give a sense of direction for the business. However,
staff were not involved in creating the mission statement so they may not identify with it. Shareholders
may accept the mission statement because the aim to be the number one waste business in the country
suggests the creation of shareholder value. The mission statement may also serve a useful purpose as a
public relations exercise due to its emphasis on protecting the environment.
2 The company accounts state an objective of expanding year on year, which does not fulfil the criteria
of being SMART. The problems that may occur from objectives not being SMART are:
• If the objective is not specific to the business, it does not provide a clear direction for the business.
There is, in effect, no clear goal for managers and employees to pursue.
• If an objective is not measurable, it is difficult to identify whether the objective has been achieved.
• If an objective is not achievable, it will demotivate managers and employees. If the business is
certain to fail to meet the target, there is little point in setting the target.
• If an objective is unrealistic given the resources of the business, achieving the objective will
consume too much of the business’s resources, causing it to face new problems.
• If the objective is not time-limited, it will be impossible to assess whether the objective has
been achieved.
3 Any reasonable answer using the data in the table or the text.
• The company is dumping waste in landfill. This is contrary to their new mission statement.
• Most waste is used to generate electricity and heat. This is described as reducing the impact on the
environment and thus meets the new mission statement.
• STS sales revenue has doubled between 2018 and 2021 with a reduced number of employees.
This indicates a more efficient use of resources.
• STS aims to be the number one waste business in the country. STS’s revenue as a share of the total
market size has increased from 16.7% in 2018 to 22% in 2021.
• Operating profit has increased from $3m in 2018 to $20m in 2021. This is almost a seven-fold
increase (567%). Increasing profit is meeting its aim to maximise returns to shareholders.
• Evaluation could consider that STS is some way towards reaching its financial and operating aims.
However, it does not yet have the resources needed to protect the environment when the level of
waste it deals with increases.
Activity 4.4
• It provides targets to achieve and a measure of success (e.g. achieving the profit target of $90 000
within five years).
• With objectives set, June and Will can identify how to achieve them. They have identified the need
to improve image and raise prices.
2 Specific and measurable: a profit target of $90 000 per year has been set.
Achievable: opening a new salon and doubling revenue is achievable within the time frame. However,
Will is concerned about the employee and marketing problems associated with a new salon.
Realistic: the business has survived economic recession and increased competition. Although it
is covering costs, does it have the resources to open a new salon? The case does not suggest any
significant profits being available. However, its survival and their planning may mean that the business
can access necessary finance.
Time-limited: there is a clear timescale of opening the new salon and doubling revenue within three
years and long-term profit of $90 000 in five years.
Activity 4.5
Activity 4.6
1 Business ethics: moral guidelines that determine decision-making; code of conduct: rules and
guidelines on staff behaviour.
SCG may benefit from increased sales if it gains a reputation for ethical behaviour. It might also be
possible to charge higher prices, resulting in higher profits.
Fair treatment of employees will make recruitment easier for SCG as its reputation will be enhanced in
the labour market. Employees may be more motivated and this could increase labour productivity and
therefore improve SCG’s competitiveness.
2 If SCG uses unethical methods, it risks long-term damage to its reputation. This could result in lower
sales in Thailand and increased scrutiny from interest groups regarding its activities. Negative publicity
in the media could decrease demand. Brand reputation is difficult to build but easily destroyed.
However, in evaluation, in some countries failure to offer bribes will mean that SCG cannot win
contracts. So, there will be a loss of customers and therefore revenue. To be able to compete, some
managers might think it necessary for SCG to lower its ethical standards. However, on balance this
would be a mistake in the long run. Once the company’s reputation is damaged by a well-publicised
unethical action it will be very difficult to restore it. This will lead to a long-term decline in sales and
profit.
1 It identifies core aims, which can then be communicated with stakeholder groups.
2 They are too vague as they are often a public relations exercise rather than SMART objectives.
3 Learners’ answers will vary, e.g. increasing shareholder value includes increasing dividends and the
share price. This may be achieved by increasing profit. To increase profit, a business might cut costs by
(learner should consider one of these):
• reducing employee pay
• spending less on health and safety
• reducing environmental standards and not properly disposing of waste.
These actions conflict with corporate social responsibility, which takes into account the impact of
decisions on society.
4 Private sector: objective of increasing profit and shareholder value because these businesses are owned
by people in the private sector who want a return on their investment.
Public sector: objective of providing a public service and profit is not the main objective because these
businesses are owned by the state.
5 Specific, Measurable, Achievable, Realistic and Time-limited objectives.
6 Economic: make a profit for re-investment.
Social: provide benefit to society (e.g. jobs).
Environment: minimise the environmental impact of business activity.
7 Learners’ answers will vary, e.g. objectives change over time due to changes in the external
environment, e.g. in a recession, the objective may change from sales growth to survival.
8 They give a target to achieve and can motivate managers and other employees.
9 Ethics can influence where to source supplies, e.g. using Fairtrade products produced in ethical ways.
10 It may make the business price uncompetitive due to higher costs and therefore the business may lose
sales to competitors. Customers may be price sensitive so will not pay more for the products of an
ethical business.
11 Increase proportion of students achieving three A Levels at grade B or above to 70% within two years.
This objective is specific, measurable, achievable, realistic and time-limited.
12 To increase market share by 5% in the next three years.
13 It might be better to sacrifice short-term profit in order to provide finance for investment in R&D of
new medicines. If these are successful, they will increase profits in the longer term.
14 To achieve work–life balance by reducing the risk of overwork, which can lead to health problems.
15 The objective for a new business is typically survival, as a high proportion of businesses fail in the first
year of operations. As the business establishes itself, the objective might shift to a focus on growth and
increasing market share.
16 Learners’ answers will vary, e.g. marketing advantages; many consumers now aim to buy products which
do not damage the environment or which are not produced by people in very bad working conditions.
A business which follows a strict ethical code will be able to promote itself as an ethical supplier.
17 Learners’ answers will vary, e.g. if the objective is to expand export sales by 10%, products must be
designed and promoted in ways that appeal to customers in other countries with different cultural values.
Essay questions
1 a Define corporate social responsibility (CSR). Learners’ answers will vary, e.g. CSR motivates
workers; attracts customers; enhances business reputation; generates positive media attention.
Learners should apply two of these to a business context and explain why they are a benefit.
b If objectives are specific, measurable, achievable, realistic, timed, it:
• gives a target to achieve and can motivate employees
• increases productivity by having objectives
• enables managers to know if the business has been successful.
If they are not achievable, this will demotivate employees.
Objectives may need to be agreed so that employees feel empowered.
If they are not realistic, the business may lack the resources to achieve the objectives.
If objectives are not specific, managers do not have a clear goal to work towards.
Evaluation could consider that having SMART objectives is important but cannot guarantee
success as the business environment is dynamic. There are external factors that a business cannot
control that will help determine success. Answers could be illustrated with explained examples of
external changes.
2 a Learners’ answers will vary, e.g. in an ethical business, objectives are likely to focus less on profits
and cost cutting. Instead, objectives will reflect responsibility for the impact of business activities
on customers, employees, communities and the environment. Therefore, activities will need to be
more ethical, e.g. paying workers a living wage, paying suppliers on time, recognising trade unions,
not employing child labour, minimising pollution, disposing of waste responsibly, recycling and
not using bribes to win contracts.
b Define mission statement. A clear mission statement may provide a number of benefits to a
retail business:
• It helps motivate employees, especially when the statement promotes values that employees are
likely to share.
• It attracts customers and other outside groups that can identify with the mission statement.
• Moral statements or values to be worked towards can help to guide and direct employee
behaviour.
• It helps establish what the business seeks to achieve. The mission statement can be a starting
point from which all goals are derived.
• It provides a basis for advertising and a consistent image to customers.
However, in evaluation, the beneficial impact of having a mission statement will be influenced by a
number of factors. Answers should analyse two of the following possible limitations and apply them to
a large retailing business.
• If a mission statement is to be useful, it does need to be clear. Many mission statements are
vague and therefore do not set a real direction for the business as such statements could apply to
any business.
• To aid success, the mission statement should be a genuine statement of intent, not just a public
relations exercise.
• Communicating the mission statement is very important. Making sure employees are aware of the
business’s vision is essential if it is to have any effect on behaviour and motivation.
• Having an appropriate mission statement is also important. A mission statement that simply
focuses on shareholder value will do little to motivate employees or encourage other stakeholders.
• Mission statements do not set SMART objectives for a business and they do not tell managers
what decisions to take or how to manage the business. They are merely a framework for the
business to develop within.
• There are many external factors that influence the success of a large retailer: competitors, the
economy, legal factors, technological factors.

1 Peugeot Citroën
a i Growth.
ii Long-term plan of action to achieve business objectives.
b i 0.45 × 4m = 1.8m
ii Meeting the objective depends on the ability to penetrate new markets such as the Indian and
US markets. Peugeot has been absent from the US market since 1991. It may be difficult to
re-establish the brand in this competitive market.
c SMART objectives that have been set include: rate of return of 10% and 7.5% profit margin of
each car sold by 2025. These objectives:
• give a target to work towards to allow for measurement of performance
• can aid in motivating employees and managers by their having clear targets.
d Business objectives provide the goals a business is to achieve. Business strategies are the long-term
plan of action to achieve the goals. Peugeot has strategies to achieve the objective of selling 4m
cars by 2025. These include entering the Indian market, which offers significant growth potential,
and re-entering the US market with a new model line-up including new electric vehicles. To
increase the profit margin on each car sold, Peugeot has closed factories and made redundancies.
Objectives have been discussed with employees so the changes required are understood and
accepted. Without objectives, Peugeot would not be able to develop focused strategies so the
success of the business will be greater with long-term plans based on clear objectives.
2 South American Forest Corporation (SAFC )

a i Communicates business purpose.
ii A decision informed by moral guidelines (e.g. not using child workers).
b i Profit = revenue – total cost
Revenue = $45m + 15% = $51.75m
Profit = $51.75m – $30m = $21.75m
ii Directors may decide to pay a higher dividend payment. A dividend is part of the return
for investing in a company. Higher dividends would encourage shareholders to invest in
this company.
c Employment of child workers is considered in many countries to be unethical. Children should be
in education, rather than working, in order to enhance their life opportunities.
Increasing the rate of tree felling by 50% without an equivalent increase in replanting will degrade
the natural resources available to society and the economy. This approach is unsustainable in the
long term.
d Learners’ answers might include:
• The current approach to the use of natural resources is unsustainable. Therefore, in the future
there will be no trees locally for them to harvest and sell, resulting in a decrease in sales.
• Using child workers may lead to bad publicity in the media and potentially reduce sales.
A more socially responsible approach could give SAFC a competitive edge and could make
demand less price sensitive so higher prices could be charged.
• However, making ethical decisions will increase costs (i.e. paying workers more and the cost of
replanting trees). As the market is competitive, if prices are increased due to ethical decisions,
demand may decrease. SAFC has increased sales and profits by making unethical decisions.
Are customers concerned about child workers and exploitation of the natural environment?
• Evaluation could include a consideration of the growing importance to consumers of ethical
decisions and sustainable products, meaning that SAFC must adopt more ethical strategies
in future.
3 Kenya Re
a i Target to aim for.
ii When businesses consider the interests of society by taking responsibility for the impact of
their decisions and activities on customers, employees, communities and the environment.
b Lower sales growth objectives as there is more competition for market share.
Lower targets for profit margins as pricing may need to be more competitive.
c To increase return on capital: the benefit is that greater profitability provides profits to re-invest.
This maximises shareholder value, which will keep shareholders satisfied and encourage future
investment if required.
To increase revenue in new and existing markets: the benefit is that greater sales growth will
increase the market share and market power of Kenya Re. Economies of scale from growth reduce
unit costs, making the business more competitive.
d Yes: it helps create a USP in a competitive industry; helps build reputation and brand loyalty,
which can increase revenue in the long term; supports local communities, which can lead to
positive publicity.
No: it is a competitive industry so it is more important to cut costs to keep prices as low as
possible; the cost of premiums to customers might have to rise if too much is spent on CSR
projects; it depends on how responsive to price changes consumer demand is.
Overall judgement in context is required such as an assessment of whether this insurance company
deals directly with final consumers or not. If it does not, its business customers might be more
concerned with low-cost insurance than with the social responsibility policies of insurance providers.
be different.
Coursebook answers
Chapter 5
Business in context
Different groups have different interests and objectives
• Tour operators will benefit from increased demand to visit Machu Picchu and can make more profit.
• Government in Peru is concerned about jobs and economic growth to increase living standards.
• Conservationists want to preserve this major historical site and are concerned about the damage that
might result from increased tourism.
• Environmental groups are concerned about the increased pollution and CO2 emissions, which
contribute to global warming.
Government may:
• regulate the number of flights to control tourist numbers
• use taxes to pay for environmental protection.
Activities
Activity 5.1
1 Build new factory to expand business
• Positive impacts on owners and shareholders: increased scale of production, reducing unit costs
and increasing profit; increased output and profit to pay dividends.
• Negative impacts on owners and shareholders: capital investment, increasing gearing and interest
payments; disruption to production in the short term.
• Positive impacts on suppliers: increased demand for components; higher sales so higher profit;
contracts for the construction industry.
• Negative impacts on suppliers: the need to expand production to meet increased demand may
require investment to increase capacity.
Horizontal integration (takeover)
• Positive impacts on owners and shareholders: increased market share and higher profits; share
price increase due to increased market power.
• Negative impacts on owners and shareholders: cost of takeover, diverting profit from paying
dividends; risk of integration failing to achieve synergy.
• Positive impacts on suppliers: increased sales for favoured suppliers; greater security of demand
due to increased finances of integrated business.
• Negative impacts on suppliers: some suppliers may lose contracts; expectation of lower prices from
the customer.
Purchase of IT-controlled automated machines
• Positive impacts on owners and shareholders: increased efficiency and profit; improvements in
control of quality, resulting in greater customer satisfaction and therefore profits.
• Negative impacts on owners and shareholders: risk of IT failure impacting output.
• Positive impacts on suppliers: demand for automated machinery; maintenance contracts and
demand for replacement parts.
• Negative impacts on suppliers: reduced demand for worker safety equipment.
2 Learners’ own answers.
Activity 5.2
• Inadequate working conditions. Not giving sufficient protection to the health and safety
of workers.
• No job security. Workers are employed on temporary rather than permanent contracts.
• ‘Unfair’ wages. Exploiting the availability of East European workers to drive down wages.
2 There may be a shortage of skilled workers in the future if East European workers decide to return to
Eastern Europe. This will affect the ability of businesses to fulfil contracts.
Younger workers will not be attracted into the industry due to low wages and lack of opportunities for
training, as businesses prefer the cheaper short-term option of employing East European workers.
Negative publicity resulting from accidents and injuries will also discourage new workers from entering
the industry.
Prosecution for not meeting the legal obligations will damage profits.
Evaluation could include an assessment of whether the impact on businesses will be different in the
short and long run; whether the rate of unemployment is high or not as this will affect the ability of
the companies to recruit replacement workers; whether the government insists on high standards of
workers’ welfare from construction companies building government projects.
Activity 5.3
1 Shareholders: long-term benefit due to improved image of the company. This can drive profits upwards
and lead to higher dividend payments.
Local communities: directly benefit from the financial support given by Shell. This will improve the
local environment and increase security of income for local farmers. The early learning centre funded
by Shell will increase the life chances of local children in South Africa.
2 The analysis of the short- and long-term effects on different stakeholder groups could include:
• Shell as a multinational oil and chemicals giant inevitably comes into conflict with local
communities and the environment. This generates bad publicity for the business, so local
community projects might be seen as a relatively cheap public relations exercise aimed at
generating more positive publicity for the company. Failure to promote a positive image may
lead to a loss of customers and greater difficulty in recruiting workers. Consumers in many
countries are concerned about the state of the environment so will expect Shell to take its social
responsibilities seriously.
• Within the communities that are supported, there will be a much more positive attitude towards
Shell and its products. So Shell is more likely to receive support if it needs to build factories in
those countries in which the Foundation is operating.
• The comprehensive set of codes, policies and processes that define how the company aims to
operate in socially and environmentally responsible ways will attract employees and customers.
• It may be essential for the future survival of the company, as Shell operates in a competitive
market and competitors such as BP and Exxon have similar charitable foundations. Without
accepting its responsibilities, Shell will lose customers to other businesses.
• In evaluation, it may be argued that accepting corporate social responsibility makes good business
sense in the long run to shareholders and ultimately it enables the smooth operation of the
business and supports long-term profitability.
Activity 5.4
1 Local community and mining company: the environmental damage caused by the open-cast mining
would be substantial. The mining would spoil the landscape and cause the diversion of a river and the
destruction of a forest. It would impact on those who depend on the forest for making a living. There
would also be the disruption to the thousands of people whose homes would have to be relocated.
The mining company could make substantial profits from the project. The 570 million tonnes of coal
available would have given security of future revenues to the mining company.
Government: major investment would create jobs, increase demand in the economy and provide cheap
electricity to businesses.
Conservation groups would be concerned about the destruction of the mangrove forest, a World
Heritage site.
2 The government would have to balance the significant economic benefits of extracting the coal against the
environmental and societal impact of mining activities. Although employment would be created, benefiting
many workers, and the investment would raise Bangladesh’s GDP, the level of disruption to the local
community and damage to the environment eventually persuaded the government to cancel the project.
The government must have decided that the negative long-term impact outweighed the short-term boost to
the economy. It is also possible that international pressure played a significant role in ending the project.
Activity 5.5
1 Suppliers of palm oil: supply product in a sustainable manner, with respect for the environment.
Customers: demand for products containing palm oil, paying a high enough price to encourage
responsible actions by suppliers.
2 Suppliers: less demand, fall in profits, less likely to behave responsibly.
Customers: less choice, will have to pay higher price or buy from less ethical suppliers.
• Government regulation to ensure that production is more sustainable.
• Publicity about the impact of palm oil to educate consumers so that they are prepared to pay
higher prices for products made with sustainable palm oil.
• Stronger protection of the property rights of native populations to prevent exploitation.
• Establish a code of ethics so that socially responsible businesses are not undercut by those with
lower standards.
• Evaluation could consider an assessment of the measures most likely to reduce conflict between
the important stakeholders affected by this decision.
1 Responsibility to just shareholders (shareholder concept) or to a wide range of stakeholders
(stakeholder concept).
2 Learners’ answers will vary, e.g. higher cost of meeting stakeholder aims: ethically sourced raw
materials to meet aims of some consumers; higher wage costs to meet employees’ aims; disposing of
waste cleanly to meet pressure-group aims.
3 Better reputation for acting responsibly towards stakeholders. This could become a USP and attract
good publicity. Higher sales could lead to higher profit.
4 Acting legally is acting within the law, an obligation; acting in a socially responsible way goes beyond
legal requirements to look after the interests of society and wider stakeholders.
5 A business cannot meet everyone’s needs, e.g. a higher but fair price paid to suppliers versus
shareholder returns.
6 Internal stakeholders: individuals or groups who work within the business or own it and are affected
by the operations of the business.
External stakeholders: individuals or groups who are separate from the business but are affected by or
interested in its operations.
7 Learners’ answers will vary, e.g. society: to reduce the risk of environmental disasters caused by cost-
cutting or lack of safety equipment, e.g. on an oil rig.
8 A retailer has a responsibility to customers to sell goods that are safe to use, with clear instructions on
contents and the method of operation.
9 Learners’ answers will vary, e.g. a decision to close down a loss-making factory will benefit
shareholders as the reduction in costs from not operating the factory will result in higher profit.
However, employees will be made redundant and they will lose job security and incomes.
10 The business could discuss with workers and trade unions ways to operate the factory more efficiently
so that costs are reduced to allow operations to either reduce losses substantially or make a profit.
Essay questions
1 a Teachers: role is to teach students; rights are to be paid fairly for the work they undertake
and to have safe working conditions; responsibilities are to prepare lessons thoroughly and to
teach effectively.
Government/local government: role is to provide the finance and other resources required by the
school; rights are to expect the school to meet government guidelines and minimum standards;
responsibility is to create a society in which education is valued.
b Learners should define external stakeholders and give examples. Answers are likely to focus
on potential clashes between internal and external stakeholders or between groups of
external stakeholders.
Responsibilities to shareholders: managers of companies have a primary responsibility to
shareholders who are the owners of the business. It could therefore be argued that:
• Decisions should focus on increasing shareholder value. This is achieved through increasing profit.
Social responsibility should take second place and, where there is conflict with the objective of
profit, ignored. By spending money on corporate social responsibility projects, businesses have less
to invest in expansion and less to pay out to owners, who took the risk to invest.
• To increase profit, managers have to reduce costs and increase revenue. To achieve this goal,
there will often be a conflict with social responsibility, e.g.:
• making employees redundant to reduce costs
Responsibilities to other external stakeholders: this view argues that companies have a duty to
consider wider society when making decisions (i.e. to take account of the impact of decisions on
other stakeholders). However, it may be argued that in many cases social responsibility and the
interests of shareholders are not incompatible. There are many benefits to acting in a socially
responsible manner:
• Recruitment and retention of employees. Employers will find it easier to recruit good-quality
staff and retain them.
• It is commercially beneficial to make operations more socially responsible. A reputation for
social responsibility will lead to an increase in sales and profits.
• Improve stock market valuation. An improved reputation will enhance the value of a business
on the stock market.
Evaluation: It seems that meeting responsibilities to all external stakeholders is expensive and
might reduce profits in the short run. However, over a longer period of time, the marketing,
public relations and employee motivation benefits of trying to fulfil responsibilities to all external
stakeholders might generate higher profits.
2 a Employees
• Checkout employees are typically low paid. The supermarket has a responsibility to pay at
least the minimum wage (if one exists) or a living wage.
• Provide protective clothing for employees (e.g. warm clothing for filling freezers).
• Flexible working hours. Many employees wish to balance working with childcare.
Local community
• Consideration of delivery times. Lorries add to congestion on the roads and have an impact
on local residents.
• Provide employment to the local community.
• Support for local community projects and groups.
b Internal stakeholders, including employees, managers and shareholders, are likely to be in favour of a
decision to open a large new supermarket as it meets the objectives of jobs, promotion opportunities
and profits. However, some within the local community may oppose the new supermarket due to
concerns about the impact on the local environment, road congestion and small local businesses.
• The supermarket may engage in public relations activity to improve its image and thus reduce
the likelihood of conflict (e.g. sponsor local schools or sports teams to generate positive local
publicity and gain support).
• It could offer to pay for local infrastructure improvements (e.g. children’s play parks) as part
of the development.
• It could consult relevant stakeholders who will be affected by decisions, explain why certain
decisions need to be taken and highlight the benefits to key stakeholders.
• The supermarket could develop ethical codes of practice and embrace the concept of corporate
social responsibility (CSR). If a supermarket is recognised as taking its social responsibilities
seriously, it is likely to reduce conflicts with external stakeholders such as interest groups and
the local community. Although there is a cost to CSR, this may be outweighed by the benefits in
terms of sales and labour turnover.
• Social audits can form part of CSR and indicate that a business has genuine commitment to
its responsibilities.
Evaluation may comment on the relative costs and benefits of different strategies to reduce
conflicts or recognise that the approach taken will depend on the potential conflicts likely to arise
from the specific decision.

1 Airline merger
a i Managers.
ii Being answerable to stakeholders for a business’s activities and decisions.
b The threat of industrial action could lead to higher redundancy payments.
Government may act to prevent the merger from being completed to protect towns that are
threatened with losing routes.
c There is a conflict between stakeholder objectives. For example, shareholders are interested in
profit and growth as this increases shareholder value and potential dividend payments. However,
driving down costs to increase profit will conflict with the objectives of other stakeholders such as
employees. In this case, there will be job losses and communities may suffer from the loss of routes.
Therefore, some customers will also lose out due to the reduced level of service. But, to offer lower
prices on the more popular routes, it is necessary to cut unprofitable routes.
The key issue for Special Air and Flights4U centres on its relationship with employees. The job
losses from closing Special Air’s headquarters and some regional routes appear likely to result in
industrial action. Any industrial action is costly in terms of lost revenues if flights cannot operate.
Further, the merged airline may have to pay compensation to stranded customers. However, if
industrial action is prolonged then the airline stands to lose customers to competitors and will
have a tarnished public image. The loss of long-term custom will reduce revenues; therefore, the
merger may turn out not to be as profitable as expected.
• Consult with trade unions over proposed job cuts and how they are implemented. Voluntary
redundancy, where possible, may lessen the likelihood of industrial action. Consultation and
negotiation with unions costs little and will avoid strike action. However, whilst negotiating,
the proposed changes may be delayed, which does cost the business money.
• Offer a generous redundancy package to employees. Although expensive, the annual savings of
$10 million will, in the long term, recoup any payments made.
• Wind down operations on regional routes gradually to allow communities and suppliers time
to make adjustments. This will delay cost savings but will reduce bad publicity.
• Provide support to redundant workers (e.g. help with finding new work or accessing training).
• Evaluation could include an assessment of the measures that are most likely to reduce conflicts
resulting from the merger.
2 Honda
a i Government.
ii Where the goals and interests of different stakeholders are not compatible.
b Learners’ answers will vary, e.g. shareholders have a responsibility to ensure that employees are
treated fairly. This could mean that employees are consulted about the closure, receive generous
redundancy pay and are given support to find new jobs.
Shareholders have the right to protect their investment, in this case resulting in the right to move
production to Japan and focus on electric vehicle production.
c Different stakeholder groups have different interests and aims. Therefore, Honda’s decision will
affect some groups positively and others negatively. Learners’ answers will vary, e.g.:
• Employees in Britain will lose their jobs and therefore their income. This will reduce their
living standards.
• Shareholders may benefit from the long-term survival of Honda and could see an increase in
share price and dividends in the future.
• Suppliers of batteries to Honda will see an increase in sales and profit in the future.
• The British government’s economic objectives will be negatively impacted by Honda’s decision.
There will be an increase in unemployment in Britain, reduced exports and lower economic growth.
d Yes: Honda could have discussed with employees and trade unions how to make the factory more
productive to reduce costs; asked for government support or subsidy; offered workers jobs in other
Honda factories; paid higher redundancy payments.
No: Honda aims to make a profit, so loss-making factories must be closed; changes in technology
often involve big impacts on different stakeholder groups, both positive and negative.
Overall evaluation and judgement are needed. Learners’ conclusions will vary, e.g. Honda
operates in a competitive market and would not survive if it did not respond to changing market
conditions. Therefore, Honda has to change objectives and target the electric vehicle market.
be different.
Coursebook answers
Chapter 6
Business in context
Learners’ discussion might include
Private sector more efficient
• Competition and profit motive give the incentive to reduce costs.
• The private sector is more innovative as there is an incentive to gain a competitive edge.
• It can raise capital from financial markets for investment.
• Political interference in the public sector reduces efficiency and control may be bureaucratic.
Public sector more efficient
• Private-sector monopolies may exploit consumers and increase prices.
• State-controlled business may benefit from economies of scale.
• Private sector focuses on short-term returns for shareholders rather than long-term goals.
Should government own and control any business?
• It could focus on social and environmental objectives rather than profit.
• It might prevent job losses in failing industries.
• It might own and control public utilities (e.g. water, energy and communications) because they are
vital to private-sector success.
Activities
Activity 6.1
1 Benefits of privatisation
• The private-sector owner, motivated by profit and subject to market forces, will seek to reduce
operating costs through rationalisation, i.e. cutting jobs and modernising working practices.
This will benefit consumers, as prices will fall.
• It allows PSM to access private-sector finance for investment purposes. This could increase efficiency.
• Consumers may also benefit from improved customer service as efficiency increases.
• Government will benefit from a one-off cash inflow from the sale of PSM. This can be spent on
government projects or help balance government budgets.
• Profit made by PSM will be taxed. This will generate future revenue for the government.
• Lower prices through increased efficiency will benefit the economy as a whole.
Disadvantages of privatisation
• The most likely problem in the short term is that there would be a restructuring of the company.
Six thousand jobs might be lost.
• This will increase unemployment and increase government spending to create jobs and/or support
the unemployed.
• It will be difficult for those losing their jobs to find alternative work and this will cause hardship
for many families.
• There will be short-term disruption to supplies, caused by any industrial action by unions.
• As a nationalised industry, PSM may have had an operating surplus (i.e. profit). The government
will lose that surplus.
Evaluation should balance or weight key arguments and provide a supported judgement. Although
remaining in the state sector protects jobs, it is more efficient for the government to retrain workers
than continue to subsidise a loss-making business. Once in the private sector, PSM can acquire the
capital needed to invest in improving efficiency so that it can compete internationally.
Activity 6.2
• Absence of a written contract of employment.
• Payment below the minimum wage.
• Failure to disclose payments to the tax authorities.
• Discrimination on the grounds of gender.
• Summary dismissal without justification.
• Businesses enjoy the protection provided by the laws of the country and should therefore observe
laws which set out worker rights. Employment laws also provide protection for the employer.
• Observing employment laws helps businesses recruit and retain staff. Failure to pay minimum wage
leads to higher rates of labour turnover. This could put businesses at a competitive disadvantage.
• If laws are broken, this may result in bad publicity and lost sales.
• If laws are broken, legal action may be taken. This could lead to fines, suspension of production
or even complete closure. The penalties for breaking the law may be so great that it is not worth
taking the risk for the sake of reducing short-term costs.
• Employment laws add to the costs of a business, e.g. safety equipment.
• Employment laws may make recruitment processes more time-consuming.
• A business may be able to gain a competitive edge by cutting corners on safety or paying workers
below minimum wage. Consumers are primarily interested in value for money so if costs can be cut
and prices reduced then the business will benefit from higher sales.
• Evaluation could include an assessment that the impact will be greater on businesses with large
numbers of employees or on those that do not currently treat employees in responsible ways.
Activity 6.3
• Businesses have more resources, knowledge and power than individual consumers. This gives a
significant advantage to the business in its relationship with the consumer.
• The complexity of modern products means that it is difficult for consumers to fully understand
individual products and the claims made about them.
• To protect the consumer from unsafe products.
• To protect the consumer from unfair selling techniques.
• To prevent businesses making false claims about products, e.g. ensuring that food sold by weight
really is the weight that is claimed.
• To protect consumers from unfair competitive practice. Such practices may lead to higher prices
and less choice.
2 Benefits to business
• Through regulating business activity, consumer protection laws prevent dishonest and
unscrupulous businesses from gaining a competitive advantage. Consumer laws ensure that there is
fair competition and therefore protect businesses that behave responsibly. Learners should provide
examples of relevant consumer protection laws.
• Consumer protection laws may prevent claims through civil courts regarding unsafe products, as
businesses have to improve their standards.
Harmful impact on business
• There are costs of conformance with the law, e.g. they impose a need to meet minimum
safety standards.
• When consumer protection laws are introduced or changed, they may require businesses
to substantially change their practices. Increased costs could result in bankruptcy for
some businesses.
• The more rights that consumers have, the more likely it is that firms will have to defend their
actions in court. For example, strict liability for defective and potentially dangerous products
could result in companies being sued.
Evaluation may recognise that, although there are compliance costs to businesses, consumer protection
laws ensure that competition is fair, which is beneficial to most businesses.
Activity 6.4
• FastJet may benefit from misleading customers because, once they have been attracted to the
website by advertised low prices, customers may continue with the booking even when the price
starts to rise due to the addition of taxes and charges.
• FastJet may gain a competitive advantage over-other low cost airlines that take a more honest
approach to advertising.
• The publicity generated highlights the fact that FastJet is offering flights at these low prices even
if restrictions apply. This free publicity may encourage consumers to check FastJet’s website when
searching for cheap flights.
2 In favour of control
• False and misleading claims cause consumer confusion and cloud their judgement when making
purchases. This is an unfair practice both to the consumer and to other competing businesses.
With no controls, businesses would be free to make any claim they wished, however untrue.
Against control
• The claims made and promotional techniques used do not force consumers to actually purchase.
Consumers still enter into contracts voluntarily. Consumers can vote with their spending power if
they are unhappy about misleading claims.
3 Response of the CEO could include the following:
• Withdrawing the adverts that have broken the country’s Advertising Code. This will avoid legal
action, fines and further bad publicity. Legal action could be extremely damaging to FastJet in
terms of its reputation, making it more difficult to attract customers.
• Ignoring the threat of legal action, as compliance with the law could be costly. Having to change
advertised prices to include taxes and charges could lead to a loss of sales as well as disruption
to the website whilst the changes are made. Therefore, FastJet risks losing passengers to other
low-cost airlines. The problem with this strategy is that, if the Office for Consumer Affairs does
take legal action, the costs could be even greater. FastJet would need to take legal advice as to the
likelihood of any prosecution being successful.
• The airline may launch a counteroffensive to boost public support. The CEO may undertake
public relations exercises and make press releases. FastJet may claim unfair treatment by the
Advertising Standards Authority (ASA); much would depend on the number of complaints the
ASA has received. If there have been few complaints about the advertising, it may be assumed
that the majority of consumers do not object to the advertising imagery used. There might be
substantial media interest in the story and the publicity would not necessarily harm FastJet.
• Evaluation could include an assessment of which response is likely to be most effective in restoring
the reputation of the business.
Activity 6.5
Activity 6.6
1 Possible reasons include:
• Work–life balance. Employees may be trying to balance their work with leisure time. By reducing
working hours, this releases time for leisure activities and, although income will fall, quality of life
may be improved. The employee values leisure time more highly than work.
• Childcare. Working part-time may fit in with childcare needs, enabling parents to collect children
from school. Childcare may also be expensive so it may be preferable to work part-time to reduce
the cost of childcare.
• Part-time employment may complement other priorities that employees have, e.g. students at
university will not be able to take full-time work but may need to earn money to pay for their
studies.
• Part-time employment gives some workers the opportunity to take a second job to supplement
their income.
• Older workers who have retired may wish to supplement their pensions through part-time work.
2 Benefits and threats of more part-time staff, temporary workers and zero-hours contracts:
• Employees in many countries have fewer rights than their colleagues who have permanent
contracts. Rights to sick pay, maternity leave, holidays etc. may differ significantly.
• Some jobs may not be attractive to full-time employees. Some businesses employ a high proportion
of part-time workers. These businesses may find it difficult to recruit and retain sufficient full-time
staff due to the nature of the work or low rates of pay.
• Some businesses actively recruit older employees as they are often considered more reliable.
Part-time work may be particularly attractive to older workers who have retired or are approaching
retirement age.
• These contracts offer greater flexibility to alter staffing costs to match the economic cycle. In
a recession, businesses will be able to reduce costs by not renewing temporary contracts or by
changing hours of work for zero-hours contract employees. If a business only employs permanent
staff, reducing the labour force may be expensive due to payment of redundancy.
• Temporary workers are essential in seasonal industries, e.g. harvesting crops. Using temporary
workers reduces the fixed costs of full-time and salaried posts.
• Employees on these types of contract may be less committed to the business and therefore
less productive.
• Higher labour turnover will increase the costs of recruitment.
• Employees on these types of contract may gain less experience than their full-time equivalents.
This could reduce the quality of customer service and production of goods.
• Evaluation could include an assessment of the type of employees that a business employs and the
importance of having full-time employees.
Activity 6.7
1 Gender: increasing rates of female participation may require web design businesses to offer more
flexible working contracts. As women often fulfil the primary care role for children, child-friendly
hours and part-time employment contracts may be more suitable.
Education: if higher levels of education are attained, more skilled employees are available. Recruitment
of individuals with computing skills will be easier.
2 The labour force is predicted to increase by 3.4m workers between 2021 and 2026. So, although the
proportion of young workers is set to decrease by two percentage points, there will be an increase in
the number of people aged 15–24. This would suggest that the business does not need to change its
employment policy.
However, the forecast is that, by 2026, 35% of the labour force will be educated to degree level. This
could mean there will be fewer young males willing to accept low-paid employment. This would suggest
that the business might need to increase wages to attract workers. If there is no Equal Pay law in the
country, an unethical business could recruit more female workers and try to pay lower wages. However,
more flexible employment contracts might be required to attract female workers if they are primary
carers for children.
Activity 6.8
1 Bar codes give more accurate inventory control, ensuring that customers can find the products they
want. Bar codes can be scanned, so increase speed at the checkout.
Online shopping is constantly available so customers can shop when it suits them. This reduces
pressure on the shopper to make a purchase, as there are no shop assistants. The customer can take
more time over purchases. Customers have the ability to compare prices more easily, which increases
competitive forces to push prices down. Online shopping reduces the time spent travelling to and
from shops.
2 Benefits may include:
• Reduced queuing at checkouts because the technology tracks exactly what the customer has as
they pass a receiver. Supermarkets are able to make cost savings in staffing as there is a reduced
need for checkout operators. Reducing costs contributes to higher profits and prices can be
lowered to increase the level of custom.
• Better inventory control, as it is known exactly what has been sold. Sell-by dates are automatically
transmitted, so out-of-date products are identified and customer dissatisfaction is avoided.
• Reducing theft, as products that have not been paid for are automatically identified when leaving
the store.
• Greater awareness of which supplier products come from. This may help with quality control.
3 RFID is a potentially difficult technology to introduce as it will have a significant impact on human
resources. It is important to discuss its introduction with affected workers.
• The supermarket may benefit from consulting unions, where they exist, and/or all employees. This
is necessary to ensure that employees understand the need for the technology and impact of it on
working practices. Consultation may reduce opposition to the technology and help avoid conflict
and industrial unrest.
• If the technology will lead to redundancy, further consultation will be needed. This is a
statutory requirement in some countries. Managers will have to determine the criteria on which
redundancies will be made, ensuring that they do not breach employment rights. Voluntary
redundancy may be favoured to reduce conflict.
• Finance will have to ensure that sufficient capital is available for purchasing the system.
• Different systems will have to be assessed to compare cost and effectiveness.
• Operations will need to carefully plan the timing of introducing the technology. Managers may
utilise techniques such as critical path analysis. There is likely to be disruption of the supermarket
as the technology is installed.
• HRM will need to provide training for employees to ensure they are familiar with and able to
operate the technology.
• Marketing may wish to publicise the changeover in advance to prepare customers. Once RFID is
introduced, staffing levels may need to be temporarily increased to inform and guide customers as
to the use of RFID technology.
• The new technology will have to be monitored to assess whether it is providing the expected
benefits and, if not, what can be done to improve performance.
Evaluation may focus on the need for effective planning to ensure that disruption is kept to a minimum.
The costs of disruption will relate to dissatisfied customers and lost sales. Alternatively, the importance of
HRM may be emphasised, with the costs to the business of not overcoming possible employee opposition.
Activity 6.9
1 Market size: a global market gives the potential for more sales.
Economies of scale: an increase in the scale of production, made possible by operating globally, will
reduce unit costs. Therefore, Coca-Cola can benefit from higher profit margins.
2 Employment. The bottling plants need labour and therefore jobs are created. This will raise incomes in
the country.
Improved infrastructure. Building bottling plants increases the capital in the country and there are
likely to be associated improvements to local roads.
3 Benefits
• Suppliers’ sales will increase, e.g. in logistics, electricity and water. Coca-Cola claims to benefit
local businesses.
• A rise in incomes will increase demand for the goods of other businesses.
• The use of new technology will spread. Coca-Cola’s operations will use the latest technologies and
other firms may learn from this.
Disadvantages
• There may be reduced demand for products from competitors, which may struggle to compete
with such a well-known brand. Some businesses will close down.
• There may be competition for resources (e.g. water and labour), which may damage other
businesses. Water shortages may occur. Competition may drive wages upwards.
Evaluation might focus on the possible disruption to water supplies in local communities and impact
on business of water shortages. Assess which businesses are most likely to benefit/be adversely affected
by Coca-Cola’s operations.
Activity 6.10
1 ETG has operations in 12 countries and is not simply selling its products in Britain, where its headquarters
are located. ETG clearly has manufacturing capacity in a number of countries, such as Mexico.
• ETG’s factories have a poor record on pollution. If ETG cuts costs through having low
environmental standards, its new factory will impose significant external costs on Malaysian
society, such as the impact on children’s health of increased levels of pollution.
• The Malaysian Tyre Group (MTG) may be forced out of business as it will be unable to compete
with ETG. MTG may be disadvantaged because of its smaller-scale production and inferior
technology. If MTG is unable to compete on price, it will lose business.
• To access new and developing markets such as Malaysia and Mexico. By locating in those
countries, ETG is near to potential consumers.
• To cut costs of production. In many European countries, there are strict labour laws and minimum
wage legislation. So it is relatively expensive to employ workers and this pushes up the costs of
production, leading to higher prices for consumers.
• To avoid environmental standards applied in the European Union. Strict controls on emissions
and disposal of waste will add to costs. Locating in developing countries may avoid such
environmental controls, enabling ETG to be more price competitive.
4 A discussion of the advantages and disadvantages that multinationals bring to a country is the simplest
approach. However, the question refers to the extent to which multinationals should be controlled
rather than whether they are good or bad. Most answers are likely to conclude in evaluation that some
control of multinationals is necessary, whilst recognising that too much control would lead to a loss of
investment with detrimental effects to the economy.
Control is required to address the following:
• The impact of multinationals on local firms. The competition from multinationals may drive
national firms out of the market. Multinationals have greater resources and strong brand identity,
so national producers may be unable to compete. Countries may have competition laws to prevent
this negative aspect of multinational activity.
• Multinationals may stifle the development of entrepreneurial skills in the economy as local
businesses cannot compete.
• The profits of multinationals may be repatriated to the country of origin, benefiting shareholders
abroad rather than local citizens.
• Multinationals may take their investment elsewhere if market conditions change or
opportunities arise.
• Multinationals may exploit the local workforce, paying lower wages and offering few of the
benefits offered to employees in their base country.
Activity 6.11
1 Reasons may include:
• To reduce costs. The biofuel may be cheaper than usual jet kerosene. Cost savings will give a
competitive edge to Virgin, as these will allow it to reduce prices. Reducing costs will make Virgin
more profitable.
• To generate publicity. Environmental issues are increasingly newsworthy as concern grows about
global warming. The publicity generated provides free advertising for Virgin.
• To increase sales. As Virgin is claiming that the use of biofuel is less polluting than normal jet
kerosene, this may attract customers who are concerned about their carbon footprint. It would be
a USP for Virgin and could enable them to charge higher prices as demand is less price elastic.
• Corporate social responsibility. Virgin may be genuinely committed to measures to reduce its
impact on the environment as it recognises its responsibility to wider society. Reducing the use of
normal jet kerosene will reduce pollution and the external costs associated with it.
2 By highlighting environmental and other issues related to corporate social responsibility, pressure
groups can influence business decisions.
• Virgin’s use of biofuels is a response to criticisms of the carbon emissions of airlines. This may
increase costs and therefore prices.
• If the accusation of greenwashing is widely accepted by consumers, Virgin will gain little from the
widespread publicity and may even lose out. If consumers do not believe that Virgin is genuinely
interested in reducing air pollution, they may take their custom elsewhere. This may force Virgin to
pay for independent social audits to give credibility to its environmental policies.
• The publicity is potentially beneficial to Virgin’s image and reputation.
• Business passengers may, or may not, be influenced by the environmental credentials of Virgin.
They are, perhaps, more likely to make decisions based on price, convenience and comfort of
travel. Therefore, when making decisions, businesses may ignore groups such as Greenpeace and
Friends of the Earth.
Evaluation could include a discussion that the impact of pressure groups on business decisions will depend
on the amount of support those groups have and the costs to business of making changes to operations.
Activity 6.12
• Making more efficient use of resources will increase output from given inputs.
• Reducing waste will reduce costs.
• Better insulation of buildings will reduce energy costs.
• Using more fuel-efficient vehicles will reduce transportation costs.
• A reputation for CSR may enable higher prices to be charged.
• Investment in new technologies may reduce production costs.
• Analysis should include, in each case, development of how either lower costs or higher revenue will
increase profits of the business, making these socially responsible decisions.
• Shell will potentially enjoy increased sales if consumers are convinced that it is the leading multi-
national in economic, environmental and social responsibility. Green consumerism is increasing
and higher sales may lead to higher profits.
• Improved reputation will reduce the negative publicity that Shell has traditionally suffered from.
• It will provide a competitive advantage to Shell. Through differentiating itself from the
competition, Shell can justify charging higher prices without a resultant drop in demand.
• It will be easier to recruit and retain high-quality staff. This will reduce costs in the long term.
• There may be long-term cost savings from adopting environmentally friendly strategies. For
example, reducing energy use and increasing levels of recycling save the costs of waste disposal.
• Shell will have to alter its behaviour substantially to become the leading multinational in
economic, environmental and social responsibility. This may be costly. Shell is competing in
industries that naturally have a significant environmental impact (petroleum and chemicals are
core activities). To be responsible, Shell will have to invest substantially in new technologies and
tighten practices to prevent accidents.
• Shell will have to ensure fair treatment of all workers and this means implementing high standards
of health and safety and providing good wages.
• Shell may have to reconsider contracts with governments that are considered to be corrupt and so
may have to end operations in some countries.
• Shell will have to pay for independent social audits to convince the public that it really is socially
responsible. Further, Shell will have to act on the audit findings.
• Failure to apply high standards will lead to negative publicity. Shell will find itself subject to much
scrutiny if it is seen as being socially responsible.
Evaluation: a simple way to evaluate may be to contrast the potentially high short-term costs of
improving social responsibility with the long-term benefits.
Decision-making questions
1 Petrobras cleans up poor safety and environmental record
1 Evidence of putting the interests of investors first includes the following:
• Record profits.
• A poor safety record indicates that Petrobras has failed to consider the welfare of employees.
The recent explosion on its offshore platform may indicate that reducing costs was put ahead
of employee safety, e.g. the oil platform did not undergo the normal eight-month test phase.
• Equipment is outdated and therefore more dangerous. The lack of investment in new
equipment helps enhance short-term profitability.
• A number of oil spills reflects insufficient protection of the environment and imposes costs
on society.
• Industrial waste goes untreated. This imposes costs on society.
• Employees have a poor attitude towards the environment and safety. This may indicate
poor training.
• Bad publicity surrounding the accidents and pressure-group activity highlighting the
environmental impact of Petrobras. This could lead to a loss of custom.
• Increased difficulty in recruiting and retaining employees as a result of both the environmental
and the safety record of the business. The death of ten workers will give Petrobras a bad
reputation within the industry and deter skilled workers from working for the company.
• Loss of life and non-fatal accidents may lead to legal action over health and safety, and could
result in substantial fines and compensation.
• The long-term costs of accidents may be too great. For example, although its oil platforms are
insured, Petrobras will face increasing insurance premiums as a result of the number of accidents.
3 The case clearly indicates some of the drawbacks of Petrobras’s negligent approach to ethics and
the environment.
Drawbacks of high ethical and/or environmental standards
• Increased costs. High ethical standards will, in the short term, increase business costs, e.g.:
• Paying fair wages to workers.
• Increasing expenditure on health and safety, e.g. having to train workers properly and
invest in necessary safety standards.
• Increased costs of investing in cleaner technology.
• Cost of sourcing Fairtrade products and auditing that suppliers are ethical.
• Missed opportunities to collude with other firms to fix markets. This increases the prices they
are able to charge to consumers and therefore increases profit.
• Lost sales due to refusal to bribe corrupt governments and organisations.
• Missed opportunities to boost sales through unethical marketing techniques, e.g. persuasive
advertising of toys to children.
Benefits of high ethical and/or environmental standards
• Prevents prosecution and fines. For example, poor health and safety policies could lead to
injury of employees and claims for compensation. Failure to ensure the safety of consumer
products may also lead to legal action and negative publicity.
• Prevents the negative publicity and loss of sales that may arise from unethical behaviour.
• High ethical standards are likely to make recruitment and retention of skilled staff easier. This
will reduce the long-term costs of the business.
• An ethical code can be used as a marketing tool for the business to attract customers and
differentiate the firm from competitors.
• High environmental standards can reduce costs in the long term, e.g. greater efficiency in
energy use.
• The environment is increasingly a significant factor in the spending decisions of consumers.
Therefore, businesses with low environmental standards risk demand decreasing.
Evaluation is likely to focus on the question of the long-term impact of high ethical and/or
environmental standards in increasing consumer and employee loyalty. However, the effect will
also depend on the following:
• Society’s attitude towards ethics and the environment. In many countries, it is an increasingly
important consideration for consumers.
• How ethical competitors are. If competitors have low environmental standards, a firm will be
at a cost disadvantage if it adopts high standards itself.
• The nature of the unethical behaviour, including whether it contravenes the law and might
lead to legal action.
• Whether there are sufficient ethical consumers for high standards to really matter.
2 Social audits – measuring corporate social responsibility
1 An audit examines the social impact of a business and compares performance with objectives.
Benefits for Exxon: corrects poor reputation; changes Exxon’s reputation to the best in the
industry; gains favour with stakeholders. Benefits for Soft Touch: being a social enterprise fits with
objectives; gains funding. Learners should also support answers with evidence from their own
research.
• Large businesses have a greater number of stakeholders, so there are more people to view a
social audit.
• There is a greater risk of negative PR and media or public interest in large businesses because
their activities have a more substantial impact on society.
• Social audits can be expensive and, therefore, smaller businesses do not have sufficient
resources to pay for them.
• The public may be more suspicious of the activities of big business and therefore need to be
reassured that their behaviour is socially responsible.
• Charities may be subject to greater external scrutiny of their activities. Therefore, whether a
charity is large or small, social audits are important.
Evaluation: the cost of conducting a social audit, relative to the benefit, is often too great for
a small business. The need for a social audit will depend on the extent to which the activities
of a business have significant impacts on society. Therefore, a social audit is more likely to be
worthwhile for a large business.
3 Dangerous toys recalled
1 Yes, the toys should have been withdrawn
• Legal issues. If found out, Fisher Price and Mattel could face legal action and fines.
• Loss of sales. If consumers or trading standards officers had discovered the high levels of
lead in the paint, this would have caused catastrophic publicity for Fisher Price and Mattel,
particularly as this relates to toys for children. Such publicity would potentially lead to a
significant decline in demand, in both the short and the long term.
• Brand image. Both companies are leading brand names. Bad publicity would undermine their
brand images, which have taken years to build.
• Swift action by Fisher Price and Mattel reinforces their reputation for quality and customer
care.
• It would be unethical to supply the toys with high levels of lead.
• Corporate social responsibility. Fisher Price and Mattel have a responsibility to stakeholders
such as customers.
• The paint breached their own specification, and therefore undermines quality.
No, the toys should not have been withdrawn
• One view is that a company’s first responsibility is to its shareholders. Recalling millions of
toys will cost thousands of dollars in lost sales and reduce profit.
• The recall draws attention to the problem which otherwise might have gone unnoticed.
Consumers may doubt the safety of other toys made by Mattel and Fisher Price, leading to a
loss of sales.
Evaluation may contrast the short-term benefit of not taking action against the potentially
damaging long-term consequences if consumers find out about unethical behaviour. As this has
a direct impact on consumers, it is particularly important that the two companies withdraw the
dangerous products.
2 Persuasive advertising aimed at children is acceptable

• Ultimate responsibility for deciding whether a toy is purchased lies with parents.
• In many countries, advertising aimed at children is accepted.
• Children are aware of what advertising is and have an understanding of its purpose.
• A business has responsibility to its owners. Businesses exist to make profit; advertising is just
one element of the marketing mix at a firm’s disposal to influence customers. Pursuing profit is
good for society as a whole.
• Advertising helps fund television for children. Some of this TV output is educational and
arguably beneficial for the development of the child viewer.
• As long as the advertising is not misleading, it is acceptable.
Persuasive advertising aimed at children is unacceptable
• Younger children are vulnerable to persuasive advertising and do not have the capacity to
make decisions about what toys are good or bad for them.
• Direct advertising to children leads to parents being pestered. The pressure to buy can be
great. This becomes a particular problem when parents are pressured into buying toys they
cannot really afford.
• Businesses have a social responsibility to their stakeholders. They should take into account the
consequences of their marketing decisions.
• Advertising is a cost to business and simply leads to higher prices for goods.
Evaluation may depend on a number of factors:
• The type of toy being advertised. Is the toy beneficial to a child’s education and development?
• The issue may be one of controlling advertising rather than banning it, e.g. controlling the
content of adverts and the times at which adverts can be televised. These controls would
reduce the exposure of children to advertising.
• The age group at which the toy is aimed. Older children are more able to recognise what is
good or bad for them.
4 Volkswagen (VW) clean diesels – the claim that was not true
• VW will need to act quickly and take comprehensive measures to reassure the public that this
type of activity will not happen again.
• Public relations campaigns to rebuild the brand image. This may require the CEO to apologise
to customers.
• Advertisements in the national press to apologise.
• Recall vehicles immediately to carry out remedial work.
• The CEO and other directors may have to resign and a new board be appointed to
demonstrate the company is changing.
• Compensation paid to customers.
2 Learners should define greenwash. Possible consequences of untrue or greenwash environmental
policies include:
• Pressure-group activity will generate negative publicity.
• Compensation may be paid voluntarily but it is likely the company will be prosecuted in the
courts for misleading the public. Substantial fines will have to be paid. This will reduce profits.
• The business may have to engage in expensive public relations to repair damage to the brand.
• Loss of confidence in the brand will result in lower sales as customers switch to competitors.
• However, in evaluation, it is possible that VW’s brand is sufficiently well established that the
long-term effect is not significant. Other manufacturers have also misled the public.
5 South Africa accelerates its car production

• Financial incentives are provided. These reduce the cost of setting up production in South
Africa through, for example, providing multinationals with a contribution to the capital cost
of factories.
• There is significant unemployment in South Africa and, therefore, wages are relatively low
compared to countries such as Germany. Recruiting workers is easy, e.g. when 23 000 people
turned up in the hope of replacing 1 300 sacked VW workers.
• South Africa has emerged as a leading supplier of automotive components such as catalytic
converters. The ready availability of components is attractive to car manufacturers. There are
hundreds of small and medium-sized local suppliers, so it is a highly competitive market. This
has driven up productivity and quality to the benefit of the multinational producers.
2 Advantages
• Employment for locals, e.g. the Mercedes investment will create 800 direct jobs and 3 000 jobs
in the supply industry. Reducing unemployment will increase living standards.
• Greater spending by workers creates demand for other businesses.
• There is more demand for suppliers.
• Improvements to infrastructure. Investment will facilitate the building of ports and transport links.
• New technologies imported into the country. This raises productivity.
• Taxation of profits and employee incomes boosts government revenues.
• Export earnings, e.g. BMW will export 30 000 3-Series cars.
Disadvantages
• The impact on South African firms. Competition from multinationals may drive national
firms out of the market. Multinationals have greater resources and strong brand identity, thus
national producers may be unable to compete. However, the case study suggests that the South
African car industry was in a mess before the arrival of BMW and others.
• Multinationals may stifle the development of entrepreneurial skills in the economy as local
businesses cannot compete.
• The profits of the multinationals may be sent back to their country of origin, benefiting
shareholders abroad rather than the citizens of South Africa.
• Multinationals may take their investment elsewhere if market conditions change or
opportunities arise, e.g. IBM decided to leave South Africa.
• Multinationals may exploit the local workforce, paying lower wages and offering few of the
benefits offered to employees in their base country.
An evaluative answer will provide a balanced analysis of the advantages and disadvantages of
multinational investment whilst reaching a conclusion either in favour of or against support for
further investment. In this case, a valid conclusion may reflect that multinational investment is
desirable in some but not all industries, depending on whether there is a fledgling national industry
that merits protection.
Further, the cost of extra government support should be balanced against the potential benefits
to South Africa of that support and consideration of how else the government could spend that
money.
be different.
Coursebook answers
Chapter 7
Business in context
Benefits from economic growth
• Reduction in unemployment as output increases.
• Reduction in the number of people living in poverty.
• Increasing incomes and living standards.
• Better quality of healthcare.
• Improvements in education and skills of the labour force, which will increase productivity.
Financial support for business will:
• encourage extraction of raw materials to export
• help add value in agriculture by supporting processing industries
• encourage entrepreneurship and make the economy more dynamic
• provide jobs and training.
Activities
Activity 7.1
Activity 7.2
1 The level of economic activity has a significant impact on the level of spending within an economy
as it affects income. In a recession, unemployment is rising and workers are concerned about losing
their jobs. Consequently, there is a decline in expenditure on luxury goods. This will affect tourism
as consumers seek to save money, leading to a fall in demand for holidays. People are more likely
to holiday in their own country and choose less expensive holiday options. The reverse is true of an
economic boom, as unemployment falls and people are more confident about the future. In these
circumstances, the demand for foreign holidays will grow as people have more money to spend.
2 In a time of rising inflation and slower economic growth, many businesses delay expansion plans due
to the falling real disposable incomes of consumers. Consumers wish to save money by reducing luxury
purchases and are more likely to focus on necessities. The tourist industry, in general, may be adversely
affected. However, there are a number of reasons, suggested in this case, for believing that Mr De
Smit’s strategy of business expansion has merit. These include:
• In a recession, as inefficient businesses face bankruptcy due to declining sales and a failure to
control costs, there will be opportunities for takeover at low cost. Mr De Smit will be able to
acquire businesses at very competitive prices. Mr De Smit was able to take over another business
cheaply in the last recession.
• Mr De Smit is also considering the wider market for his safari parks, e.g. even if southern Africa
faces recession, there may still be demand from non-Africans. These tourists can be attracted with
appropriate promotion.
• It is suggested that the safari parks are not expensive holidays and so, as incomes fall, people may
switch to these cheaper holidays.
However, growth may be a high-risk strategy because:
• Taking over businesses that are failing will increase borrowing and increase payments. If Mr De
Smit is unable to turn these businesses around, they will remain unprofitable. He must choose
takeover targets very carefully to ensure that they really do have the potential for profit.
• If the world economy is in recession, tourists from outside southern Africa will face declining
disposable incomes. Therefore, it may be difficult to attract tourists to the safari park.
• The business is also affected by the response of competitors to rising prices and a recession.
Competitors may increase their marketing activity to protect demand. They may limit price
increases to remain competitive even though this will reduce profit margins.
Evaluation: much will depend on the position of the firm in the market. Is it really a low-cost
alternative to expensive hotels?
The severity of the recession will also be significant. Holidays are a luxury, so even low-cost options
will suffer if there is a significant downturn in economic activity. The income elasticity of demand will
be important. If it is negative, a decline in income will lead to an increase in demand.
Activity 7.3
1 To control the rate of inflation by managing aggregate demand in the economy. Excess demand has
caused the price of chicken and vegetables to increase. This is an example of demand-pull inflation.
High levels of consumer demand relative to the economy’s ability to supply lead to price increases
as consumers are effectively competing for limited supply. Higher interest rates will reduce spending
in the economy and therefore reduce inflationary pressure. Increasing interest rates is referred to as
deflationary monetary policy.
• Consumer spending on luxury goods. As the cost of borrowing rises, consumers will face higher
interest charges on any new borrowing. Therefore, they will reduce their expenditure on luxury
goods that require finance to purchase.
• Business investment. Higher interest rates will reduce the growth of consumer spending and this
will reduce the potential returns from investment. Therefore investment will fall. Further, as some
investment is financed from borrowing, an increase in interest rates will reduce the potential profit
of investment due to the increased repayments needed to service debt.
• The external value of the exchange rate. Two forces will influence the exchange rate. The increase
in interest rates will encourage currency flows into the financial sector, attracted by the higher
rates of interest available. This will create a demand for the currency, leading to an appreciation of
the exchange rate. However, the deflationary impact of increased interest rates will reduce import
growth into the economy. This will cause further upward pressure on the exchange rate.
• Greater uncertainty about the future. High rates of inflation make it more difficult to predict the
revenues and costs associated with long-term investment. Therefore investment is discouraged.
• Employees will demand higher wages and there may be an increase in industrial unrest. A wage-
price spiral may result.
• If inflation is high relative to other countries, businesses will be less competitive over time. This
will lead to a reduction in exports and an increase in imports.
• Manufacturing businesses will benefit from increasing demand due to rising incomes. This will lead
to higher levels of profit and reduced pressure to be price competitive.
• Increased growth leading to higher profits will lead to increased investment and technological
change.
Activity 7.4
1 30 000 ÷ 3 = $10 000
2 30 000 ÷ 2.70 = $11 111.11
3 Renard could pass the cost increase onto customers by increasing the price. It could absorb some or all
of the cost increase by accepting a lower profit margin.
4 15 000 × 3 = €45 000
5 15 000 × 2.70 = €40 500
6 If Foxbore leaves the dollar price of its exports unchanged, the euro price paid by the German
importer will be less. Therefore, Foxbore may benefit from increased sales as there is an inverse
relationship between price and the quantity demanded.
Alternatively, Foxbore could actually increase the dollar price to the German importer and enjoy a
higher profit margin without reducing demand. For example, a price of $16 666.66 would leave the
euro price unchanged at €45 000.
7 If Foxbore imported raw materials from Germany, the depreciation would be less beneficial as it would
now be paying more for raw materials, i.e. costs of production would be higher.
Activity 7.5
1 BMWs are exported to the USA, so a depreciation of the dollar will raise the dollar price of a BMW.
This will lead to a reduction in demand for BMWs unless BMW is willing to accept a lower euro
price for its cars. However, a lower euro price will reduce BMW’s profit margins. Analysis could be
demonstrated by the use of an appropriate simple numerical example.
2 Increase production by 60% in US factory
• Benefits: protects BMW from the dollar exchange rate fluctuations affecting sales and profit;
increased US production will encourage Americans to purchase BMWs; reduction in transport
costs to market will benefit BMW’s profits.
• Negatives: if the dollar appreciates, BMW will be worse off as a result of increased US production.
Expand marketing of its products in non-US and non-EU markets such as China
• Benefits: reduced reliance on US and EU markets and an increase in sales and revenue, which
could increase profit.
• Negatives: few can afford the luxury brand; establishing a presence in these new markets will
initially be expensive.
Cut back on its expensive German workforce
• Benefits: more price competitive due to cost savings as high wage costs result in higher average
costs of car production in Germany.
• Negatives: if production is transferred away from Germany, this may affect the company’s image,
which feeds on the perception of German engineering excellence; potential industrial unrest; costs
of redundancy.
Evaluation of these strategies could include an assessment of the likely impact of them on the long-
term profitability of BMW.
Activity 7.6
1 Pakistan’s economy: a mixture of hope and future problems
1 Supply-side policies aim to improve the conditions of supply. Policies to increase agricultural
productivity will decrease the costs for food processing manufacturers. Improvements to transport
will enable agricultural businesses to get their products to market and reduce wastage of fresh
produce. There will be an increase in profits to farmers. This will also reduce the cost of produce to
businesses supplied by farmers.
2 Deflationary monetary policy will be used to control inflation. This means higher interest rates.
This increases the cost of borrowing and will discourage investment. Households will have less
discretionary income and spending will decrease. Lower demand will reduce business profits and
reduce inflationary pressure as businesses cut prices to attract consumers.
Evaluation could include a consideration that some businesses will be more affected than others.
Businesses with high debts will be more affected than those with no or low debt levels. Businesses
that produce or sell essential products might experience a smaller fall in demand than those that
provide luxury products.
2 Prospects for the economy
1 A recession involves a reduction of demand in the economy. Lower sales put downward pressure
on prices and may mean that businesses are no longer able to cover costs, leading to losses which,
if prolonged, will cause bankruptcy. A recession also leads to some customers defaulting on
payments for goods and services bought on credit. This causes cash flow problems for business and
can lead to bankruptcy as businesses will be unable to pay their debts.
2 Interest rate cuts is reflationary monetary policy. The reduced cost of borrowing boosts consumer
spending on products for which borrowing is required. The fall in interest rates also reduces the
mortgage payments of some households and thus increases their discretionary income. This leads
to increased consumption. The increase in demand raises the rate of economic growth.
Tax cuts and increased government spending is expansionary fiscal policy. The cut in tax rates
increases household disposable income and therefore increases consumer spending. This increases
demand for the goods and services of businesses, which increases output, increasing economic
growth. Increased government spending gives a direct boost to demand in the economy. Some of
the money is spent on the goods and services, increasing economic growth.
Depreciation of the currency makes exports more price competitive, leading to an increase
in demand. Imports become more price uncompetitive and therefore consumers switch to
domestically produced goods.
3 Depreciation will encourage business to export more goods and enter new markets abroad. This
may require businesses to find new channel intermediaries abroad, e.g. agents. Marketing may
also be required and products changed to meet customer tastes. As the cost of imports increases,
businesses may look for domestic suppliers of materials and components. Quality will need to be
monitored to ensure that customer satisfaction is not reduced.
Higher indirect taxes will increase prices. To maintain demand, businesses may have to cut profit
margins. This will depend on price elasticity of demand. If demand is price inelastic, businesses
may be able to pass on the increased costs to consumers.
Evaluation could include a consideration of how responsive demand is to price rises as, for
some essential products, businesses might not have to react much to higher indirect taxes. Also
a currency depreciation will affect businesses that import a high proportion of their inputs,
especially when it might not be easy to find domestic suppliers.
3 Coaching Inns (CI)

1 Decrease in economic growth: the economy has expanded in recent years. Economic growth will
have created jobs and reduced unemployment, so it will become increasingly difficult for businesses
to recruit staff. This may be a particular problem for hotels if that type of work is perceived to
be low paid. The forecast decrease in economic growth will reverse this trend and therefore, as
demand is reduced, there will be lower capacity utilisation and a fall in profits.
Higher interest rates: as a premium hotel, CI may be adversely affected by increased interest rates as
tourists and businesses switch to cheaper alternatives. CI may have to offer more discounted packages
to maintain occupancy levels. This will negatively affect profits and there will be less retained profit for
re-investment into the business. Further expansion will be made more difficult due to the higher cost
of borrowing. If expansion requires additional borrowing, increased repayments will make expansion
less attractive. Further, the increase in interest rates will dampen demand and thus make expansion
less desirable. The business has borrowed heavily to purchase suitable properties in the past. Higher
interest rates may increase the cost of servicing its existing debt (i.e. paying the interest on the debt it
already has). Interest payments represent an expense to the business and therefore any increase will
reduce profit.
2 Focus expansion downmarket: the premium end of the market may be adversely affected by
higher interest rates, so CI could consider opening lower-priced hotels. However, this may require
establishing a new brand name to avoid contamination of the existing brand, which may be
expensive. The lower end of the market may already have well-established brands and be highly
competitive. The budget end of the market is a segment that CI may have little knowledge of, so
recruitment of suitable managers will be important.
Consolidation, putting expansion on hold and focusing on the existing 23 hotels: expansion is
expensive and places a strain on resources, particularly if funds are borrowed. CI may benefit from
focusing its resources on its current hotels. Higher interest rates may cause a reduction in aggregate
demand and a slowdown of economic growth, so further expansion will be more risky.
Restructure debt: CI has borrowed heavily to finance expansion so, with higher interest rates,
it will face higher interest payments. The business could consider raising more equity finance
by issuing shares, which would be particularly relevant if expansion remains a key objective. CI
may be able to re-negotiate the terms of its existing debt with financial institutions to reduce the
interest burden. Extending the length of commercial mortgages and loans will reduce interest
payments but will cost the business more in the long term.
Evaluation could include an assessment and justification of which decision is most likely to lead to
maintained or even higher profitability for CI.
be different.
Coursebook answers
Chapter 8
Business in context
New strategies needed because of:
• legal environment protecting family-owned shops in India preventing Walmart opening retail stores
• social differences in how people shop in India.
Risks of entering new markets versus increasing sales in existing markets
• Limited knowledge of new markets.
• Differences in customer expectations.
• Differences in legal environment.
• Need for different products and marketing.
• Existing markets may be saturated.
• Threat of competition regulations preventing expansion in existing markets.
Activities
Activity 8.1
Business Decision Strategic or tactical?
context Add explanation
Multinational switch from cans to plastic Strategic. This will involve significant capital expenditure.
drinks company bottles
Supermarket start selling non-food items, Strategic. This changes the nature of the supermarket and
business such as clothes, for the first represents a significant change in markets. Perhaps it relates
time to a long-term objective to diversify.
Steel-making recruit production Tactical. The impact is at a departmental level and is a decision
company supervisors internally, not that would be taken at middle management level. The
externally objective might be to improve the motivation of employees.
Holiday tour increase prices of holidays Tactical. This may be to take advantage of an opportunity in the
operator to a popular destination market or part of achieving a strategy to increase sales revenue.
Major develop a range of advanced Strategic. This involves a significant commitment of resources
computer mobile (cell) phones with as the firm is entering a completely new market. It has a
manufacturer internet capability cross-functional impact and is long term.
Activity 8.2
Activity 8.3
1 PCI has a strategy prepared to respond to the plans of the Australian educational businesses to open
in Country Z. Therefore, PCI will be able to act quickly to protect its market share and ensure students
are not lost to the new competitors. This will help prevent loss of revenue.
2 PCI could increase its promotional budget ahead of the new competitors entering the market.
Promotion might focus on the strengths of PCI, e.g. its academic success. This could be supported
by public relations activity to increase awareness of the PCI brand. Pricing might be changed to
ensure PCI maintains a competitive edge. However, such a strategy will potentially reduce income and
increased promotion costs would affect profit.
Activity 8.4
1
Strengths Weaknesses
• Excellent staff relationships. • Limited factory capacity.
• Relationship with major brands. • Cash flow concerns.
• R&D into faster computer models. • Does not sell computers under its own
• Steady profits. brand name.
• Insufficient training of labour.
Opportunities Threats
• High growth potential in the Asian market • Shortages of skilled labour.
when trade barriers are lifted. • Increase in interest rates.
• Depreciation of the exchange rate. • Inflation.
• Changing pattern of demand towards laptop • New mobile phone technology.
computers.
• Relocation.
2 Every six months, LVM holds meetings to review key strategic decisions. This helps managers
assess the most likely successful future strategies and their constraints. It identifies weaknesses so
that actions can be taken to address potential internal problems. It enables the business to take
advantage of potential opportunities. However, subjectivity is often a limitation of SWOT. It is not a
quantitative technique and should be used as a management guide for future strategies rather than as
a prescription. Part of the value of SWOT is the clarification and mutual understanding that senior
managers gain.
3 Having conducted a SWOT analysis, a business may wish to build on its strengths, address weaknesses,
take advantage of opportunities and prepare to deal with threats. For LVM, there are a number
of strategic options suggested by the SWOT analysis. Learners could consider two from the
following strategies:
Address a weakness by selling under its own brand name. LVM would need to consider:
• The cost of entering the market as a distinct brand, including the marketing expenditure required
to develop brand loyalty.
• Competition from established brands such as Dell.
• Operational issues, including the capacity of the existing factory.
• Models currently under development could give competitive advantage.
• Choice of channels of distribution: direct to consumer or via retailers.
• Inexperience of selling to retailers and consumers.
Address a threat by developing mobile phone technology. LVM would need to consider:
• That this would be a risky option, especially after rejecting it two years ago. Competitors have a
significant early lead in developing the product. It would be difficult for LVM to catch up.
• Cost of R&D is significant. Although profits are steady, would LVM have the funds available
for research?
Take advantage of an opportunity to relocate to an area of high unemployment. LVM would need
to consider:
• The impact on the existing workforce and ethical considerations.
• The size of the government grant available balanced against other location factors, such as the
availability of labour.
• Low cost of labour could give competitive advantage.
• The need for finance and concern over rising interest rates.
Evaluation: cost and risk are likely to be important issues. The Ansoff matrix could be used to help
evaluate risk.
Activity 8.5
1 Product differentiation
• Demand will be less sensitive to price. Product differentiation will enable a firm to charge higher
prices for its product.
• Differentiation may be expensive to develop if the aim is for genuine differences.
• The strategy may be more successful when a firm is able to patent innovations that give rise to
product differentiation.
Buying out competitors
• Competition policy. In some countries, there is strict control of takeover activity to prevent one
firm gaining too much influence within an industry. The regulatory authorities have the power to
investigate proposed mergers and block them if it is felt that they are not in the public interest.
• Availability of finance. Can the business raise the capital to launch a takeover bid?
• Ownership of competitors. Private limited companies may be more difficult to take over because
shares are concentrated in a few hands.
Focus on less competitive market segments
• Size of the market segments. If demand is very low, the segment will be of less interest to other
firms. However, the returns will also be low.
• How easy it is for other firms to enter the market segment.
• Different needs of the market segment. The degree of difference will have an impact on the cost of
developing products for the segment.
Activity 8.6
1 Fashion industry
• The threat of new entrants is low due to the strength of the existing brands in the market. It would
be expensive for new entrants to build brand awareness. It is difficult for new entrants to establish
appropriate distribution chains as exclusive shops often have agreements with fashion companies
to be their exclusive outlets. E-commerce may make a route to the market possible for new
fashion houses.
• Power of buyers. There is a limited number of large buyers, which increases their power over
the fashion companies and increases competitive rivalry. However, there is a large number of
independent buyers, which would reduce competitive rivalry.
• Power of suppliers. Suppliers are relatively weak as there are many suppliers of the materials used
in the industry.
World car industry

• The threat of new entrants is relatively low due to worldwide overcapacity and the substantial
costs of capital equipment. Economies of scale are also significant in the car industry and this led
to mergers in the 1980s and 1990s so that firms could share components between models.
• Brand awareness is high and it would be expensive to build a new brand from scratch.
• Threat of substitute products. Alternatives to the car are limited. Other forms of transport, such
as trains and buses, lack the flexibility offered by the car.
• Power of buyers. Manufacturers control many of the car showrooms directly or indirectly. Large
multinationals dominate the car industry.
• Power of suppliers. Car manufacturers such as Toyota and Nissan have tried hard to build supply
chains rather than use multiple suppliers. This enhances the power of the remaining suppliers.
• To gain sales, manufacturers have to take market share from each other as industry growth is low.
This increases competitive rivalry between firms.
Activity 8.7
• Just setting objectives is not sufficient to ensure that they are achieved. Logically, having
determined its objectives, a business needs to develop strategies that will facilitate achievement of
the objectives. Therefore, it needs a long-term plan.
• Long-term plans provide a sense of direction for a business and its employees. A plan helps ensure
that all parts of the organisation are working towards fulfilling the objectives.
• A plan can also motivate employees.
• GDP per head. This will affect consumer demand for coffee shops. Rising incomes provide an
opportunity for increasing sales at the type of coffee bars operated by Caffè Nero.
• Inflation. If inflation is volatile in Turkey, it will be more difficult to plan. Predicting future costs
and revenues becomes increasingly difficult the more volatile the inflation rate.
• The number of established coffee chains in the market and their market share. If another chain has
already built a substantial market share, it may be more difficult for Caffè Nero to establish itself.
• Recent growth in the market. A rapidly growing market will be easier to enter, as competition may
be less intense as there are sufficient consumers to share.
• Changing patterns of consumption, e.g. relative spending on different types of coffee. This may
indicate whether there is potential for the type of products that Caffè Nero sells.
• Exchange rate. This will affect the cost to Caffè Nero of entering the market.
3 Caffè Nero is adopting market development as it is aiming to sell its existing products in new markets
by entering the Turkish market, among others. Caffè Nero is therefore focusing on the product that
it already understands, which reduces risk. However, by entering new markets, the business is taking
a risk as the consumers in new markets may be very different to consumers in existing markets. Caffè
Nero may need to adapt its product offer. The appointment of a manager with experience of the
Turkish market and understanding of changing consumer tastes in the country will give Caffè Nero a
better chance of success.
Caffè Nero may have decided on this strategy because:
• existing markets are saturated
• the Turkish market has growth potential.
Siemens Gasema is using product development and market penetration. It is developing more efficient
wind turbines to gain a competitive edge and therefore penetrate its existing markets. It is using this
approach because of its expertise in developing products and because it has significant cost advantages
due to its scale of production.
4 Businesses typically aim to make profit, increase market share and increase sales. Factors
influencing strategy include the following:
• Ownership. This will affect the availability of finance and skills within the business and therefore
the strategies which can successfully be adopted.
• Owner attitude to risk. If owners are risk averse, they will avoid taking on too much debt and
will use more cautious strategies, e.g. expansion may be far less aggressive and organic growth
more likely.
• Economic factors.
• Interest rates affect the desirability of debt finance.
• Economic growth will be critical.
• The exchange rate may influence location decisions.
• Market factors such as the long-term prospects within a market, e.g. oil companies will have
to look for alternative energies if they are to continue to grow. Competition will also have a
significant impact on strategic decisions, e.g. if one supermarket is to compete with another,
it may have to expand rapidly into non-food retailing.
• Social factors. For example, tobacco companies have had to develop strategies to respond to
declining sales in western economies. This has typically involved diversification and targeting
developing economies.
• Political factors. Tobacco company strategies have been influenced by legal restrictions in
many countries.
• The evolution of trading blocs (e.g. the EU) influences location decisions.
• Evaluation could include an assessment, using examples, of how different factors will vary in
importance depending on the business context.
Activity 8.8
1 Market development: Buildit Construction is aiming to enter a new segment of the property market.
Previously, the firm built houses for sale, but now it is considering entering the rental market.
2 Force-field analysis diagram:
Forces for change Forces against change

(driving forces) (constraining forces)
Cutting costs due to

Manager opposition (7)
economic downturn (8)
Change proposal:
Staff worried about new
Increasing responsibilities delayering of
responsibilities (3)
of staff (3) management and
multi-skilling
administration Avoiding redundancy (2)
Giving staff greater staff to increase
skills (3) flexibility Inadequate skills of
existing staff (3)
Disruption (4)
Total 14 Total 19
3 Improving the chances of this strategic choice being successful requires the directors to increase the
forces pushing the plan and/or reduce the strength of the forces opposing it. Possible approaches
may include the following:
• Raising the wages of remaining staff to reflect their additional responsibilities. This would add a
new force in favour of the change.
• Staff training would reduce inadequate skills but add a new constraining force in terms of the cost
of transition.
• Offer attractive redundancy packages. This would reduce the manager opposition but add to the
cost of transition.
• Evaluation could include an assessment of which way is likely to be more effective; also a
suggestion that a new force-field analysis is undertaken once these measures are taken to analyse
the impact on the chances of the strategy succeeding.
Activity 8.9
1 Node 1: EV = 60 000 × 0.3 + 120 000 × 0.7 = $102 000
Node 2: EV = 80 000 × 0.3 + 200 000 × 0.7 = $164 000
2 Net return of Town A = 102 000 – 50 000 = $52 000
Net return of Town B = 164 000 – 75 000 = $89 000
3 Factors include:
• Expected change in GDP and its impact on demand. If GDP is growing, there will be an increase
in demand. Income elasticity of demand will be important.
• Level of unemployment. Unemployment affects household income and therefore spending.
• Impact of competition in each town. If a competitor is offering similar products in a town, this
will affect estimated revenues.
Activity 8.10
1 Decision tree showing strategic options:
0.8 High
$500 000
Petrol forecourt
($100 000) 0.2 Low
$380 000 $400 000
$530 000 0.8 High

$800 000
Car showroom
($150 000)
0.2 Low
$200 000
2 Node 2: EV = 500 000 × 0.8 + 400 000 × 0.2 = $480 000

Node 3: EV = 800 000 × 0.8 + 200 000 × 0.2 = $680 000
Net return for petrol forecourt = 480 000 – 100 000 = $380 000
Net return for car showroom = 680 000 – 150 000 = $530 000
Based on the decision-tree analysis, the car showroom is the better option.
• Attitude towards risk. If demand is low, the car showroom only provides a return of $50 000
whereas the petrol forecourt provides more consistent returns of $400 000 and $300 000
respectively for high and low demand.
• Availability of finance. The car showroom has a cost of $150 000 compared to $100 000 for the
petrol forecourt. The owner may struggle to finance the car showroom.
• Cash flow. The petrol forecourt is likely to provide a quick turnover of stock and require less
working capital to run. The car showroom may require significant inventory and working capital
to run.
1 Which country?
1 Decision tree showing options:
0.4
$5m
Country A
0.6
$8m
0.3
$3m
Country B 0.5
$4m
$6.9m 0.2
$8m
0.4
$3m
Country C
0.5
$6m
0.1
$10m
0.3
$5m
Country D 0.3
$6m
0.4
$9m
2 Country A: EV = 5m × 0.4 + 8m × 0.6 = $6.8m

Country B: EV = 3m × 0.3 + 4m × 0.5 + 8m × 0.2 = $4.5m
Country C: EV = 3m × 0.4 + 6m × 0.5 + 10m × 0.1 = $5.2m
Country D: EV = 5m × 0.3 + 6m × 0.3 + 9m × 0.4 = $6.9m
Based on quantitative data, Keenan should expand into Country D.
3 Benefits of the decision tree technique
• It gives a quantitative measure for making the decision between the four markets.
• By estimating probability, it helps minimise risk and the decision can be based on potential
profitability.
• It encourages managers to consider and discuss all options.
Limitations of the decision tree technique
• These are new markets abroad and Keenan’s estimate of returns and risk depend on the
quality of the data. Keenan has no experience of the markets, so the estimated probabilities
may be inaccurate.
• Expected values are average returns. However, there will only be one outcome and this is still
unknown, so the decision tree does not eliminate risk.
• Decision-tree analysis does not take account of qualitative factors’ impact on a decision.
Evaluation: the managers’ attitude to risk is very important. They may prefer a country that offers
greater certainty rather than the highest returns.
4 SWOT analysis: this provides a useful starting point for strategic analysis. It can identify strengths
that the business can build on and weaknesses that should be addressed. Opportunities will help
identify areas for expansion. However, SWOT analysis is highly subjective and one manager’s
assessment might be very different to another’s.
Force-field analysis: this considers all the forces for and against a decision. These forces are given a
numerical score to establish whether the driving forces outweigh the constraining forces. Managers
can then consider how to increase the strength of the driving forces and reduce the constraining
forces. The technique encourages managers to consider a range of qualitative factors, including the
reaction of workers to a proposed strategy. However, assigning a numerical value to the forces is
subjective and different managers will identify different factors as being important.
2 Restaurant owner considers her options
1 Big extension:
Expected value = 60 000 × 0.5 + 600 000 × 0.5 = 30 000 + 300 000 = $330 000
Subtract cost = 330 000 – 200 000 = $130 000
Small extension:
Expected value = 40 000 × 0.2 + 200 000 × 0.8 = 8 000 + 160 000 = $168 000
Subtract cost = 168 000 – 75 000 = $93 000
Do nothing: expected value = $0
2 A number of factors should be considered:
• The decision-tree analysis demonstrates that the big extension has a higher expected value, so
is preferable. It offers an average expected value of $130 000, which is $37 000 (approximately
40%) more than the small extension.
• If June proceeds with the big extension and it is a success, it will produce a profit of $400 000
compared with only $125 000 for the small extension. That represents a 200% return on
the investment.
• However, with the big extension, the chance of success is only 50% or 1 in 2. The investment is,
in other words, just as likely to be a failure. If it fails, June will lose $140 000. Such a loss could
destroy June’s business.
• In contrast, the small extension has a strong chance of being successful and generating a
return of $125 000. If it fails, the loss would be a more modest $35 000.
• Doing nothing generates no extra profit. There is the possibility that customers will tire of
having to wait for tables and, therefore, start using other restaurants.
• June normally avoids risks. The lowest-risk option is to do nothing. The highest-risk option is
to build the big extension.
• Given her attitude towards risk, the most stressful option is to build the big extension. June
will be worried about the 1 in 2 chance of failure and will also have to cope with the greater
disruption to the business as it is built.
• If June has to borrow most of the $200 000 for the extension, the gearing of the business will
increase significantly. There is a greater risk of being unable to repay the principal loan and
service the debt.
• The decision-tree analysis is based on estimates of revenue and costs, and the probability
of success and failure. Although it is a quantitative technique, the estimates may be highly
inaccurate.
Evaluation: the decision tree favours the big extension. However, June is risk averse and this
suggests she would favour the smaller extension because the big extension has a relatively high risk
of failure and potentially catastrophic consequences for June’s business. The big extension is more
than twice the cost, will cause more disruption, necessitates targeting a higher-income market
segment and is as likely to fail as to succeed. Therefore, of the two options, June should choose the
smaller extension.
3 PEST analysis. This is a form of strategic analysis that analyses the external environment within
which the business operates or where it is thinking of operating. It encourages managers to
consider the political, economic, social and technological influences on business. The analysis
will guide managers towards possible strategies that can be developed or determine whether a
new market is suitable. For example, understanding the economic environment could highlight
the possibility of June taking the restaurant upmarket due to rising incomes. PEST complements
SWOT analysis and considering the external environment is essential in assessing the chances of
a strategy being successful. As the business environment is dynamic, a PEST analysis can quickly
become outdated.
Porter’s five forces. This technique analyses competitive forces within a market based on
considering the barriers to entry, power of suppliers and buyers, and threat of substitutes. This
enables competitive rivalry to be determined. It helps make decisions about whether to enter a new
industry and can provide insight into the profitability of markets. It can analyse existing markets
to decide whether to stay in the market and help formulate strategies to reduce competitive rivalry.
The Ansoff matrix. This focuses on the different options for increasing sales growth based on
the two variables of market and product. The four options are market penetration, product
development, market development and diversification. The matrix allows managers to analyse the
degree of risk associated with each option. However, it is limited by its focus on just two variables.
It is therefore essential that other factors are also considered.
be different.
Coursebook answers
Chapter 9
Business in context
Why is constant business change occurring?
• Changes to the external environment including economic, social, technological and environmental.
Good leadership and corporate culture during a period of significant change
• Corporate culture determines how things are done in the business.
• Culture is a powerful influence on flexibility to meet change.
• Leadership provides vision for the business.
• Inspirational leaders can lead change and persuade employees of the need for change.
Activities
Activity 9.1
1 A corporate plan provides managers with a clear focus for several years ahead, e.g. to continue with
earnings per share growth. Its sense of purpose can be communicated to all managers and employees.
It helps ensure that all employees are moving the business in a uniform direction. It enables control
and review; actual outcomes can be compared with the objectives and the performance of PepsiCo can
be assessed. It helps ensure that resources are used effectively and that all departments are working
together. The planning process itself is useful as it encourages directors and managers to consider the
current situation of the firm and to set objectives accordingly.
2 A key part of corporate planning is control and review, which is likely to be more successful with
quantifiable targets. Targets are used not just by managers but also by external stakeholders (e.g.
investors looking for financial targets). Targets allow for planning financial resources (e.g. a budget for
increased marketing support or cost of retrenchment). However, qualitative factors such as culture or
environmental impact also need to be considered. The main limitation of corporate planning is that the
business environment can change so rapidly, particularly for a multinational corporation operating in
a large number of markets. Change to the business environment will make parts of the plan outdated.
The planning process should try to identify how the firm should react to a variety of changes in
the environment.
Activity 9.2
1 Learners’ answers might include two from the following:
• Power culture: in response to a crisis as it is important to make decisions quickly.
• Role culture: where stability is needed, e.g. in a large bank.
• Task culture: where product life cycles are short and therefore there is a need to be adaptable,
e.g. in technology industries.
• Person culture: where an organisation has employees working abroad on their own, so those
individuals do not have to refer all decisions back to head office.
• Entrepreneurial culture: in a highly competitive industry, encouraging risk-taking in order to gain
a competitive edge.
Activity 9.3
1 Problems: no sense of common purpose; employees motivated by self-interest rather than corporate
goals; no code of ethics to inform appropriate behaviour.
2 Change the way pay and bonuses are determined, e.g. not just based on volume of business but on
whether the actions of the employees follow the values. Internally appoint change champions to share
new values and encourage commitment to these values. Ensure that values are communicated to and
understood by all employees.
Activity 9.4
1 If organisational cultures are different, expansion is less likely to be successful because:
• The two cultures will conflict and lead to disputes at all levels of the new organisation.
• The firms have different ways of operating. For example, if a business with a power culture merges
with a business that has a person culture, the role of the individual is very different. Autocratic
leaders in the first business would fight to maintain their power, whilst employees in the second
business would resist any loss of freedom to express themselves fully.
• Conflict will cause inefficiency in decision-making.
• The merged business will not share the same values.
• If cultures are different, there will be no synergy between the merged businesses.
As Porsche adopts more of a stakeholder view of its role, if it merges with a firm that puts the
shareholder first, there will be conflict between the management of the two businesses.
After a merger, the business may have to adopt a single culture. Changing the value system of a
business and attitudes of staff is never an easy task.
The success of an expansion depends, in part, on the businesses sharing common values and goals.
Activity 9.5
• Sally should have tried to obtain the support and commitment of existing directors to drive
through the changes she believed were required. Replacing 50% of directors and key managers
within five weeks is likely to cause conflict and demotivate employees used to the old culture, which
rewarded service.
• Sally should have explained to workers that the culture needed to change as it is a very
competitive market.
• It would be useful to allow discussion and for employees to be able to propose alternatives rather
than imposing change on them.
• The business could have adopted a new mission statement that reflects its values without
completely removing the positive aspects of the old culture. The statement should have been
communicated to employees. Sally could have focused more on some of the good aspects of the
business that promoted staff loyalty and contributed to high levels of customer service.
2 Answers need to identify the benefits of the change in culture and the weaknesses of the existing
culture. These might include:
• The old culture promoted a complacent attitude towards business growth.
• Low profitability threatens the future competitiveness of the business due to a lack of funds
for investment.
• Promoting staff for long service does not guarantee that they will be competent to do the job.
It also reduces the exposure of the business to new ideas.
• The change in culture has enabled the business to make cost savings through driving supplier
prices down and changing pension arrangements for new staff.
Problems:
• The change in culture will have significant short-term costs due to employee resistance and the
disruption caused by the loss of 50% of key managers and directors.
• The power culture adopted by Sally extends to treatment of suppliers. An adversarial relationship
with suppliers will impact long-term prices and quality.
Evaluation: the culture is being changed to meet the expectations of shareholders. These expectations
may focus on short-term profit at the expense of the long-term viability of the business. The old culture
at President Supermarkets was beneficial in promoting a stakeholder view of the role of the business
and it may be argued that such a view provides a firm foundation for long-term success.
Businesses that involve employees may be more profitable in the long term because the employees will
be more dedicated to achieving the goals of the business. Sally appears to be alienating her staff.
Activity 9.6
Activity 9.7
1 Communicating the need for change: this reduces resistance to change as employees will understand
why the organisation has to adapt.
Training: as Britax has introduced a complex computer system, it is critical to provide employees with
suitable training. Training reduces the fear of modern technology felt by some employees.
2 Answers might follow Kotter’s eight-stage change model:
• Create a sense of urgency. Identify why change is necessary. Change is easier to implement if
everyone in the organisation wants it.
• Create an effective project team to lead the change. Strong leadership, supported by key
individuals from different departments, is needed to lead change. When Britax introduced its
complex computer system, the change would have required different departments to work together
and therefore an effective project team was essential.
• Develop a vision and a strategy for change. A clear vision, based on values that are central to the
change and easy to remember, helps people understand why change is necessary.
• Communicate this change of vision. The new computer system at Britax required a change in
working practices and skills, so it was important to communicate the need for change to employees.
• Empower people. Get rid of obstacles to change. At Britax, employees were empowered through
training. This would reduce opposition to change.
• Build short-term gains from change that benefit as many people as possible. Success will motivate
people. Short-term targets that are achievable help maintain the momentum of change.
• Consolidate the gains. Real change runs deep in an organisation. Kotter argues that many projects
fail because they do not build on their successes.
• Build change into the culture of the organisation. The link between change and improved
performance needs to be communicated effectively.
• Evaluation might include a discussion of why each stage is important and could suggest that
involvement of employees (for example) is often the most important factor.
Activity 9.8
1 Environmental disaster, e.g. allowing pollutants such as the vegetable oils used in manufacturing
chocolate to be released into rivers. Pollution of local waterways by Cadbury would lead to negative
press coverage in the national press. As environmental issues are increasingly important to consumers,
this could impact on sales.
Industrial action by the workforce. Strike activity would disrupt supplies of Cadbury’s products
to retailers and potentially lead to consumer dissatisfaction. As consumers switch to rival brands,
Cadbury would lose market share.
2 Contingency planning for events such as contamination of food products is critical to protect the
market position of manufacturers like Cadbury. The benefits of contingency planning include:
• Swift action will minimise the damage to reputation.
• The public will be reassured by a decisive reaction to the problem. Retailers will also be
encouraged by a proactive approach by the manufacturer, e.g. in immediately recalling inventory
and providing compensation.
• The existence of a contingency plan highlights commitment to consumer safety.
• Contingency planning should reduce the risk of such an outbreak. However, even if safety
measures fail to prevent contamination, the authorities will be reassured that the manufacturer
takes these potential problems seriously.
• Appropriate action following the identification of the contamination reduces the risk of further injury
to consumers. Having made a plan, the response from the manufacturer will be more measured and
not just a knee-jerk reaction. Management is less likely to make mistakes in managing the situation.
Evaluation might consider:
• The contingency plan will not prevent crises and it is not possible to anticipate all possible
problems. Contingency planning also consumes valuable business resources.
• Contamination of foodstuffs will cost a manufacturer a great deal of money but might have been
significantly greater without a contingency plan.
• Crisis management is typically about damage limitation. In this case, the effective implementation
of a contingency plan ensured that there was only short-term damage to Cadbury’s image.
Activity 9.9
1 Problems might have included:
• Delay in relocating the business and loss of potential clients to competitors.
• Loss of data and disruption to marketing campaigns being planned for clients.
• Delay in payment from the insurance company, resulting in cash flow problems.
2 Arguments in favour
• Will reduce the impact of a crisis.
• Can help prevent crises.
• Reassures staff and customers that concerns for safety are a priority.
Arguments against
• The resources of a small business are insufficient to make detailed contingency planning feasible.
• An incomplete or poorly prepared contingency plan may cause more harm.
• The chances of most crises happening are too low to make a plan worthwhile.
Evaluation: this should balance the difficulties of undertaking planning for events that may never
occur with the consequences of failing to respond appropriately to a crisis.
Although it is primarily large firms which draw up detailed contingency plans for a range of possible
disasters, all firms may face crises. Small firms are just as likely to have to deal with crises such as fire,
earthquake, IT failures or accidents. They will have to make quick decisions and act to minimise the
negative impacts of a disaster and ensure survival. Small firms should therefore engage in some form
of contingency planning even if it is less formalised and on a smaller scale than in very large firms.
1 Choclite corporate plans
1 Ten percent sales growth of chocolates marketed at children:
• Competitors may launch new products aimed at children, making it difficult for Choclite to
increase sales.
• The external environment may change, e.g. the government might introduce increased
regulation on advertising directed at children. Therefore, Choclite would not be able to
promote its chocolates as effectively.
Increase shareholder returns:
• Share prices may be affected by factors outside Choclite’s control, e.g. global recession could
result in a fall in share prices.
• It may not be possible to decrease costs, due to an increase in the price of ingredients such as
cocoa. This would affect Choclite’s profits and therefore share price.
2 Useful: corporate planning gives a shared sense of direction and shared values, which are important
to a multinational company in keeping consistency across countries and protecting brand equity.
Limitations: corporate planning cannot cater for external changes (e.g. attitudes to obesity,
tax changes, exchange rate fluctuations, government policies), which will be different in all the
countries in which the firm operates.
Evaluation could include a discussion of why flexibility is important in a business plan in this
context and that not to plan could have serious long-term drawbacks for the business.
2 Culture change in a competitive market
1 With worsening profits, and in an increasingly competitive air-travel market, this service company
needed to be more customer focused. Change to focus on frontline staff, who are providing
customer service, was needed to give them more autonomy in order to increase their motivation.
2 To change corporate culture, some of the following are important:
• Commitment from senior management might have been difficult to acquire at DLM because
managers had previously been autocratic and in full control.
• A new mission statement needs to be developed to reflect the new values being introduced.
• Employees need to be involved in devising solutions to problems rather than a new culture
being imposed on them.
• Staff need to be trained.
• Reward systems to encourage appropriate behaviour.
Evidence of effective management of change:
• A critical element of the change was to provide training to employees. This was essential, as
changing the culture of the organisation will make increasing demands on employees. To avoid
them being overwhelmed by their new freedom, training is required. It is important to note
that employees had not previously been asked for their opinions. DLM provided extensive
simulation training so that employees would be prepared for dealing with customer issues.
• Training enables DLM to give staff considerable independence to deal with customer problems.
This independence means that they have more authority to be responsive to customer needs
and to act without seeking permission from head office. This will improve customer service.
• The case study states that the organisation was completely restructured to support staff. This
will also have contributed to the successful development of a new culture.
• Managers are now advisors. This reflects the new relationship between employees and
managers, as required for a more democratic culture.
Evaluation may consider that the case study provides only a brief indication of the way in which
the CEO has introduced change. However, the positive outcomes, in terms of profits and passenger
numbers, suggest that the changes were introduced successfully.
be different.
Coursebook answers
Unit 1
End-of-unit questions
African Publishing Company (APC)
1 Privatisation involves the transfer of assets from state ownership to the private sector. Privatisation
gave individuals and organisations an opportunity to become part-owners of APC as shareholders.
Shareholders have the benefit of potentially making a capital gain from an increase in the market share
price of APC shares. This is likely to have occurred as APC’s profit after tax increased by $95m over a
five-year period. With rising profits, the demand for APC shares will increase, resulting in a rise in the
share price. Therefore, shareholders will make a profit if they sell their shares at a later date.
The second benefit to shareholders is that, with rising profits following privatisation, it is likely that
there has been an increase in dividends paid. Dividends are the reward for investing in a company. As
dividends increase, shareholders benefit from a higher return on their investment. One of the factors
that has contributed to an increase in profits is that, following privatisation, APC has been able to
reduce operational costs by reducing the average annual salary of employees from $8 350 to $7 690.
2 Relevant terms and factors for learners to address include:
• Technological change will affect APC operations, e.g. computer typesetting of each book,
computerised inventory control, printing books, how consumers access reading through tablets
and e-book readers.
• Introducing new technology requires investment and therefore financing. APC has updated book
production and printing methods at considerable cost.
• APC has been able to expand the number of books in publication by just over 40% in the last five
years. This may be a result of the benefits of new technology. This could increase revenue for APC.
• Employee accidents have decreased, perhaps as a result of greater automation. This will reduce
costs to APC.
• Demand for e-books will reduce production costs as books no longer have to be printed on paper.
This will increase profit margins and sales as prices can be reduced but still have a higher mark-up.
• New technology has reduced the annual increase in energy usage, despite the continued growth of
the business.
• The introduction of new technology may be resisted by employees, due to fears over job losses.
• Computerised inventory control will reduce inventory holding and costs. APC will need less
working capital. This will increase profitability.
Evaluation: technological change has made the publishing market more dynamic. Therefore, APC has to
be able to adapt to change in order to remain successful. Technology is just one of many factors that will
affect APC’s future success. Appendix 2 includes a range of economic factors that will also be important.
Business strategy question

1 Strategy A benefits (the Ansoff matrix)
• Taking over DSF absorbs the profit margin of the bookshops and therefore increases profitability.
• It gives control over the price at which books are sold to consumers. This could be used to increase sales.
• It gives control over the promotion of books within the bookshops, i.e. favouring APC books.
Better marketing could result in higher demand and profit. This is a key driving force in the
force-field analysis conducted.
• APC estimates that the probability of success is 85% (i.e. only a 15% chance of failure).
Decision-tree analysis gives an expected value of $15m over five years.
• Country X’s economy is growing so, assuming that books have a positive income elasticity of
demand, there should be an increase in demand for books.
• DSF is the largest chain of bookshops in Country X so may benefit from economies of scale and
therefore drive other bookshops out of the market.
Strategy A disadvantages
• Competitive rivalry is high (Porter’s five forces).
• APC has no retail experience.
• Economic growth in Country X is only expected to be 1.5% per annum. Low economic growth and
a competitive market mean that competition between bookshops for market share will be fierce.
Therefore, profit margins are unlikely to increase.
• It may be that technological change will move demand from paper copies of books to e-books.
The bookshop market may be saturated and could decline in the future. Therefore, it is not a good
time to take over bookshops.
Strategy B benefits
• The merger would reduce the costs of printing in Country Y, enabling APC to reduce price.
Therefore demand will increase.
• The forecast depreciation of Country Y’s exchange rate and appreciation of Country X’s exchange
rate will make importing printed books from Country Y cheaper for APC. This will further
increase the price competitiveness of APC books in Country X.
• Strategy B has an expected value of $20m, which is greater than Strategy A.
• This is a horizontal integration. APC has experience of production so managers may be better
equipped to make the investment work.
• There is low competitive rivalry for Strategy B. This increases the chances of success.
Strategy B disadvantages
• Higher rate of inflation in Country Y may offset the benefit of a depreciating exchange rate.
Labour costs and material costs will increase.
• If there is a culture clash between APC and PAN, this makes integrating the two businesses more
difficult. PAN employees may resist changes that APC introduces.
• If production is moved from Country X to Country Y, there will be resistance from APC printing
workers. Recent investment in technology at APC may be wasted if production is moved completely.
• Estimated risk of failure is greater than Strategy A.
Evaluation
• Weighting of the quantitative and qualitative factors is required to reach a final judgement.
• Attitude to risk is important. Strategy A has a higher probability of success yet APC lacks
experience of retailing. APC may prefer to focus on its core competence, which is publishing and
printing. APC has been successful over the last five years in that market.
be different.
Coursebook answers
Chapter 10
Business in context
• Employees are often described as being the most important asset of a business.
• For example, Huawei is a technology business and depends on employees for the research and
development necessary to maintain competitiveness.
• A poorly managed workforce is likely to be less productive, resulting in higher labour turnover
and absenteeism.
• If health and safety is neglected then there will be more accidents and employee absence. This may also
result in compensation claims being made.
• Nurturing employees through, for example, training, increases their skills and productivity.
• Policies on gender equality will help attract the best employees to a business.
• Keeping labour costs low is important to remain competitive but in the long term a focus on just
reducing costs at the expense of keeping employees safe and nurturing them can be damaging to
business reputation. Costs may rise in the long term due to labour problems.
Activities
Activity 10.1
• Demographic change. Age distribution of the population will impact the number of students due to
start school and therefore the number of teachers required.
• Labour turnover in the school. This is the average number of teachers that change jobs and therefore
leave the school and need replacing.
• Competition. A new school opening would affect the number of pupils attending and teachers required.
• State of the economy. This could affect the number of students deciding to study A Levels rather than
looking for employment.
Activity 10.2
• Competition from other telecoms businesses. Demand for products is reduced and, as labour is
in derived demand (the demand for workers depends on the demand for the products they make),
there is a need to make workers redundant.
• Economic recession. Negative economic growth has reduced demand for goods and services. To
reduce costs, Alcatel-Lucent has made workers redundant.
2 Learners should define workforce planning. Without a workforce plan problems may arise:
• Incorrect employee numbers. This may result in insufficient output to meet demand. This could
lead to a loss of goodwill and market share.
• If there are too many employees, it may lead to an increase in costs, making the product less price
competitive or reducing the profit margin.
• Skill shortages. For example, research and development employees are required to innovate new
technologies for which demand will rise in the future.
• Workers need to be recruited in time for future demand. Training may take several years.
Specific skills may be in short supply so planning is needed to prevent shortages.
• For Alcatel-Lucent, there is also a need to plan for reducing the number of production
workers. With planning they may be able to avoid compulsory redundancies and industrial
relations problems.
Evaluation might focus on the importance of workforce planning, especially for skilled employees in
a business such as this. However, it is possible that the success of the business depends on many other
factors too, such as the competitive nature of the industry and therefore the need to be innovative
while also controlling costs.
Activity 10.3
1 Training increases employee motivation as it makes employees feel more valued and improves self-
esteem. Maslow’s hierarchy of needs emphasises the importance of higher-level needs being met.
Training also provides a sense of career development. This is a motivator in Herzberg’s
two-factor theory.
Appraisals show that managers are taking an interest in employees and improving communication.
Mayo’s human relations theory emphasises the importance of this to motivation.
2 Arguments for: lower recruitment and training costs, established teams, maintains skills and experience
leading to better customer service.
Arguments against: no fresh ideas, increases complacency, may expect higher wages.
Evaluation: there may be an optimal level of labour turnover to allow new ideas to come into the
business without disrupting customer service. Labour turnover of 69% may be too high to allow
maintenance of customer service standards.
Activity 10.4
1 Advantage: a recruitment agency has specialist knowledge and experience so should be able to recruit
more effectively than SugarCo, which only has a small HR department.
Disadvantage: less control over who is finally recruited, as the recruitment agency provides a shortlist
of ten applicants from which SugarCo makes a choice for interview.
2 Factors influencing the final decision: experience is important as SugarCo is introducing new
computer-controlled machinery; enthusiasm and drive; commitment (Will the individual stay with
SugarCo in the long term?); salary expected (Can SugarCo afford to employ the research scientist?);
leadership skills (they will be controlling the operations department); reason for wanting the job.
Each of the three candidates has positive and negative points. Identifying the most important factor or
the best balance of qualities is important in the final decision. A recommendation should be made that
explains why one candidate should be chosen and not the others.
Activity 10.5
Activity 10.6
1 Training will reduce labour turnover. There will be lower recruitment and training costs, which will
help keep Lunar Cafés competitive. Employees will be more experienced and have higher skill levels
resulting in better customer service. Companies such as Lunar Cafés rely on high volume of face-to-
face customer interactions for sales success. Ultimately it is the employees working in the cafés that
create the customers’ experience and brand image for Lunar Cafés.
Lunar Cafés’ reputation as a good place to work will be improved, making it easier to attract new
employees of the correct calibre.
2 Arguments for: employees will feel more valued and learn new skills that will improve opportunities
for promotion.
Arguments against: they may use their new skills to gain higher-paid employment elsewhere. Other
needs must also be met, such as social needs and security needs. Financial incentives and working
conditions will also be important (e.g. competitors such as Starbucks give employees health insurance
and good pay).
Evaluation might focus on the industry-leading low level of labour turnover which, in part, is a
consequence of extensive investment in training and this suggests that training, and the benefits from
it, is the most important factor in employee motivation in this case.
Activity 10.7
1 A strike would have been harmful to Cathay Pacific as it would disrupt flights and therefore reduce
flights and sales. The disruption caused to passengers would damage the airline’s reputation, leading to
a long-term loss of sales and profit. Customers would travel with other airlines and might never return
to Cathay Pacific. Compensation might have to be paid to customers and many of the airline’s costs
would still have to be paid.
The strike would be harmful to employees as they would lose pay whilst on strike. Loss of earnings
would decrease living standards. If the business were to lose long-term custom then jobs would
be threatened.
• It is a competitive industry and therefore controlling costs is important.
• Airlines have high levels of fixed costs which must be met during any industrial disputes.
• Customer service is important. Employees need to be motivated.
• Employees may need to be flexible in their working arrangements to allow airlines to operate
varied routes.
• Evaluation could include a consideration of the importance of reliable flight schedules, especially
for business travellers, so avoiding conflict with effective management–employee cooperation is
particularly important in this industry.
1 Learners’ answers will vary, e.g. recruitment and selection of employees. This is important as
the competitiveness of businesses depends largely on the quality, experience and skills of the
selected employees.
2 Without appropriate employees, a business cannot operate efficiently across its functional areas.
Efficient employees will assist the business in becoming more competitive.
3 A job description focuses on the job to be done, i.e. title, roles, responsibilities, place in the hierarchy.
A person specification, in contrast, focuses on the employee required, i.e. their skills, experience,
qualifications and personality traits.
4 The monetary and time costs of training employees need to be considered and weighed against the
cost of bad reputation and faults if employees are not fully trained. Training may take time and take
employees away from productive activity. However, with insufficient training, employees will not
provide effective customer service and will have lower productivity.
5 Learners’ answers will vary, e.g. training and development can make an employee feel valued and part
of the business. This increases motivation, which gives employees more satisfaction at work. This can
result in increased productivity. Higher productivity will help to make the business more competitive.
6 The process of assessing the effectiveness of an employee judged against pre-set objectives.
7 As these contracts are legally binding, they protect the rights of both parties by clarifying the
responsibilities of both parties, e.g. the hours expected to be worked by an employee and the number
of weeks’ holiday they are allowed.
8 Dismissal means the worker loses the job but the job still exists. A worker may be dismissed for
gross misconduct (e.g. stealing or persistent failure to complete the job role as required). In contrast,
redundancy means a worker loses their job because the job no longer exists. This could be because of a
fall in demand or change in operations.
9 Balance between hours and stress of work and the time spent with friends and family on leisure time.
This allows employees to be more satisfied at work, less tired and more productive.
10 Learners’ answers will vary, e.g. recruiting employees from diverse backgrounds can ensure that the
business’s workforce reflects the demographics of society. Recruitment will be from a wider section of
society and therefore ensures that the business can employ the best workers.
11 Outlines the key qualifications (e.g. nursing degree); characteristics (e.g. able to work under pressure);
and skills (e.g. care of the elderly). This helps select the best candidate for the position.
12 An external candidate will bring new ideas and practices to the business. This may help identify
improvements that need to be made in the business’s procedures and operations, especially as the post
is for a senior manager.
13 On-the-job training takes place within the business itself, often as the worker performs the actual work.
In contrast, off-the-job training takes place away from the business, either through a specialist training
provider or at a college or training institute.
14 The decision on whom to employ is based on merit, e.g. the quality of work the employee can
undertake. This improves the competitiveness of the business.
15 Industrial action would put lives at risk. It is important that there is management–worker cooperation
so that workers and management do not misunderstand each other. This might mean that management
discusses issues with workforce representatives such as a trade union. Misunderstanding can lead to
industrial action which reduces the ability of a business to provide good customer service.
Essay questions
1 a As HRM is a strategic approach to the effective management of a business’s workers to ensure
that they aid the business in gaining a competitive advantage, there are several key roles. Learners’
answers will vary, e.g. workforce planning; recruitment and selection; appraisal and development
of staff; measuring staff performance. Learners need to explain any two of these in the context of
a business.
b Learners should define recruitment and selection. Effective recruitment and selection:
• Ensures that job roles can be performed effectively across all functional areas (e.g. chefs for
preparing menus and cooking meals; waiters for serving customers). As restaurants focus on
customer service, it is essential that the right individuals are recruited for these roles.
• Reduces labour turnover and therefore saves costs.
• Improves cooperation and teamworking within the business.
• Reduces the need for training.
• Evaluation could assess the other factors that are important to effective HRM in a restaurant
such as pay methods, effective communication and management style used.
2 a Learners should define training. Labour is one of the most important resources that a business has
and training may be essential to maximise the efficiency of that resource. Learners’ answers may
include development of any two of:
• Higher labour productivity and therefore an increased value of work undertaken
by employees.
• Better-quality product or service as employees will be able to carry out their jobs more
effectively. Therefore, the value of work completed by employees will be greater.
• More motivated employees as new skills are developed and work becomes more challenging.
• Reduced labour turnover as employees feel valued. This means that the costs of recruitment
can be reduced, resulting in cost savings across the organisation.
• A reduced level of accidents in the workplace as employees are more familiar with good
working practices.
• It may be beneficial to train internal employees rather than recruit from other firms. This
ensures that employees do things the company way.
• Well-trained staff are an asset to the business and help to retain customers.
b Improving employee morale is important as it may increase labour productivity and help control
costs due to lower labour turnover. Improving employee welfare is a hygiene factor according
to Herzberg and this will also reduce the costs associated with labour turnover. However, HR
performs many other important tasks including:
• Workforce planning to ensure that the business has the necessary human resources to
achieve its goals. This function will include ensuring that there are appropriate contracts of
employment.
• Recruitment and selection to ensure that the business has the right workers. If employees are
recruited effectively, they will be more valuable to the business and their skills are more likely
to match the needs of the business.
• Training to improve workforce skills, bringing benefits such as higher labour productivity,
which increases the value of work undertaken by employees; a better-quality product or
service as employees will be able to carry out their jobs more effectively; reduced labour
turnover as employees feel valued.
• Disciplining and dismissal of employees.
• Developing appropriate pay systems to reward and motivate employees.
• HRM also helps avoid costly errors in terms of the misapplication of labour laws. Contracts
of employment must be fair and accord with current employment laws.
Overall evaluation is needed and should consider the relative importance of morale and welfare in the
context of the many other roles of HRM in a manufacturing business.
3 a Learners’ answers should develop any two of:
• reducing workload by ensuring that class sizes are not too large
• employing support staff (e.g. to photocopy work)
• setting appropriate expectations of work to set and mark
• managing contact hours with students
• offering professional development through training to enhance skills
• scheduling meetings with parents at appropriate times.
• Role of effective workforce planning in ensuring that the business has the necessary human
resources to achieve its goals. Customer service is important in retailing and HRM needs to
ensure that, for example, there are always shop assistants available.
• Workforce planning will also ensure that there are appropriate contracts of employment.
• Importance of recruitment and selection to ensure that the business has the right workers.
Effective recruitment also reduces labour turnover, which adds to costs.
• Role of training in improving the skills of the workforce. Training brings a range of benefits
such as:
• better customer service
• reduced labour turnover as employees feel valued.
However, in evaluation, the profitability of a retailer is not the responsibility of just HRM. Human
resources is just one of the functional areas of the business and must work with finance, operations
and marketing to create a successful retail business. Other factors will also affect profitability.

1 E&B Engineering
a i The employee brings new ideas to the business.
ii Legal document that sets out the terms and conditions governing a worker’s job.
b i 15/60 ×100 = 25%
ii Has to recruit new employees to replace those who have left. It then takes time to discover whether
the new recruits are suitable. This disrupts production, making it difficult to fulfil customer orders.
c Learners’ answers should include analysis of any two of:
• The use of the job centre appears to be ineffective. The job centre does not understand the
needs of the operations manager and is sending unsuitable candidates. However, the job centre
is likely to be cheap to use and can provide workers at short notice.
• E&B needs to communicate more effectively with the job centre about its particular needs.
Alternatively, E&B could use a specialist recruitment agency although this might prove expensive.
• Poor selection procedures mean that unsuitable workers start work before E&B finds out what
they are really like. E&B makes do with whoever happens to be available from the job centre.
• Advertising is not effective at filtering out unsuitable applicants. Job adverts should clearly
identify the skills and experience expected from applicants. However, advertising in the local
media will be relatively cheap.
• Recruitment and selection have been left to the operations manager. It might be more effective
to use an HR specialist.
d HRM is an approach to managing people that emphasises the importance of planning and
developing the workforce. It is a strategic approach to the effective management of a business’s
workers to ensure that they aid the business in gaining a competitive advantage.
Effective induction training will help new recruits settle at E&B. Harryo has little idea how to
introduce recruits to the organisation and is unprepared for this role. Training improves skills and
provides new challenges for employees. Developing skills may help employees achieve their esteem
needs within Maslow’s hierarchy of needs. This would reduce the number of employees leaving the
business. Evaluation could include an assessment of the view that workers may use their training
to look for better employment opportunities. It is therefore important that E&B pays competitive
wages to retain employees.
2 Cameron Sweets Ltd (CS)

a i Theft.
ii Acquiring skills to complete different tasks (i.e. being able to operate the different machines
used by CS).
b Learners should define workforce plan. A workforce plan will enable CS to have:
• Appropriate staffing levels to meet the demand for sweets from customers. Without sufficient
employees, there may be bottlenecks in production. This could lead to a loss of goodwill
and market share. If there are too many staff, it may lead to an increase in costs, making the
product less price competitive or reducing the profit margin.
• Necessary range of employee skills. With new machinery being installed, if CS does not plan
its future labour needs, it may result in not having workers with the right skills to maintain and
programme the machinery.
c Learners’ answers should include development of any two of:

• These policies should ensure that CS recruits from the widest possible range of potential
employees. Therefore, the best workers can be recruited.
• People who come from different backgrounds can add new experiences, talent and skills to the
workforce. Diversity creates more innovative business outputs. By contributing different ideas,
a diverse team can generate more creative solutions to problems.
• When a business introduces people into teams with different social, geographical and cultural
backgrounds, it gets a new knowledge base for potential new markets.
d Negotiating pay and conditions is easier and less likely to result in conflict. CS introduced flexible
working with the support of trade union officials. This change helps CS control costs and remain
competitive. Cooperation resulted in improvements being made to employee welfare and this
helped improve morale, which should lead to an increase in productivity. A culture of cooperation
between management and the trade union was significant in ensuring that the dismissal of the
three workers did not result in industrial action.
Evaluation could include the view that well-motivated employees and good cooperation between
the union and management will provide a good foundation for business success in a competitive
confectionery industry.
be different.
Coursebook answers
Chapter 11
Business in context
• People’s needs: income; friendship; satisfaction; achievement.
• Different needs: cultural differences; differences in living standards between countries; level of
unemployment differences between countries.
• Recognition: learners’ own answers.
Activities
Activity 11.1
1 Learners’ answers will vary, e.g. sense of belonging; social needs; achievement and involvement, which
helps satisfy esteem needs.
• Low labour turnover, which helps to create customer loyalty.
• Lower recruitment and selection costs so the business is more competitive as a result, which is
important in this market.
• Better customer service, which is important in a fresh food store where customers expect rapid and
efficient service.
Activity 11.2
1 Maria’s esteem needs appear to be met as she feels appreciated by the firms she works for.
Asif’s social needs are met through the group of friends he works with. Esteem needs are not met as he
does not feel appreciated.
Imran is keen to find a more permanent job. This indicates that his safety needs have not been met.
Therefore, he is on the physical needs level of the hierarchy.
2 Herzberg’s two-factor theory identifies two sets of factors related to motivation. Firstly, hygiene factors
have the potential to cause dissatisfaction and are therefore related to labour turnover. However,
hygiene factors do not motivate employees; these factors include job security, wages and conditions
at work. Motivators are those factors that motivate the individual and these relate to responsibility,
opportunities for promotion and achievement.
Currently many hygiene factors are present for Asif in the shop. He has a good relationship with his
colleagues and is pleased with his pay. To motivate Asif, a manager could:
• Increase his level of responsibility (e.g. give him the task of arranging the shop displays).
• Provide training to enhance his skill level. Training would also prepare Asif for the possibility of
promotion, another motivator according to Herzberg.
• Job enrichment. This involves making a job more challenging or rewarding. This could involve
the shop providing Asif with a range of roles and activities within his job (e.g. mentoring newer
workers or being involved in induction training).
• Empowerment. This could include giving Asif the right to take decisions that affect his working
life (e.g. making decisions over how and when work is done).
• Job rotation could be used to give more variety to Asif’s work. However, switching between a
variety of boring tasks does not necessarily make the job more interesting than performing one
boring task.
• Offering a clear career path so there are opportunities for promotion. Asif would like
responsibility for deciding what stock should be sold. He would need to gain experience and might
need training before he could be given such a role.
Activity 11.3
1 Herzberg’s motivators include sense of achievement, recognition, responsibility, promotion
opportunity, interesting work. These link to the comments regarding need for feedback, control over
work and job enrichment.
Vroom believed individuals have different goals, the value of the goal to the individual affects
motivation, people act to achieve their goals if they believe they’ll succeed. This links to the view that
people want leaders to provide clear expectations, structure and appropriate rewards if expectations
are met.
McClelland identified three types of motivational need found in workers and managers:
• Achievement motivation – feedback is needed and job advancement is important. This links to the
view that people want the opportunity for growth and development.
• Authority motivation – the desire to control others and to be influential. This links to the desire to
be given responsibility.
• Affiliation motivation – the need to be liked and held in high regard. This links to teamworking
and recognition for achievement.
2 To improve motivation of teachers, a principal could ensure that there is the following:
• A clear career path identified in the organisational structure (e.g. head of department, head of
faculty, vice principal, principal).
• Involvement in decision-making through consultation and staff meetings.
• Teamwork in departments.
• Freedom to deliver course content without interference from management.
• Professional development training.
• An appraisal system in place.
In evaluation, it could be suggested that these ‘motivators’ might not be sufficient, on their own, to
improve teacher motivations. It is also necessary to have good working conditions and pay to retain
teachers in the long term.
Activity 11.4
1 Commission-based – % paid on sales. Appropriate for sales staff as reward is directly related to their
sales performance.
Performance-related pay (PRP) – lump sum for achieving a target. Motivates managers to meet targets,
involves coordinating resources effectively, increases overall efficiency.
2 Shop workers – hourly rate: number of hours per week will vary; fair system, the more hours worked,
the more hours paid. Relatively junior members of staff are likely to be motivated by money. Plus
commission – % commission on each sale made, encourages good customer service, increases sales.
However, pushy salespeople may annoy customers.
Shop managers – salary: expected to work additional hours at no extra pay if necessary to complete
the job. Plus profit-sharing scheme – meets esteem needs (Maslow), strives to achieve business
objectives, rewards for position.
Activity 11.5
• Supply of suitably experienced and qualified recruits will be very different for these two jobs.
• There is a need to attract the right type of recruit for the management post so the financial and
non-financial benefits must be competitive.
• Other driving vacancies may offer similar pay and benefits to those offered in this advert.
2 Financial rewards offer the job holder the ability to satisfy physical needs; esteem; recognition for
important work. Financial rewards are necessary for employee motivation; Maslow and Herzberg
(hygiene factors).
Evaluation could include an assessment of whether financial rewards will be sufficient to motivate
people to do these two jobs well, but not according to Herzberg. In addition, some evaluation is
possible about whether ‘motivators’ are sufficient and how these could be incorporated into both of
these jobs to increase the chances of motivation.
Activity 11.6
Activity 11.7
1 Learners’ answers will vary, e.g. Maslow: physical needs – high salaries; safety/security needs – working
for a large, stable and growing business; social needs – opportunities for group work and meeting
colleagues in non-work situations; esteem needs – being consulted and participation.
2 Yes: employees are a major factor determining competitiveness, e.g. Google and the importance of
creativity and original ideas to keep the business at the forefront of online search engines.
No: in some businesses, the work might be fully automated or very unskilled so the type and skills of
employees are less important than other factors such as availability of the latest equipment.
Overall evaluation is needed, perhaps contrasting different types of businesses.
1 The internal and external factors that stimulate the desire in workers to be continually interested in and
committed to doing a job well.
2 Responsibility and communication, e.g. management consultation and teamwork are more important
for motivation than changes in working conditions and financial rewards.
3 Needs determine actions; meeting needs leads to motivation and motivated workers have
high productivity.
4 Loss of job security (e.g. a firm reducing the size of workforce).

5 Learners’ answers will vary, e.g. physical needs, where income is sufficient to meet basic needs (e.g.
food, housing, looking after family); esteem needs, including appraisal, recognition, job title, office.
6 Hygiene factors – based around the job, these factors do not motivate but if withdrawn lead to
dissatisfaction (e.g. company policy, pay). Motivators – based around the work, these factors do
motivate (e.g. achievement, responsibility).
7 Movement may make someone do a job but will not create a sense of want or pride. Motivation will
make a worker want to do a job and want to do it well.
8 Learners’ answers will vary, e.g. complete units of work – contribution identified and further challenge
offered; direct feedback on performance – awareness of progress; challenging tasks – gaining status
and recognition.
9 Achievement – workers need realistic and challenging goals; achieving these leads to a sense of
accomplishment; it is a common characteristic in business people, important to motivation.
10 Content theories focus on the inner needs of individuals as a source of motivation. Process theories
focus on how and why people choose behaviours to meet needs.
11 Learners’ answers will vary, e.g. basic needs – sufficient to meet essential needs; safety needs – ensured
regular and predictable payments; esteem needs – tends to be paid to managers.
12 Benefit: acts as a motivator as it can encourage hard work and loyalty because the success of the
business leads to higher profit bonuses for employees.
13 Job rotation: workers gain greater variety by switching between same-level jobs. Job enrichment: in
contrast, when workers gain a greater sense of achievement by completing more challenging jobs and
using a full range of skills.
14 Social needs are more easily met by working in teams, which helps to encourage a group spirit
amongst workers.
15 Autocratic managers will not encourage participation or teamwork, so emphasis will be on pay and
possibly threats of removing job security if work is not done to a certain standard.
16 The measurement of performance is always a major difficulty with performance-related pay. Learners
should discuss whether teachers should only be paid on results and how results should be measured for
teachers who do not teach exam classes.
17 Customers of a high-quality clothing shop will expect polite and well-informed sales staff who have
been well trained. Low motivation will mean the customer experience is poor and customer loyalty is
likely to be low, damaging brand image.
18 Learners’ answers will vary, e.g. close supervision – automated production lines; specialism – small
tasks carried out repetitively in mass production; piece rate – highly competitive, increased productivity
resulting in lower unit costs.
19 Piece work can encourage hasty and careless work, which means passing on faults to the next person
on the production line, leading to low quality.
20 Learners’ answers will vary, e.g. sharing ideas and expertise, leading to improvements to the product or
process; meeting social needs and overcoming monotony at work, leading to greater productivity.
21 A pension scheme linked to length of service which will encourage experienced senior managers not
to leave.
22 Learners’ answers will vary, e.g. ideas from employees on how to cut down on wastage; workers aware
of busy times so can help plan food production in advance.
23 Pay based on sales per employee, which can encourage better attention to customers and their needs.
Employee can also upsell (e.g. adding on the sale of accessories, warranties), therefore commission is
also appropriate for motivation.
Essay questions
1 a Herzberg’s two-factor theory. Employees are motivated by motivating factors (e.g. achievement
and recognition) but not by hygiene factors (e.g. company policy and salary). However, if the
hygiene factors are removed, it would lead to dissatisfaction.
Job enrichment is a major change that managers can introduce to improve employee motivation.
Learners should explain how the three elements of job enrichment can raise motivation levels.
b Learners’ answers will vary, e.g. Taylor. Selecting the right people for the job is still very important
even in automated manufacturing (e.g. software engineers); observing and recording employee
performance might not be possible, as automated production lines make measuring output of any
one worker very difficult; establishing the best method for doing a job to increase productivity is
still important to save time and avoid wastage of resources; piece-rate pay system is not widely
used in manufacturing as it can be divisive and individual output is difficult to measure.
Evaluation could consider that, perhaps, no single motivational theorist can provide all of the
answers to HR problems. Many of Taylor’s views have become less applicable in manufacturing as
the expectations of employees have changed.
2 a Learners’ answers will vary, e.g. high levels of productivity help to reduce costs and increase
competitiveness, which is important as there are many computer manufacturers; computer
designers might be key employees to the business so it is important to encourage them to stay with
the business to reduce labour turnover; technological change is rapid in computer manufacturing
so motivated R&D workers are important.
b Learners’ answers will vary, e.g.:
• Learners should explain Maslow’s hierarchy of needs.
• The statement is a Taylorist view of motivation. Taylor (scientific management) believed
that people work only for money. He suggested that piece-rate pay systems were effective in
motivating workers to work more productively.
• Money provides the means for workers to achieve other goals, e.g. money confers status on
employees; provides the means to satisfy material desires.
• Good rates of pay will attract recruits and help prevent dissatisfaction, reducing labour turnover.
• However, most motivational theories, although acknowledging the important role of pay,
suggest that there are other factors that lead to effort. If a car manufacturer wishes to
motivate staff and reduce unit costs of production, non-financial methods of motivation
should be used.
• The human relations approach. Mayo stressed the importance of teamwork and of managers
taking an interest in workers.
• Herzberg’s two-factor theory identified ‘motivators’, such as achievement and recognition,
which motivate workers. He advocated job enrichment to motivate workers.
Evaluation may recognise that, whilst pay remains very important, most theorists and many chief
executives accept that pay is not a sufficient condition to motivate workers.
3 a Financial rewards have a monetary value (e.g. bonus payment and profit share).
Non-financial rewards are non-quantifiable and therefore more difficult to measure (e.g. praise and
self-esteem).
Financial rewards (e.g. bonuses for good service or customer recommendations). Workers are
likely to be young, still looking to be motivated at the lower level of Maslow (basic needs). Non-
financial rewards might be recognition of good work (e.g. certificates of achievement to show good
service and used on CVs); opportunities for progression (e.g. shift leader).
b Learners’ answers will vary, e.g.:
• Taylor. Piece-rate pay may work, but the problem is how to measure output.
• Herzberg. Ensure hygiene factors are adequate but then offer job enrichment, though this will
be more difficult with part-time employees.
• Mayo. Focus on social needs and teamwork, but this may not be possible in a fast-food
business where quick service is required and one waiter serves each customer at a time.
Overall evaluation could be based on a balance of arguments either between the views of
motivational theorists or between financial and non-financial factors.

1 Telemarketing
a i Quality is not put at risk through working too fast.
ii Payment to a salesperson for each sale made.
b Hygiene factors such as an adequate wage and working conditions are not present, leading to
dissatisfaction, labour turnover and absenteeism. There is also an absence of motivating factors
such as teamwork, as telephonists work at individual workstations.
Lower-order needs are not being suitably addressed. The basic pay is low and therefore
physiological needs are not being met. There is no security of income, as wages depend on the
value of sales being made. There is no opportunity for teamwork, so belonging needs are not
being met. Employees may feel that they are not trusted, as all calls are recorded and monitored by
supervisors, so esteem needs are undermined.
c Herzberg defines job enrichment as ‘giving people the opportunity to use their ability’. Call centres
often have very strict guidelines on exactly how each product should be sold, which reduces the
opportunity for employees to use their ability.
Learners’ answers will vary, e.g.: to provide job enrichment, workers should be given a complete
unit of work rather than a repetitive element of work. At Telemarketing, what is a complete unit
of work? Perhaps telephonists, having discussed a financial product with a client, could have
complete responsibility for preparing the necessary paperwork and following up the sale.
Job enrichment usually involves a reduction in direct supervision as workers take more
responsibility for their own work. At Telemarketing, all of the calls are recorded and monitored
by supervisors, which increases the pressure on employees and does not create an atmosphere of
trust. By reducing supervision, Telemarketing will demonstrate confidence in its employees and this
will increase their level of responsibility. However, given that the selling of financial products may be
heavily regulated, it may be necessary to record conversations to ensure that products are not missold.
Job enrichment would allow telephonists some degree of decision-making authority (e.g. the
opportunity to decide when breaks are taken).
d Learners should evaluate at least two pay methods and apply them to this business. Learners’
answers will vary, e.g. profit sharing:
Advantages: It encourages employees to work collectively and cooperatively in order to increase
profit; it links rewards to the success of the business; by linking the pay of employees to the
profitability of the business, it ensures that employees and employer have the same interest, which
should motivate them to work together.
Disadvantages: Individuals who do not contribute still receive a share of the profit; it reduces
the profit available for investment or for shareholders. In telemarketing, many workers might be
temporary and part-time employees, who might prefer immediate financial rewards rather than
waiting until profit is calculated at the end of each year.
Overall evaluation with justification is required on the most suitable pay methods within this business.
2 Technoloc
a i It helps to satisfy social needs.
ii The annual amount of money paid to workers as monthly payments.
b Lower labour turnover. Only two people had left the business during a 12-month period.
This reduces recruitment and training costs.
Long-term loyalty. The associates were willing to accept the need for difficult changes due to the
recession, including a salary cut and voluntary redundancies.
c Learners’ answers will vary, e.g. any two of:

• The business has a record of discussing changes to production with the teams that are
affected. Associates were involved and consulted in drawing up the proposals. In fact, a group
of associates was appointed to look into how the workforce could adapt to the fall in demand;
thus it was the workers themselves who made the recommendations. Genuine consultation
increases the chances of workers accepting the outcome, as they have contributed to the
decision reached. If associates feel that management has listened sympathetically to their
views they are more likely to accept changes.
• The business was open about the situation it faced and communicated effectively with
associates well in advance of any change. The fall in sales was given to the workers at one of
the regular team briefings.
• The business was prepared to offer a generous redundancy package and promised to rehire
workers if there was an upturn in trading conditions.
• Technoloc has treated its workers fairly in the past; it has always rewarded and recognised
outstanding work. This approach has increased worker loyalty to the firm.
d Learners’ answers will vary. An evaluation of at least two issues is needed, followed by an overall
judgement, e.g.:
Technoloc methods:
• Production is organised on a team-based system.
• All major decisions concerning production are discussed by management with the teams.
• Employees contributed to the plan to cut costs.
• Teams have responsibility for assembling a significant part of the product.
• Workers are rewarded and recognised for outstanding work or contributing ideas.
• Supervisors assist production rather than observing or giving instructions.
• There is no clear management–worker divide.
• There are regular team briefings.
Links to motivational theory:
• Teamwork is an important element of Mayo’s theory of motivation.
• Mayo also emphasised involvement in decision-making.
• This should give a greater sense of achievement, a motivator in Herzberg’s two-factor theory.
• Herzberg identified recognition of effort as a motivator.
• This gives greater responsibility to, and demonstrates trust in, production workers. These are
motivators in the two-factor theory.
• This gives greater status to production workers and helps meet workers’ esteem needs.
• Mayo identified the need for clear communication.
3 Harvard Bicycles
a i Security of pay level.
ii Pay per unit produced.
b i Total labour cost/output: (800 × 4)/120 = $26.67
ii Workers paid insufficient attention to quality, resulting in poor-quality products, customer
dissatisfaction and a loss of sales.
c Benefit: improvements in motivation as employees are working in teams (Mayo). This may improve
productivity and reduce unit costs.
Limitation: the workers are not used to working collaboratively and there may be conflicts within
the team between dominant personalities.
d Focus on non-financial incentives is supported by motivational theorists such as Herzberg, Mayo

and Maslow. The changes introduced by Min-Chul should improve production:
• Utilising the knowledge of employees to solve production problems will give workers
responsibility and develop their skills. These are motivating factors according to Herzberg.
Quality circles will lead to improvements in the production process and therefore reduce costs.
• As a salary is paid to production line workers, they will be able to focus more on quality rather
than volume of output. Improvements in quality will lead to customer satisfaction.
• Labour turnover will be lower due to increased job satisfaction.
• Management costs may be reduced as fewer supervisory staff are needed.
Overall judgement/evaluation might include: Taylor emphasises financial rewards and strict
supervision as the best way to motivate and manage workers. The changes introduced represent a
significant shift in culture. It may take time for workers to get used to this change and to deliver
the expected benefits. Much will depend on how the teams are introduced and whether workers are
given appropriate training.
be different.
Coursebook answers
Chapter 12
Business in context
• Functions of management: planning for the future direction of the business; setting objectives to be
achieved; organising resources to achieve objectives; motivating human resources in the business;
communication with employees, suppliers and customers; reviewing performance of the business.
• Impact of a good CEO: inspires managers and employees to achieve goals; sets the culture of the
organisation; anticipates change in the market. However, external factors may result in business failure
despite having a good CEO.
Activities
Activity 12.1
1 Rebecca fulfilled five management functions. Learners should give examples from the case study and
explain the management function in each case:
• Setting objectives and planning.
• Directing and motivating staff.
• Measuring performance against targets and taking action over underperformance.
• Organising resources to meet objectives.
• Coordinating activities.
2 Consequences for the store of ineffective management include:
• Lack of coordination of activities, e.g. the electronic exercise bicycle being stocked by two
departments. This would waste scarce sales space.
• Lack of direction for staff, e.g. Rebecca has ensured that all managers are prepared to deliver the
store’s end-of-season sale. Without this, the store’s organisational goals will not be met.
• Failure to plan for the future, e.g. it is crucial that Rebecca is able to plan strategies for achieving
the targets set by senior executives. It is also important that she is able to ensure that senior
executives set realistic goals for the store.
• Poorly motivated staff. This would affect the quality of customer service and consequently reduce
sales. Demotivated staff would be more likely to fail to meet targets set.
Activity 12.2
1 Eli has demonstrated the following management roles, according to Mintzberg:
• Liaison. Communicating with people outside the business, e.g. the owner of the competing bakery.
• Monitor. Collecting information from relevant sources, e.g. the commercial estate agent.
• Disseminator. Communicating with staff following the fire.
• Spokesperson. Communicating information about the bakery to suppliers and customers.
• Disturbance handler. Responding to the changing situation of the business as a result of the fire.
• Resource allocator. Deciding how to use human resources.
2 The management style is autocratic: Eli took a range of decisions without discussion with
workers and managers or consulting them. As workers started to arrive at the bakery, he gave them all
‘clear instructions’.
Appropriate
• In a crisis, decisions need to be taken quickly. Consultation and discussion would slow down
decision-making. Eli needed to get some production up and running immediately.
• Eli, although being autocratic, took complete control of the situation and showed strong
leadership to his employees at this difficult time. His style may have reassured workers that the
crisis would be overcome.
• With such a serious problem, a laissez-faire approach may have sent the wrong message
to employees.
Inappropriate
• Involving workers in discussion may lead to better decision-making. Workers may have had useful
ideas on how to tackle the crisis.
• The sales manager may feel undermined by Eli’s decision to contact customers. He or she might
feel that Eli does not trust him or her, thus causing demotivation.
The evaluation may be that the exceptional circumstances of a fire destroying the bakery justify a
more autocratic style of management. There is no time for consultation and participation, and there
is potentially great risk to the business if decision-making is delayed. However, it might also be noted
that, as a relatively small business, more discussion could have been accommodated without any
significant impact on the length of decision-making.
Activity 12.3
a Autocratic: one person takes charge, quick decisions, speed is important.
b Democratic: promotes participation, encourages innovation and teamwork, it is important to
share ideas.
c Democratic: promotes participation; needs input from all levels; operates so the group feel
comfortable contributing; the production team has hands-on experience (maybe kaizen groups).
Activity 12.4
1 Kevin has an approach to management which suggests Theory X assumptions. The case provides the
following evidence:
• Kevin has a set way of doing a job and believes that efficiency requires things to be done that way.
• He gives clear instructions and doesn’t expect workers to think for themselves.
2 Appropriate
• Kevin does not have the skills and personality to take a Theory Y approach.
• This may ensure that operations are carried out in a consistent manner due to Kevin’s
clear instructions.
• Kevin has 25 years of experience and is knowledgeable about the operations of the steel industry.
• He is in charge of $10m worth of equipment. It is important that equipment and processes run
efficiently; therefore clear instructions are beneficial so that all workers know what they have to do.
Inappropriate
• The workers that Kevin is responsible for are multi-skilled and educated. They are capable of making
decisions and do not need close supervision. Kevin is not making the most of these workers’ skills.
• A Theory X approach alienates the workers in the steelworks. They will be demotivated as they are
being stripped of responsibility and control over their working day.
• The workers do not approve of Kevin’s style. There will be an increased likelihood of conflict.
Evaluation may consider:
• The leadership style may not be appropriate, but it may be the only style that works for Kevin.
The situation appears to demand a more Theory Y approach in which there is worker involvement
and delegation. However, some studies have suggested that it is difficult to change someone’s
leadership style.
• There is no evidence that the employees fit the Theory X assumptions about worker behaviour
and attitudes. These are workers who wish to take responsibility and would benefit from a more
participative style of management. Kevin’s approach may result in workers gradually fulfilling his
expectations of them and they will cease to contribute in any meaningful way to the business.
Activity 12.5
1 Learners’ answers will vary, e.g. setting objectives provides direction for all workers and this increases
the chance of a motivated workforce; effective allocation of resources to meet demand and objectives
will reduce wasted resources and meet consumer demand.
2 Learners’ answers will vary, e.g. effective decision-making (e.g. to develop a new product) could lead to
high sales success and profit.
3 Management style where one manager takes all decisions with very little, if any, input from others.
4 Democratic managers encourage discussion with workers but make the final decision; in contrast,
laissez-faire managers delegate authority to workers to make their own decisions.
5 The Theory X view is that employees are lazy, but the Theory Y view is that employees have the
potential to be well motivated.
6 Autocratic, because the belief is that workers need to be directed and will not accept responsibility.
7 Planning: managers decide objectives, then plan strategies and tactics to achieve them.
Organising resources: ensuring that the structure of the business is suitable for appropriate division of
tasks; recruiting employees with suitable skills to meet the needs of the business and fulfil its objectives.
8 Learners’ answers will vary, e.g. leaders motivate subordinates to achieve business objectives by
creating a vision for the future of the business.
9 A management style based on the view that the manager is in a better position than the workers to
know what is best for an organisation.
10 When decisions need to be made quickly and there is no time for discussion, e.g. in response to a
problem such as product recall.
11 Learners’ answers will vary, e.g. Mintzberg’s roles: interpersonal role (e.g. figurehead when opening
new operations in another country; leader when motivating new subordinates in another country);
informational role (e.g. acting as spokesperson providing information about the organisation’s
operations in the countries in which it operates); decisional role (e.g. negotiator with government in a
country in which the organisation plans to operate).
12 Benefit: the opportunity to participate in decision-making, especially on those issues that directly affect
employees, such as working methods, work scheduling etc. This will increase their self-esteem and
levels of motivation. Work will become more satisfying because of this benefit.
13 When dealing with different employees, e.g. may be more democratic when dealing with skilled workers
higher up the hierarchy and more autocratic with less skilled workers OR in different situations, e.g.
making day-to-day decisions versus dealing with an emergency.
14 When consistency in approach is important to corporate image, e.g. all employees respond in the same
way to customers, such as providing customer services on an aeroplane.
Essay questions
1 a Learners’ answers might include two of the following:
• Setting objectives and planning – sharing strategic and tactical objectives with all employees
with a plan for how they will be achieved.
• Organising resources to meet objectives – ensuring sufficient availability and efficient use of
financial and non-financial resources.
• Directing and motivating staff – ensuring employees are motivated to achieve
organisational goals.
• Coordinating activities – achieving a common sense of purpose across different functions,
branches and nations.
b Autocratic leadership
• This may be useful in crisis situations where decisions need to be taken quickly. In a crisis,
there is no time to discuss issues with workers; leaders may need to act quickly to minimise the
damage to the business.
• It is a typical approach in the armed forces and police where there is a need for swift
decision-making.
• It may be appropriate if workers are lazy and unwilling to take responsibility.
• In a recession, it may be that an autocratic leader is better as they will make quick decisions to
reduce costs, e.g. close a factory.
• It is likely to cause problems as it leaves workers feeling demotivated and unimportant.
• A problem with autocratic leaders is that they can cause bottlenecks because people learn that
the best survival skill is to ask the manager before making a decision. People learn to wait for
instructions or become terrified about making the wrong decision. Creativity is discouraged
and the most talented people eventually leave.
Democratic leadership
• This approach may be more effective at motivating workers as they will feel valued by the
organisation. Refer to the relevant motivational theorists.
• Where workers are highly trained, motivated and ambitious, a democratic style of
management may be beneficial.
• In a recession, it may be that a democratic leader is better, as they will help create a more
positive environment.
• Democratic leaders typically need excellent communication skills and the ability to generate
two-way communication.
Laissez-faire leadership
• This may be beneficial where jobs are easily learned and therefore workers can be left to get on
with it.
• It may also be appropriate where workers are highly skilled or have technical expertise, for
example in research and development.
• If workers are essentially lazy then it will not be successful as they will avoid work if allowed to.
Evaluation may include:

• The most appropriate style of management depends on a wide range of factors, such as
the abilities of the manager and employees, the nature of the task and the circumstances
of the firm. Illustrate the answer with examples of situations that might require different
management styles.
• A manager’s leadership style should change according to the specific circumstances and the
people involved.
2 a Theory Y managers believe that workers enjoy work and can therefore be given more responsibility
and encouraged to be creative. Benefits include:
• If workers are self-motivated and keen to accept responsibility, this will increase
motivation levels.
• If workers accept responsibility, this will encourage managers to ask workers to participate in
decision-making. Employees’ contributions might lead to more effective decisions.
b Fayol identified five functions of management, whereas Mintzberg considered those five functions
to be just vague objectives of managerial work. Mintzberg divided the roles of managers into three
broad groups and subdivided those into ten specific roles.
Mintzberg identified specific roles that do not have a direct parallel function identified by Fayol.
These include: figurehead – symbolic leader of the organisation; entrepreneur – looking for
new opportunities; disturbance handler – responding to change that puts the business at risk;
negotiator – representing the organisation in all important negotiations.
However, in evaluation, many of the roles Mintzberg identified have a similar function to those
identified by Fayol, e.g.:
• Resource allocator of physical and human resources (Mintzberg); organising resources (Fayol).
• Leader to motivate employees (Mintzberg); commanding, directing and motivating
employees (Fayol).

1 McNuggets
a i There is no consultation with employees.
ii The desire to carry out work and perform well.
b There are several reasons why motivation appears to be at a low level and learners’ answers should
include any two of:
• Workers’ views, although requested, are ignored.
• Workers have no influence over their working day. They must follow set procedures without
any deviation. There is no delegation of decision-making.
• There is no opportunity for workers to show initiative.
• Workers specialise in just two tasks. This may contribute to jobs becoming too repetitive and
therefore boring.
Organisations that use paternalistic or autocratic styles of leadership frequently find that
workers have low motivation. Workers become disillusioned at the lack of participation in
decision-making.
c Commanding, directing and motivating employees. Management sets out ‘every single activity of
the workers’ to ensure that there is consistency and that objectives are met. Therefore, the chicken
nuggets are cooked for exactly two minutes and customers are greeted with the same welcome.
Managers are proud that workers do not need to think of anything.
Controlling and measuring performance against targets. The quality of the food is constantly
checked against pre-set standards. This helps to make sure that customers have the same quality of
experience every time and in every branch they visit.
d Appropriate
• It provides consistency throughout the chain in terms of customer service and quality
standards. This is one of the key strengths of the business. Adopting a democratic
management style may undermine this marketing advantage.
• It may be that workers inevitably become dissatisfied because of the nature of the job, which is
low skilled. The work is intrinsically not satisfying for many people. Thus, whatever leadership
style is adopted will fail to motivate them. An autocratic approach saves time and makes sure
that workers are working.
Inappropriate
• It fails to make use of the full skills of the workforce. Employees could contribute more to
the success of the business if given the opportunity. For example, employees deal directly with
customers and can therefore make informed recommendations for improving service to meet
customer expectations.
• Although the approach promotes uniformity, it is inflexible and may therefore be unresponsive
to local conditions.
• It contributes to the high level of labour turnover and absenteeism. Labour turnover adds to
the cost of recruitment and training. Absenteeism threatens levels of customer service.
A more democratic approach may be effective in raising motivation. If the head office delegates
more decision-making to individual restaurants then there will be scope for workers becoming
more involved in the business. This may increase their commitment to the organisation and reduce
labour turnover. A democratic style might include some of the following innovations:
• Discussions should be widened beyond targets to include, e.g. the causes of high labour
turnover and absenteeism.
• It is not sufficient to encourage workers to make suggestions. It is also necessary for
management to act on some of those suggestions.
• Workers have an input into the food served in McNuggets.
• Training of managers at McNuggets may be necessary, as adapting leadership styles is a major
shift in behaviour and managers may resist change.
Evaluation may consider that there would need to be a cultural shift at the head office for a change
in leadership style to occur and be effective. The head office has to be prepared to lose some of its
control over operations. If senior managers are not committed to adapting leadership styles, it
will fail.
be different.
Coursebook answers
Chapter 13
Business in context
Need for an organisational structure
• It shows formal lines of communication and authority.
• It shows division of tasks.
• Employees will know to whom they are answerable and what authority they have.
• It facilitates planning.
How a change to business structure helps achieve objectives
• It affects efficiency of communication and decision-making.
• It can aid flexibility and responsiveness of the business to change.
• Geographical expansion may benefit from an organisation that allows different approaches in
different areas.
• Expanding product lines may require an organisation structure that focuses on the needs of the
different products.
Activities
Activity 13.1
1 a The number of subordinates reporting directly to a manager.
b The number of layers within an organisation. Personnel on the same layer have equal authority.
c Passing authority down the organisational hierarchy.
2 Flat hierarchical structure: means a short chain of command, which improves the speed and efficiency
of communication; gives more opportunity for delegation, which empowers employees (e.g. chefs may
be given more control over menus, increasing motivation); reduces the cost of middle management.
Activity 13.2
1 Current organisational structure:
Chief executive
Finance Marketing Administration Vehicle

director director director repairs
director
Accounting Sales Office Night Day

assistants manager supervisor supervisor supervisor
Junior sales assistants Office staff Mechanics Mechanics
2 Penang Valley Cars has a traditional hierarchical organisational structure. The structure is appropriate
for the business, as the role of each individual is clearly defined and there is no ambiguity regarding the
chain of command.
The business is relatively small, only employing 33 staff and therefore the number of layers of
hierarchy is also low. This allows communication to remain effective as the chain of command is short.
3 Jim could consider retaining a traditional hierarchical structure based on either functional,
geographical or product lines. Such an approach would retain the advantages associated with clear
roles and chains of command. A divisional structure would be beneficial because truck rental might
require a different approach to car rental. A geographic structure would facilitate growth of the
business abroad.
Jim may consider a combination of maintaining a departmental structure but using cross-
departmental project groups to deal with tasks such as the expansion overseas and the introduction of
a truck rental business.
Evaluation could include an assessment of how much control and authority Jim is prepared to pass
down through an organisational structure. A divisional structure may require him to keep less control
and authority at the centre of the organisation.
Activity 13.3
1 a Three assistants report directly to the film purchase director. Therefore, the span of control is three.
b There are four levels of hierarchy: cinema buildings director, regional buildings managers, cinema
managers, cinema staff.
2 Learners should define centralised structure.
Disadvantages include:
• Head office will lay down clear guidelines on how the cinemas are to be run, including opening
times and the types of films shown. This may mean that cinemas do not cater effectively for local
needs. There will be significant cultural differences between the various countries in which Majestic
operates. This could reduce demand and the cinemas might miss profitable opportunities.
• Less flexibility. Local managers will have to seek permission from head office if they want to
do anything differently. This will slow decision-making and cinemas will be less responsive to
changing market conditions.
• As managers have to follow rules imposed by head office, there is little opportunity for managers
to develop their decision-making skills. Their jobs will be less challenging and responsibility
is reduced (a motivator in Herzberg’s two-factor theory). The centralised structure will be
demotivating for staff further down the hierarchy.
3 Benefits
• Increased sales. Local managers will be able to respond to market needs without having to consult
head office. As the cinema operates in ten countries, there will be cultural differences. Films bought
centrally may not suit all countries. Standardising opening times, food and drinks will not appeal
to the varied markets. Making decisions to suit local needs will increase customer satisfaction
and sales.
• Young managers can be trained and the experience they gain from making decisions will prepare
them for promotion to more senior roles. This will benefit the business as the skills of those
promoted will have been enhanced.
• Opportunity to delayer the organisation. Removing middle managers will reduce the costs of
the business.
• Managers will gain more responsibility and this could help motivate them (Herzberg’s two-factor
theory). Work will be more challenging.
Drawbacks
• Cost of training cinema managers so that they are prepared for their extra responsibilities.
• Loss of the uniform brand image.
• Increased costs if the cinemas source different food and drink. There will be less bulk buying.
• Increased cost of films if they are not centrally purchased. Any increase in costs may necessitate
price increases to customers.
• Mistakes could be made by managers, causing the business to lose money (e.g. selecting the wrong
films). Their inexperience could be costly to Majestic.
• Delayering will incur short-term costs in redundancies and is likely to be opposed by managers.
• Not all managers will want more responsibility. They are used to following the rules set by
head office.
• The culture of the organisation will have to change to become more democratic.
Evaluation: it may be useful to contrast the short-term and long-term impacts of decentralisation. In
the short term, decentralisation will cause disruption, there may be training and redundancy costs, and
managers will take time to grow into their new roles. However, in the long term, Majestic Cinemas will
benefit from a more flexible approach which is able to meet customer needs more effectively. Therefore,
there may be an increase in sales and profit.
Activity 13.4
Activity 13.5
1 Centralisation minimises delegation and keeps important decision-making power within head office
or at the centre of the organisation. For ASP, this helps ensure that there is uniformity throughout the
organisation and in different countries. This can enable rapid decision-making as there is no discussion
required at different levels. Policy is consistent in different countries, which helps prevent conflict
between divisions. Directors will focus on the interests of the whole business when making decisions
rather than on just one division. For ASP, centralisation of R&D may help avoid duplication of
expensive research in more than one country.
2 As ASP runs manufacturing operations in the UK, Thailand, India and the Netherlands, having a
geographical organisation structure helps meet the differing needs of markets in those countries.
ASP operations can be more responsive to changing market conditions between countries.
Activity 13.6
• Chain of command is too long. This causes communication to be ineffective, leading to
misunderstanding and slower decision-making as decisions have to be approved by several
managers before they can be implemented. This can reduce productivity.
• Too many middle managers. Middle managers add costs to the business organisation but may
also reduce productivity as they do not contribute directly to the provision of services within the
airline. In effect, more middle management means more employees but no significant increase in
production, so productivity falls.
2 a Junior managers:
• This will give a wider span of control, leading to greater responsibility for managers and more
delegation of decision-making to subordinates. This should increase motivation.
• Loss of middle management job roles. Managers would be made redundant.
• The flatter organisational structure would encourage a more democratic approach to
managing employees. This will help employees achieve fulfilment at work.
• Evaluation could include a consideration of the need to motivate and train junior managers to
accept more responsibility.
b Business efficiency:
• Faster communication due to the shorter chain of command.
• More motivated employees, leading to increased productivity.
• Reduction of overhead costs due to the removal of layers of management.
• Two-way communication will be improved between employees dealing with customers and
more senior managers, so the business will be more responsive to market needs.
• Evaluation could include a recognition that business efficiency could decline if the delayering
is not managed effectively, if other employees now fear for their jobs and if junior managers
are not well prepared to accept additional responsibility.
1 Marrakesh Motors Co (MMC)
• The intrapreneurial groups might improve the speed and quality of innovation by bringing
together talent from all departments. This removes barriers between departments and ensures
a focus on tasks rather than departmental goals. Including operations, finance, marketing and
human resource perspectives in the group reduces the time taken for innovation as issues can
be discussed and resolved more easily.
• Encouraging intrapreneurship is a way of developing competitive advantage. Intrapreneurs
have the attributes of entrepreneurs, such as being risk-takers. Therefore, intrapreneurial
groups will help develop new ideas and innovations.
2 Learners should define delayering. Delayering offers the following possible benefits:
• It reduces overheads, as there are no middle managers being paid high salaries. This will
reduce costs and make MMC more price competitive.
• It reduces bureaucracy and will make MMC more responsive to customer needs. Fewer levels
of hierarchy will reduce the time taken to make decisions, making MMC more flexible in
responding to changing market conditions. Reducing bureaucracy may also reduce costs
for MMC.
3 The staff managers are specialists who provide support to senior line managers.
• Line managers might resent externally appointed staff managers coming into MMC and
changing the way line managers do their jobs. The ALPHA team has been given authority to
oversee the implementation of the company’s restructuring plan. This reduces the power and
influence of the existing line managers and may therefore cause resentment.
• The case study suggests that the ALPHA team is relatively young, as members are all under
40 years of age. Older line managers, with years of experience working at MMC, might resent
the authority given to younger employees to influence the strategic direction of the company.
4 A divisional structure (also called a product structure) breaks the organisation down into a
number of self-contained divisions. Each division is a collection of functions that work together to
produce a product and develop a strategy to compete.
Employee motivation
• The short-term effect on employee motivation may be negative. Changing from a functional to
a divisional structure will disrupt the work of employees and change lines of authority within
MMC. Employees are often resistant to change and prefer continuity.
• If the restructuring leads to a loss of jobs, employees will be dissatisfied and concerned about
their future.
• Divisional structures usually involve greater delegation of authority, which may improve
employee motivation in the longer term.
Efficiency
• A divisional structure will improve the focus of the business on its different products. For
example, trucks, cars and motorbikes might require different approaches to marketing. A
divisional structure enables better marketing of each product.
• It will result in greater flexibility in responding to changes in the market for each product.
• The performance of each division can be measured directly. As a result, division managers
usually perform better.
• There may be increased duplication of resources and efforts, such as research and
development, across divisions. This increases costs and may disperse expertise, resulting in a
decrease in efficiency.
• Interdivisional rivalry can result in divisions not working together to achieve company aims.
Evaluation might include a recognition that a significant change in culture is being attempted
at MMC and in the short term this is likely to lead to opposition and confusion. There will be a
high cost of making change, e.g. for redundancy payments. The management of change will be
important to ensure that the restructuring is successful.
2 Hotels group set for major management shake-up
1 Problems at Empire Hotels:
• They are slow to respond to changing consumer needs. The long chain of command is
reducing the effectiveness of communication in the organisation and therefore managers lack
awareness of changing consumer demands.
• Increased labour turnover. The long chain of command leads to narrow spans of control and
a lack of delegation. Therefore, staff are leaving for businesses offering more responsibility.
• Poor motivation of employees due to distance from senior managers. For example, it takes three
weeks for requests for new resources to be considered because there are so many middle managers.
2 Delegation will bring a number of potential benefits, including:
• Empire Hotels will be more responsive to local needs as decisions will be made by hotel managers
based on their understanding of the local market. For example, Excel Hotels has an excellent
reputation for local food dishes and decorations that reflect local culture and traditions.
• A reduction in the time to acquire the resources needed by individual hotels. Currently, it takes
three weeks to respond to requests.
• Increased motivation of hotel managers due to greater responsibility.

• A more flexible business organisation.
There may also be problems:
• Managers may need further training in order to be able to cope with the extra decision-making
responsibility.
• There will be less consistent corporate identity as individual hotels will make their own
decisions about operations.
Evaluation: the key problem faced by Empire Hotels is its failure to respond to changing consumer
needs, as a result of the structure of the organisation. The hotel group cannot afford to maintain
the status quo.
3 The role of the new design, marketing and catering experts is to advise their own departments.
These new appointees do not have any line authority over other people. Their role is to provide
support, information and assistance to the line managers.
The line managers are responsible for making decisions regarding design, marketing and catering.
They have direct authority over people and resources within the hotel.
4 Changing the structure by delayering will bring benefits such as:
• Reduction in costs.
• Greater delegation, which will improve motivation.
• Hotel managers will have greater responsibility and authority, so the hotels will be more
responsive to customer needs.
• The chain of command will be shorter, so decisions can be made more quickly.
• Appointment of experts will help improve design, marketing and catering.
• A new structure could help reduce labour turnover.
Problems related to changing structure include:
• Opposition to change from middle managers.
• Opposition to design, marketing and catering experts will lead to discontent. Line managers
may feel undermined.
• Short-term cost of streamlining the organisation.
• Hotel managers may need more training.
Evaluation: a change in structure, introduced after consultation with staff, should improve the
performance of the hotel group as local customer needs will be better served and key weaknesses
such as catering can be addressed. A well-designed organisation will help managers to get things
done and aid decision-making (a poorly designed structure makes it more difficult to succeed).
However, structure alone will not make the hotel as good as its competitors. Investment has to be
made in conference facilities and IT to bring them up to industry standards.
be different.
Coursebook answers
Chapter 14
Business in context
Technologically advanced methods of communication are best where:
• There is a need to communicate with a large number of recipients.
• A quick response is required.
• Two-way communication is necessary.
• Complex information needs to be exchanged.
• A record of communication is necessary.
Disadvantages of never meeting people at work to communicate with them:
• Social interaction can be an important motivator.
• Misunderstanding may be more likely.
• Discussion is reduced and therefore problems are more difficult to solve.
Activities
Activity 14.1
1 Banks and lenders: a business might need to arrange short-term finance to resolve a cash flow problem
and, without appropriate communication, there could be delays in receiving the finance; arranging
finance for expansion or investment requires the business to communicate its business plan.
Local community: expansion plans might cause disruption to the local community; therefore the
business needs effective communication to avoid misunderstandings and minimise opposition; safety
issues might need to be communicated to avoid harm to local residents and avoid court action being
taken, e.g. if there was a leak of chemicals into the atmosphere at a manufacturing plant.
Activity 14.2
• Inappropriate medium for sending messages. The use of a noticeboard in the canteen is not an
effective way of ensuring that the message reaches all workers.
• Incomplete message. The message is too brief and does not contain sufficient information about
what is required.
2 A meeting with all workers present.

• This would enable two-way communication and provide immediate feedback.
• The director would be able to give a more personal message. This would help overcome the lack
of trust that workers have in management. The presence of the director at the meeting would
reinforce the importance of the message and suggest that worker opinion is valued.
• The director would be able to answer questions if the message was not understood.
• The director can be sure that the message has been received.
• The message can be reinforced with appropriate body language.
Evaluation may focus on the effectiveness of the communication method in terms of:
• The message reaching the intended audience.
• The message being understood by the workers.
• The opportunity for two-way communication.
Activity 14.3
• It is easy to send emails to multiple recipients, so they might be sent to more people than necessary.
• Some emails are poorly worded or too long, so are misunderstood.
• Emails are sent even if the recipient is not there, so there is no guarantee that the communication
has been seen by the recipient.
• Emails are easy to ignore.
• People receive too many emails each day, so may not have time to consider them all.
Activity 14.4
a Customers and employees must be aware of, and act upon, safety information to avoid accidents and
injury to themselves. It is also possible that a failure to follow safety instructions could put lives at risk.
b Goods need to be produced and dispatched to meet customer needs. Failure to communicate
effectively could lead to incorrect production of goods and delays to orders. Consequently,
customers will be dissatisfied.
c Poor-quality work may lead to customer dissatisfaction, so it is important that the worker is fully
aware of their mistakes if quality is to be improved.
d Plans must not be lost, as this would lead to increased costs.
e Quality problems might reduce productivity and increase the number of products that have to be
reworked. This will increase costs of production.
f It may be important that confidential information is received at the same time by some employees
and not received at all by other employees. Therefore, the information needs to be appropriately
communicated.
g It is important to avoid any errors with a customer’s order. Customer dissatisfaction will result if
work does not match the customer’s specific needs.
h It is important to ensure that emergency help is received as quickly as possible and that
appropriate personnel are alerted to accidents.
2 Learners’ answers might include the following points of analysis and evaluation:
a Written communication is required. The notice should be displayed in a prominent place next to
the hazard in question. It is important that it is written so that all individuals will be made aware
of the hazard as they approach it.
b Preferably, this will be a written communication to ensure that the production department has
clear details of the order requirement. Electronic media (e.g. email) would have the benefit of
speed as well as providing a written copy.
c Face-to-face oral communication is needed to ensure the message is received and understood.
There would also need to be a written message to provide a record of the warning.
d Electronic media via the internet would provide quick and accurate transmission of plans.
Some form of registered or recorded post could also be used to ensure that the plans reach
the destination.
e Oral communication through a team meeting is needed. This will ensure that all team members
understand the problem and allow them to contribute ideas to its solution.
f As the information is essential and confidential, the method must ensure that the message is
received and understood by the right employees. Communication by telephone allows the sender to
verify who is receiving the information and whether it is understood.
g Telephone is quick and allows two-way communication to clarify details of the order. However, it
may be important to have an accurate written record.
h Written communication via a notice would ensure that the numbers are accurate and can be
accessed quickly by all staff.
Activity 14.5
1 Asian Lights (AL) working in the dark
• Size of the organisation. As the business has grown, there has been an increase in the number
of managers and the creation of more levels of hierarchy.
• Length of communication chains. Each section head has to check the message before passing
it on to the next person who needs to know. This slows down the communication process. It
took four weeks for an important message about production to reach Metta.
• Everything has to be written down. There is evidence that there is a lack of clarity from
the senders of messages; Metta can barely read the scribbled message regarding the correct
product mix to manufacture.
• Autocratic style of management. This may lead to one-way communication. It can demotivate
employees and make them less receptive to receiving messages.
2 Use of inappropriate medium to communicate, e.g. scribbled note from south-east sales manager:
• Messages need to be clear. To some extent, this is a problem of the poor attitude of the sender.
All employees need to be aware of appropriate channels of communication.
• Meetings could be held between the sales managers and Metta to discuss changing sales.
• Communication is too slow because the channel of communication is too long. The merger
has added layers of hierarchy to the organisation. Messages have to pass through too many
managers before reaching the person who needs the information.
• Delayering the organisation would remove levels of hierarchy and therefore messages would
pass through a shorter chain. This solution would be opposed by middle managers. However,
it would also reduce overhead costs.
• Installation of IT systems could lead to quicker communication. However, email can lead
to information overload and it is difficult to ensure that the message receiver has read the
communication. An advantage of a technical solution would be that communications would
still be written and therefore a record would exist.
• Autocratic style of management is a barrier to two-way communication. Directors are distant
from employees such as Metta and communication is made more difficult by having to go
through section heads.
• It is difficult to change the style of management. However, delayering would help reduce
frustration and enable more direct communication with directors.
• There may also be a problem of geographical distance since the merger with Bangkok Brightlights.
• In evaluation, using IT solutions will reduce the problems of geographical distance. As well as
email and the internet, video conferencing can be used, and one-to-one communication using the
phone is always possible.
• Cost is an issue with introducing IT solutions; there are the capital cost and training costs.
However, cost savings in the longer term can be great, as communication becomes faster and more
efficient once the equipment is installed.
2 Sonix
• Ineffective communication can demotivate employees because it prevents them from doing
their jobs effectively.
• Group discussion can help fulfil some of the needs identified by Maslow and thus aid
motivation. Herzberg also suggests that employees will be motivated by greater involvement
within the business. Effective communication can help ensure that employees feel part of the
business and that they are valued.
• Two-way communication gives a chance for employees to express their views and encourages a
sense of belonging.
• Communication is essential to give recognition to staff and promote individuals’ sense of worth.
• Effective communication may help employees understand what is happening within the
business. When change is occurring, it is important to communicate effectively with employees
as they may need reassurance about the future. This will help prevent demotivation.
• Evaluation may include a judgement that no one method of communication is the best for all
situations and messages; the type of message, the need for a permanent record, the receiver
of the message and the importance of feedback should all be considered before selecting an
appropriate communication method.
2 Possible suggestions include:
• Senior managers at Sonix should have held meetings with union leaders to discuss the
problems at the factory. This would have provided an opportunity for union feedback.
• The redundancies should be announced to employees before the press. A senior manager
would be required to communicate with employees. This could be done in a meeting with
workers at the factory. Although this would be a hostile meeting, it would be an opportunity
for the reasons to be explained clearly and for feedback to be given.
• Use of a public relations expert to deal with the announcement to the local community and to
the newspapers. A suitable press release would be essential and relevant employees would need
to be available to answer questions from the press.
• Evaluation may include a judgement that the method used should reflect the seriousness of
the situation and the impact that poor communication will have on employee morale and
motivation.
be different.
Coursebook answers
Chapter 15
Business in context
The extent to which leadership of an organisation influences success
• Definition of leadership.
• It sets a vision of where the business needs to be. This gives a sense of direction for the organisation
and its employees.
• Leaders anticipate change in the environment to give a competitive edge.
• It may have a significant impact on the commitment and motivation of employees. Leadership can
inspire employees.
• It will impact business culture.
Activities
Activity 15.1
1 Learners’ answers could include any two of the following:
Organising resources: Keira allocates bus repair jobs to workers.
Commanding employees: Keira gives clear instructions on how jobs should be done.
Informational: operations director announces there will be no pay rise.
Interpersonal: operations director links with Keira and the production manager.
Decisional: dealing with disturbances, e.g. the production manager is responsible for disciplining
employees.
2 Give Zeke his old job back:
Benefits:
• This could be conceived as enlightened management, given that Zeke had been demoted for taking
time off and the rules have subsequently been changed. This would show that management is
considerate and encourage Zeke to be more committed to the goals of the organisation.
• Zeke already has informal influence, so it is better to make him part of the formal management
team. He may then be more likely to adopt a management perspective.
• Akiko does not appear to enjoy his role, so he may be happy to lose the responsibility.
Drawbacks:
• Zeke may lose support from his workmates as he may be seen as colluding with management.
• This would show weakness on the part of management as they are backing down over Zeke’s role.
• It creates the problem of having to demote Akiko, who may become resentful and demotivated.
Give Zeke a formal warning:
Benefit: Zeke has a family to support and a warning may force him to toe the management line.
Drawbacks:
• If Zeke is being warned without having broken any disciplinary rule, it may lead to union action
and escalate the problem.
• Workmates may perceive the treatment to be unfair and heavy handed. Zeke’s influence will be
enhanced not reduced.
Communicate with employees to help achieve business aims:
Benefits:
• It is suggested that work groups are told about new targets. This autocratic approach is potentially
counterproductive. Keira should discuss changes with work groups and ensure they understand
why change is necessary. This may marginalise Zeke if arguments are persuasive.
• Workers may be able to make relevant and beneficial suggestions to improve efficiency.
Drawbacks:
• Involving workers is time-consuming.
• If workers are not convinced by Keira’s arguments and she presses ahead with new targets, workers
may feel that the consultation is not genuine.
Evaluation may include a judgement about the relative benefits and disadvantages of each
management decision, with a final conclusion suggesting which approach might be best in this context.
Activity 15.2
1 Creativity was needed to see things differently and develop a social network that was different from
MySpace and Friendster. Zuckerberg provided the imagination for others, such as Sandberg, to put
into effect.
Good skills of judgement and decision-making. He surrounded himself with the right people to
complement his skills and bring his vision to reality.
Good communicator. His weekly question and answer meeting with employees helps them understand
his vision and makes them feel part of the organisation. This increases employee commitment.
2 Trait theory. Focus on traits that can be learned and developed, such as flexibility and decision-
making skills.
Behavioural theory. Develop different leadership behaviours to use at different times. Focus on technical
skills, building knowledge of the business process; the greater the knowledge of the leader, the more likely it
is that subordinates will follow guidance. Zuckerberg has technical expertise that others will already admire.
Power and influence theories through transactional leadership. Employees will undertake tasks in
exchange for rewards and should be given clear direction, managed by a system of rewards and
punishment. This may be less important to Facebook, as success depends on creativity and flexibility.
Transformational leadership may be the most important leadership theory as Facebook operates in a
particularly dynamic sector. The business has to be able to adapt and change. Zuckerberg uses a flat
organisational structure that allows employees to work on projects they feel passionate about and
therefore produces the innovative ideas that can keep making Facebook successful.
Evaluation may include a judgement about the most appropriate leadership theory that could be
applied within the context of Facebook.
Activity 15.3
Leadership makes a difference
1 Maya displayed transformational leadership, showing a desire to transform the culture of the
organisation with a clear vision for the business. She effectively communicated that vision so that it was
understood by all factories and shops. She offered new challenges for employees and this contributed
to employees volunteering to be on committees. She showed strong emotional intelligence and
understanding of the individual needs of employees. There was also an element of power and influence
theory: Maya impressed employees with her expertise and knowledge of recycling materials.
2 Maya’s understanding of other people and their feelings was critical to success. She showed elements
of Goleman’s competencies of emotional intelligence, including social awareness and social skills to
persuade and lead. In particular, she recognised that there was too much internal competition that
resulted in jealousy. Her emotional intelligence was important to persuade employees to follow her
vision and resulted in them volunteering for committees to make the business more sustainable.
Evaluation may include a judgement about the importance of EI to Maya’s success and a
consideration of how much less effective she would have been as a leader without a high degree of EI.
be different.
Coursebook answers
Chapter 16
Business in context
Not giving employees choices about when and where they work:
• It makes it too difficult to organise production. There is a danger of not being able to fulfil
customer orders.
• Not all jobs can be done from home.
• It requires employees to be more self-motivated.
• It risks loss of team cohesiveness, as employees may not meet with each other very often.
• It interferes with communication, as employees become more reliant on emails, for example.
Benefits of flexible working:
• It reduces fixed costs if workers have short-term contracts.
• If flexible contracts result in more satisfied employees, this increases productivity and reduces
unit costs.
• Quality of work may improve.
• Lower absenteeism reduces costs.
• It avoids adherence to costly employment laws in some cases.
Activities
Activity 16.1
1 Benefits: increased flexibility; no need to employ and pay workers when demand is low, so reducing
costs; gives a competitive advantage.
Limitations: Amazon has been criticised for using zero-hours contracts and this could lead to
consumers purchasing products elsewhere; it may result in increased labour turnover and therefore
an increase in recruitment costs; lower productivity due to poor motivation and less experienced
employees.
2 Arguments for: workers are more motivated due to empowerment, so take greater care (e.g. to ensure
orders are correct); employees contribute more ideas on how to improve efficiency (e.g. layout of
warehouse); lower labour turnover results in lower recruitment and training costs.
Arguments against: in a very busy environment, lots of employees are needed for the business to
run smoothly and this is best achieved by hard HR (e.g. close supervision); workers may be low- or
semi-skilled and motivated by money not work, so they need to be closely supervised and monitored;
logistics are key to success and therefore need to be closely monitored.
Evaluation may include a consideration of the factors that will influence the decision about HR
strategy, such as the objectives of the business; the ease and cost of replacing employees who leave;
the skill levels of the employees.
Activity 16.2
• Workers can have multiple jobs at the same time. This can make work more interesting and rewarding.
• Workers have more control over their working lives as they are not contracted permanently to an
employer. Therefore, they can easily take a break from work when needed.
• Work–life balance is improved by the flexibility of being able to schedule own work.
• Gig jobs can be used to supplement regular income from employment.
2 Benefits:
• Reduces costs linked to employing workers, e.g. administration, tax and pension.
• Reduces fixed costs. If there is no work, there are no labour costs.
• Lower costs can enable competitive prices to be set to attract customers.
Disadvantages:
• Customer service may be negatively affected as workers have less commitment to the business.
• There is no incentive to invest in training as workers may take jobs with other firms. This reduces
the quality of customer service.
• High labour turnover reduces stability of the workforce.
Evaluation may include a consideration of the ease with which new gig employees can be recruited; the
importance of customer relationships; the competitive nature of the local market; the culture of the
business managers.
Activity 16.3
Full-time permanent contracts:
• Advantages: lower labour turnover offers greater stability to the business; workers may be more
committed to the business; it is worth training workers to increase their skills.
• Disadvantages: inflexible; high fixed cost; employees may have greater employment rights than
temporary workers, adding to costs.
Part-time permanent contracts:
• Advantages: lower labour turnover than temporary contracts; flexitime contracts can widen the choice
of applicants to include those with childcare responsibilities; as work is potentially boring, shorter
working hours might increase the quality of customer service.
• Disadvantages: there are more employees to manage, making communication more difficult; higher
labour turnover is possible if employees are looking for full-time work.
Temporary contracts:
• Advantages: lower fixed labour costs; the business can choose to not renew contracts of inefficient
workers; flexibility.
• Disadvantages: more employees to manage; higher labour turnover so the labour force may be
unsettled and there will be higher recruitment costs.
Evaluation of the final recommendation could conclude that: it depends on whether the additional advisers
are likely to be needed long term and the complexity of the advice that they provide (i.e. how much the
advisers need to learn to do the job effectively).
Activity 16.4
1 Company A: 2 days per worker or 0.95%; Company B: 3.1 days per worker or 1.5%; Company C: 1.5
days per worker or 0.7%.
2 Assuming that workers have the same rate of pay per day then, as labour productivity increases, the
labour cost per unit will decrease.
• Quantity of capital equipment per worker that is available. If workers at Company C have more
machinery to help manufacture, investment in capital will raise labour productivity. Machinery at
companies A and B may be less reliable, causing disruption to production.
• Quality of capital equipment. Company C may have more up-to-date technology for workers to use.
• Motivation of workers. Working conditions may be better at Company C, which will aid productivity.
• Style of management. Company C may use a more democratic approach to managing workers. This
could enhance productivity. Other HRM issues could be influential, such as the use of quality circles.
• Production at Company A may have been disrupted by industrial unrest or other factors such as
unreliable suppliers.
4 A higher rate of absenteeism makes scheduling the production of tablet computers more difficult
and will result in production hold-ups if critical workers are absent. This could cause disruption to
customer orders and a loss of sales. It increases workload and stress on other workers, which could
lead to higher labour turnover and therefore an increase in recruitment costs.
Activity 16.5
1 2 years ago: 5 ÷ 200 × 100 = 2.5%; 1 year ago: 7 ÷ 230 × 100 = 3%; this year: 15 ÷ 275 × 100 = 5.5%
2 There is an upward trend in absenteeism rates.
• The increasing number of employees may lead to increased labour dissatisfaction, as employees feel
less important within the business. Employees may feel more alienated in the larger organisation.
• Recruitment may be ineffective, resulting in unsuitable workers being employed.
• Increased levels of absenteeism will undermine quality and lead to a decrease in customer
service. This may link to the increasing proportion of customer complaints. As it is a competitive
industry, OA may lose customers and revenue could decrease. This could lead to a long-term fall in
passenger numbers and a loss of market share to competitors.
• Falling productivity this year. This means that cabin crew are selling fewer meals and gifts on each
flight. Therefore, OA’s revenue will fall and profits decline.
4 Profit sharing. This provides a reward for success and acts as an incentive to team effort. This may have
a long-term benefit to OA and be of particular use in giving employees a greater stake in the success of
the business. As such, it would help reduce labour turnover and give an incentive to improve productivity.
However, individual employees may not contribute effectively to the team, as all workers receive a share
of the profit. Shareholders may not be happy about profit sharing as it could reduce dividends.
Full-time permanent contracts. Fulfilling the security needs of cabin crew could increase motivation.
Cabin crew would feel more valued and a part of the organisation, leading to less absenteeism and
lower labour turnover. This could positively impact customer service and increase sales of meals and
gifts. However, OA would be less flexible and have higher fixed costs. As customers are sensitive to
small differences in airfares, any increase in prices would cause a more than proportionate decrease in
tickets sold and therefore reduce revenue.
Evaluation might comment on:
• The cost of the option to the business and impact on other stakeholders such as shareholders. As a
low-cost airline, it is essential to control costs. Failure to do so will result in higher prices being charged.
• HRM may need to consider the underlying nature of the problem, e.g. whether work is boring or
wages are too low (i.e. an absence of hygiene factors).
Activity 16.6
1 Change of HRM strategy
1 Management by objectives (MBO) is a feature of job enrichment, involving employees in setting
objectives. This removes the previous problem of FV failing to communicate targets. MBO
empowers workers. Individual targets are agreed, giving employees ownership of the targets, which
are therefore more likely to be achieved. MBO enables employees to see the importance of what
they do in the organisation. Individual objectives can be linked back to corporate aims and show
how the individual has a role in achieving organisational goals. Targets can be monitored and used
as a measure of success or failure.
2 Benefits of IT:
• It reduces costs as there is no need for supervisors and time-consuming interviews are replaced.
• It enables customer service employees to access information through the chatbot, which could
improve customer service.
• AI can be effective at evaluating job applicants and removes human bias.
Disadvantages of IT:
• Impersonal method used to conduct appraisals and monitor performance. This might alienate
employees and reduce their commitment to the organisation.
• Employees may be suspicious of the technology and see it as just being a means to monitor
their work more carefully. This will demotivate workers, reducing the quality of customer
service.
• The initial cost of implementing the program might be high due to the cost of the software.
Evaluation might focus on the financial cost of introducing the system versus the long-term
cost savings. As the technology is evolving, it might be better to wait until it is more established
and reliable.
2 Human resources crisis in the Theatre Lighting (TL) factory
1 a Last year = 1 400 ÷ 250 = 5.6; this year = 1 100 ÷ 220 = 5
b Profit sharing. This provides a reward for success and acts as an incentive to team effort. It
gives employees a greater stake in the success of the business. It could give an incentive to
improve productivity. However, individual employees may not contribute effectively to the
team as all workers receive a share of the profit.
Increase worker participation. This would make use of worker expertise and empower workers.
However, democratic leadership could result in more discussion and increase time taken, and
Bernardo is opposed to this approach.
2 a Last year = 50 ÷ 250 × 100 = 20%; this year = 76 ÷ 220 = 35%
b More permanent employment contracts. There is evidence that absenteeism is a problem with
part-time workers. Permanent contracts could make it easier to attract skilled employees.
However, this would reduce flexibility and increase costs.
Increase pay and fringe benefits. Although wages are competitive, they may be insufficient to
ensure employee loyalty. An increase in pay would increase costs, but this should be balanced
against the benefits of improved customer service.
3 A softer HRM strategy might focus less on reducing costs and more on retaining workers and
motivating them. This could include greater use of full-time rather than part-time contracts,
increasing pay and fringe benefits for workers, and increasing worker participation.
Arguments for:
• Better retention of workers would reduce labour turnover and decrease recruitment and
training costs.
• Worker participation in decisions could lead to improvements in productivity and therefore
decrease costs and improve the quality of work. Therefore, there would be a reduction in
customer complaints.
• More satisfied customers would increase customer loyalty and enable higher prices to be
charged. Therefore, profit margins might increase.
Arguments against:
• Cost of setting up and employing HR staff.
• Increased cost of higher pay and fringe benefits. Therefore, TL would have to increase prices
or accept a lower profit margin.
• More full-time contracts will increase fixed costs and reduce TL’s flexibility.
Evaluation: this should involve weighing up costs versus benefits. For example, the increased costs
of the suggested strategy may be outweighed by the benefits to TL of more satisfied customers. If
customers are dissatisfied, TL will eventually lose its customers and therefore its profit. Overall,
the HRM strategy depends on whether Bernardo is willing to allow workers to have some say in
decision-making.
be different.
Coursebook answers
Unit 2
Soda Cool
1 Workforce planning identifies the skills and numbers of employees required to meet the objectives of
the business.
As Soda Cool (SC) has not operated in Country X previously, a workforce plan is necessary to ensure
that it recruits the right number of employees with the right skills. SC needs to recruit employees with the
computing skills to manage the computer programs that operate the automated machinery. A sales team
is needed with the language skills to market the product in Country X. Workforce planning will enable
SC to recruit the right employees. Therefore, operations and marketing are more likely to be effective.
Secondly, by using workforce planning, SC can ensure that it has the right number of employees to
meet objectives. This will help control costs by not over-recruiting and therefore make SC more price
competitive in the market.
2 A flatter organisational structure will facilitate Leo’s objectives of more localised decision-making,
delegation, increased teamwork and fewer levels of hierarchy.
Benefits:
• Delegation gives greater responsibility to employees and can improve motivation, leading to an
increase in productivity. This could reduce the labour turnover and absenteeism problems faced
by SC.
• Fewer levels of hierarchy reduces costs as middle managers are removed. Fixed costs will be lower.
It can also improve vertical communication as there are fewer levels for messages to pass through.
• Localised decision-making can result in more effective decision-making as the decision-makers are
closer to the market. This can make SC more responsive to market changes. This is important because
Country X is a new market for operations and head office may not be aware of national differences.
• Central control over expansion strategies ensures that the strategic direction of the business remains
under the control of Leo and other directors. They may be best placed to make decisions about the
strategic growth of the whole business. Central control of finances keeps a check on costs.
Disadvantages:
• There is a risk that localised decision-making and delegation will result in inconsistency in the
brand image of SC. This could damage sales.
• Training costs may be incurred to ensure that lower levels of management have the necessary skills
for their increased responsibilities.
• There is a risk of resistance from managers over the loss of jobs.
Evaluation: as SC is expanding operations to Country X, it is beneficial to encourage localised

decision-making as market conditions in Country X are likely to be different. SC will be more
responsive to changing local conditions and therefore more effective in meeting consumer demands.

1 Competitiveness depends on a number of factors, including relative costs of production and the
quality of output. This is a competitive market so it was essential for SC to reduce its average cost of
production to improve competitiveness.
Benefits of using HRM to achieve the goal:
• Hard HR strategy has enabled SC to reduce costs by 20%. This should mean that average costs are
closer to those of competitors.
• Employee productivity is now only 12% less, not 20% less, than the main competitor.
• Zero-hours contracts increase production flexibility and reduce the costs of production.
Therefore, SC should be more responsive to changing customer demands.
• Zero-hours contracts will reduce the fixed costs of SC.
Disadvantages of approach:
• Higher labour turnover increases costs and could cause disruption to operations due to employee
shortages. However, it is evident that the cost savings from new contracts outweigh the extra
recruitment costs.
• Strike action has increased. This could disrupt the ability to meet orders and lead to customer
dissatisfaction.
• Higher labour turnover could lead to reduction in quality as there are more inexperienced workers
on the production line. However, the impact depends on how skilled the work is.
• There could be negative publicity generated by strike activity and SC could be accused of limited
consideration of its social responsibilities.
Evaluation: using HRM has achieved the key objective of reducing average costs. Price may be very
important to consumers, so controlling costs is essential. There are other approaches that SC could
have used to achieve the same goals, such as increased automation.
be different.
Coursebook answers
Chapter 17
Business in context
• To focus the attention of managers and give targets to achieve, which can be used to motivate
employees. Sales objectives will determine the resources required, e.g. the finance department can
construct cash flow forecasts, human resources can develop a workforce plan and operations can plan
for production levels required. Objectives provide a means of measuring success.
• Localised menus meet different cultural expectations (e.g. halal and kosher); different tastes between
countries will affect sales.
• Globalised menus ensure consistency between restaurants; customers know what to expect in every
restaurant; the benefits of bulk buying may reduce unit costs.
Activities
Activity 17.1
1 If coffee crops fail then there will be a reduction in supply.
2 More consumers will be able to afford Rolls-Royce cars, causing an increase in demand.
3 This is an increase in costs for the shipbuilders, so fewer ships will be supplied at any given price
(i.e. a reduction in supply).
4 Games consoles will see an increase in demand because the price of games has fallen. These two goods
are often bought together as they are used together.
Activity 17.2
1 Supply factors:
• Weather: flooding in Bangladesh and Indonesia, cold weather in Vietnam.
• Town development.
• The price of alternative foods rising will cause producers to switch from rice production to
alternative foods.
Demand factors:
• Rise in consumer incomes.
• Increasing population is hinted at though not stated. As a necessity, the demand for rice will
increase as the population increases.
2 The initial equilibrium price is P and the quantity is

Q. The reduction in supply is shown by a leftward S1
S
movement of the supply curve S. The increase in
demand is shown by a rightward movement of the P1
demand curve to D1. The new market equilibrium is
Price
P1, Q1.
P
Activity 17.3 D1
1 Being product-orientated means product development D

is focused on the strengths of the business rather than 0 Q Q1
responding to consumer needs. The belief is that high-
Quantity
quality, innovative products will attract customers.
However, product orientation may be the reason why sales have fallen for each of the last three years.
2 Benefits: there is a growing market of younger workers with higher incomes who are prepared to spend
more on fashionable goods. The Classic Ladies wristwatch has been virtually unchanged for 120 years
and does not appeal to this increasingly important market segment.
Disadvantages: greater customer orientation risks losing its established market, which provides a core
to sales revenue. That market has built up over time and fashion will change again.
Evaluation: benefits outweigh disadvantages, due to the growing target market. However, substantial
market share might be lost, therefore the business should focus on established and new markets.
Activity 17.4
1 Sales value is average price × quantity
Sales value 2020 = 54 000 × 3 = $162 000
Sales volume increased by 5% in 2021 = 54 000 × 1.05 = $56 700
Selling price has increased by 10% and is therefore 3 × 1.10 = $3.30
Therefore, the sales value is 56 700 × 3.3 = $187 110
The increase in sales value = 187 110 – 162 000 = 25 110
The percentage increase in sales value = 25 110 ÷ 162 000 × 100 = 15.5%
2 Sales volume = sales value ÷ price
Sales volume in market B in 2021 = 180 000 ÷ 12 = 15 000
The increase in the sales volume = 15 000 − 10 000 = 5 000
The percentage increase in the sales volume = 5 000 ÷ 10 000 × 100 = 50%
Activity 17.5
1 Tesco Lotus has a 10% share of total market sales of $55 billion. Therefore, its sales are:
0.10 × 55 billion = $5.5 billion.
2 Market share = sales ÷ total market sales × 100
Tesco Lotus sales would increase to $7.5 billion out of a total market of $65 billion. Therefore, its
market share would be: 7.5 ÷ 65 × 100 = 11.54%.
• Brand recognition. Consumers will be more familiar with the Tesco Lotus brand and may
therefore be more likely to use the store. This may give Tesco Lotus more control over pricing
decisions. Customers will continue to shop at Tesco Lotus even if prices are not as low as other
supermarkets due to greater brand loyalty. As market leader, the brand is more likely to be trusted.
• Buying power. Tesco Lotus will be able to exert pressure over suppliers to reduce prices because of the
volume of their purchasing. Tesco Lotus will be able to push the price of supplies downward and can
therefore be more price competitive in the market or enjoy higher profit margins. This is demonstrated
in the case material as Tesco was able to sell school uniforms at some 20% lower than traditional shops.
4 Learners’ own answers that might consider how different the market for food is in your country from
other countries that the learner might be aware of. Issues such as culture, ethnic diversity, average
income levels, regional difference could all have an impact on the need for a supermarket business to
revise its marketing mix.
Activity 17.6
• Selling bicycles in the ultra-premium cycle segment will take the TI brand upmarket and have a
beneficial impact on the image of the company’s other products. Therefore, although it may be a
niche market with only a very limited sales potential, it will lead to an increase in sales of its
lower-priced bicycles.
• There is the prestige conferred on the TI brand of selling premium products.
• Product development for the premium market may, over time, lead to improvements in the
company’s lower-priced products as technological innovation is transferred.
• Niche markets may be highly profitable due to the high margins that can be achieved.
• There may be opportunities for gaining scale economies by targeting several market segments, as
there will be shared components between products.
2 Learners’ own answers that could consider issues such as the competitiveness of the bicycle market;
average incomes; the popularity of cycling amongst different income groups; the size and diversity of
the target population who are most likely to buy bicycles.
Activity 17.7
1 Without research, it would not be possible to accurately identify relevant ways of segmenting the
market. Having identified market segments, research is necessary to understand the needs of the
consumers that make up the segment. Research will identify exactly what is wanted from the product
and the promotional strategies that will appeal to the target segment. Therefore, firms can alter the
marketing focus according to the particular segment.
In the case study, market research has supported market segmentation by:
• Identifying six distinct groups of travellers to Hong Kong.
• Demonstrating how to encourage each market segment to make repeat visits to Hong Kong.
• Providing a focus for marketing activity, e.g. ‘bring a friend’ promotions for young, single
leisure travellers.
• Identifying the size of each segment, e.g. mature repeat travellers were just 4.5% of the total
sample. Tourist firms can thus identify which segments to focus on. In this case study, research can
help identify whether mature repeat travellers are a segment worth marketing to.
• By income: business travellers with income above $50 000 or below $50 000 (i.e. different income
groups) will demand different types of holidays.
• By lifestyle: according to what benefit visitors seek from travelling to Hong Kong. This has enabled
researchers to identify, for example, that high-income business travellers will be more attracted by
promotion based on the range of leisure and shopping facilities available.
• Age: young (under 55) or older visitors to Hong Kong.
• Ethnicity: travellers visiting family in Hong Kong.
3 Benefits:
• The travel company can define its target market precisely.
• It can tailor the marketing mix to meet the needs of different segments. This means adapting
price, promotion, product and place for each segment. Increased sales will result from a mix that is
aimed at specific groups of consumers.
• A more effective marketing mix can be employed to attract customers from the different segments.
Marketing expenditure will therefore be more cost-effective. In the case study, several examples can
be referred to:
• Promotion for high-income business travellers to focus on leisure and shopping facilities.
• Young single travellers might be attracted by ‘bring a friend’ promotions.
• A small travel company would be able to specialise in one or two market segments. Thus, a firm
may decide to focus on mature repeat travellers as this is a relatively small market and will thus be
of less interest to bigger travel companies.
• Price discrimination can be used to increase revenue and profits. For example, it may be possible to
charge a higher price to business travellers than to leisure travellers.
Limitations:
• There will be high promotional costs associated with trying to appeal to different segments as
there will be a need for differentiated advertising and promotions. This means the travel firm will
miss out on marketing economies of scale.
• If a travel firm focuses on a particular segment, such as business travel, there could be problems if
changes in the external environment cause people in that segment to change their spending patterns.
For example, a recession might lead to a significant decline in business travel to Hong Kong.
• The segments are quite broad, e.g. travellers under 55. The benefit of segmentation will depend
significantly on the extent to which members of a segment have similar consumption patterns
and behaviour.
Evaluation will require comment on which are the most important benefits and whether the benefits
outweigh the limitations. In this case study, the size of the travel firm may be significant, e.g. a small
firm may particularly benefit from identifying niche segments from the research.
Activity 17.8
1 Marketing is the management process responsible for identifying, anticipating and satisfying
consumers’ requirements profitably.
2 Customer orientation is based on market research, e.g. fashion tastes dictated by consumers. In
contrast, product orientation is based on the strengths of a firm’s own products, e.g. R&D leads to
quality designs.
3 Products are adapted to the needs of the consumers and this increases the chance that the products will
sell well and make a profit for the business, especially if they become market leaders.
4 Learners’ answers will vary, e.g. increased reputation as the largest firm in the market can be used in
promotion, e.g. as the nation’s favourite brand.
5 Learners’ answers might include one of: changes in taste; technological change which makes
completely new products available; decline in consumer incomes.
6 The product does not meet the needs of the market due to poor product development, especially if
competitors encourage consumers to substitute products that do suit their needs more appropriately.
7 It can target a larger market and so increase sales, which can result in scale economies, reducing costs
per unit as a larger marketing budget is spread over more consumers.
8 Segmentation requires identifying subgroups of a market in which consumers have similar
characteristics. Learners’ answers will vary, e.g. a market can be segmented by age, where different age
groups will have different patterns of consumption; or gender, as consumers will demand different
clothing styles or cosmetic products, for example.
9 Selling to industrial markets is business to business (B2B) whereas selling to consumer markets is
business to consumer (B2C). Learners’ answers will vary and should consider one of:
• Technical knowledge of the buyer is likely to be higher in B2B.
• Impulse buying is more likely in consumer markets.
• Consumers either buy or don’t buy from listed prices. On the other hand, industrial products often
require a quotation with elaborate specifications to define the product.
10 The objective of customer relationship marketing (CRM) is to retain customers as it is relatively
expensive to attract new customers rather than retain existing ones. So using CRM initiatives such
as loyalty cards can lead to increased sales with lower costs than trying to attract new customers
with advertisements.
11 Learners’ answers will vary, e.g. increase sales by 5% in the Indian market within 12 months.
12 Learners’ answers will vary, e.g. use market research to establish consumer preferences; develop a
product or adapt an existing drink that meets these preferences; use an integrated marketing mix that
best fits the target Indian market segment.
13 Learners’ answers will vary, e.g. by age, targeting younger drivers who cannot afford larger cars.
14 It could target different market segments and therefore increase overall sales volume, leading to
increased revenue and higher profits.
15 Market share is a business’s sales divided by (/) total market sales, e.g. if business sales are 10 000
units, market size is 100 000 units, market share is 10%. Market size is the number of units sold in the
market as a whole, e.g. 100 000 by volume – or by sales revenue: 100 000 cars × average selling price of
$15 000 = $1 500 000 000.
16 Learners’ answers will vary but might consider one of the following: not linking with finance might
result in not having a large enough marketing budget; not linking with HRM might result in not
having the skills required for online activities; not linking with operations management might result in
not having the required technology to deliver online sales.
17 Increase effectiveness of advertising, promoting awareness, encouraging repeat sales and customer
loyalty, attracting new customers, focusing on promoting the benefits this brand offers over its
main competitors.
18 Learners’ answers will vary but might include one of the following: use a loyalty card so repeat
customers receive a reward for shopping, which means they are less likely to buy from competitors;
offer a guaranteed returns policy so that if customers are dissatisfied they can get their money back for
any purchase, which is particularly important with online purchases.
19 Learners’ answers will vary, e.g. the product might not be large enough or strong enough for
commercial uses and it may need to be adapted to be more robust and for preparing food in larger
quantities; advertising may focus on industry magazines and greater use might be made of personal
selling to reflect the differing needs of the business customer compared to the consumer.
Essay questions
1 a Marketing objectives provide a focus for the business and are likely to be based on market research
that can be used to inform the marketing strategy, allowing the firm to develop a marketing plan.
The success or failure of a marketing strategy can be measured against the original objective, e.g.
did sales meet the objective to increase by 10% in two years?
b The answer must contrast the benefits of a production-orientated approach relative to a market-
orientated one.
Arguments against the statement might include:
• Marketing is usefully defined as the management process of identifying, anticipating and
meeting customer needs profitably. A product-orientated approach avoids this management
process as it does not place the consumer at the centre of business activity. The focus is the
product – marketing is used as a means of trying to sell the product that has been developed.
• Market research will reduce the risk of new products failing.
• By identifying consumer needs, appropriate products are produced. These are likely to survive
for longer and make higher profits.
• Being the best does not guarantee success.
• Market research ensures that there is constant feedback from consumers and allows the
product to adapt to changing consumer tastes.
Arguments for the statement include:
• By focusing on product research, high-quality products are developed. This will attract
customers who value quality and technological advance above other factors.
• Market research does not guarantee success.
Overall conclusion or evaluation may focus on the use of market research to reduce the risk of
product development and to ensure that consumer needs are being met. Simply having the best-
designed product on the market does not guarantee success.
2 a By age: creating different drinks to meet the tastes of different age groups; making marketing more
cost-effective; raising awareness of the product within the specific group.
By geography: targeting different countries so global tastes are catered for; increasing costs of
marketing as different advertising is required for different products.
b Allocating resources to CRM: the objective of CRM is to build strong customer relationships
through the use of marketing so that the loyalty of existing customers can be maintained. This
requires the firm to communicate with the customer to gain information to guide marketing tactics
to meet customer needs.
Benefits include:
• It is cheaper to retain customers than to attract new customers.
• Repeat purchases and brand loyalty ensure sales.
• It reduces the number of customers buying from competitors.
• It may be particularly important for products that are bought frequently or where fashions
change quickly.
• Long-term impact on sales rather than short-term impact.
Aim to reduce price:
• Offering a lower price will, other things being equal, increase the quantity demanded as there
is an inverse relationship between price and quantity.
• Lower prices make products more competitive.
• It reduces the profit margin so does not necessarily increase profit.
• Competitors may react by reducing price, therefore starting a price war.
• Low prices may change customer perception of the quality.
Overall conclusion or evaluation may consider the importance of how responsive demand is to
a change in price. CRM may be an effective way of increasing differentiation of the business in a
competitive market.

1 Furniture Metallica (FM)
a i It only sells to other businesses.
ii Market growth refers to the change in sales volume or sales value, over a specified period of
time, within the market as a whole.
b i Market share = (firm’s sales in the time period ÷ total market sales in the time period) × 100
(43 ÷ 180) × 100 = 23.8%
ii FM’s sales have decreased and there is a downward trend in FM’s market share. The
company’s product range might be too old-fashioned to meet customers’ current needs.
c Change in type of promotion: targeting different market segments; making greater use of
advertising; making consumers aware of the product.
Change in pricing strategy, perhaps offering incentives to buy at first, in order to penetrate the
market, to establish market share.
d Benefits:
• FM can identify the precise characteristics of market segments within the furniture market.
• It can produce products to appeal to particular segments, e.g. rich corporate customers. If
FM wishes to enter the European market or expand further in the Asian market, it will need
to understand the different product needs within the market. There are likely to be differing
consumer needs according to geographical location. For example, the style of office and
consumer furniture in different parts of Asia and Europe will not be the same; the case study
refers to metal furniture not being fashionable in Europe.
• FM will be able to target promotional activity more effectively, e.g. advertising in high-class
magazines for wealthy segments.
• FM can use the most effective distribution channels to reach each segment, e.g. exclusive
furniture stores for high-income groups.
• FM can set prices which will reflect consumer expectations.
Costs:
• Market research is necessary to understand the different segments of the market. This may
be expensive and require some primary research, although it is likely that market intelligence
reports can be acquired at relatively low cost from organisations such as Mintel.
• There will be high promotional costs associated with trying to appeal to different segments, as
there will be a need for differentiated advertising and promotions. Therefore, FM will miss out
on marketing economies of scale.
• If FM focuses on a particular segment, such as rich corporate customers, there could be
problems if changes in the external environment cause that segment to change their
spending patterns.
Conclusion or evaluation might focus on the need for FM to make significant change to its
marketing mix. Given the weak performance of FM in the Malaysian market, there appears to be
a pressing need for the business to become more market-orientated if it is to survive. Thus, using
market segmentation represents an effective way for FM to become more responsive to the needs
of the market.
2 Adidas and Rapha

a i Low cost as the product is not changed.
ii A part of a whole market in which consumers have similar characteristics.
b i $222 billion × 1.0362 = $238.27 billion
ii As market share is the ratio of a firm’s sales compared to sales in the whole market, if sales
growth is slower than the total market sales growth then a firm’s market share will decrease.
Therefore, Adidas must increase sales by more than 3.6% if it aims to increase its share of this
global market.
c Mass marketing occurs when a firm targets the market as a whole, e.g. Adidas selling cheap
shoes to rural areas of India on a large scale. This can lead to cost advantages as undifferentiated
marketing can be used and economies of scale are likely.
Mass marketing can be very profitable if the business has a high market share. Sales will be high
and costs relatively low, so the profit from this marketing strategy could be high.
d A specialist market has less competition because larger firms are unlikely to enter as there are no
economies of scale and so higher unit costs. Businesses such as Rapha are unable to target larger
markets, which restricts growth over time and therefore reduces potential revenue. Such firms
should remain in the niche market as they understand their market better. This is more important
than targeting the mass market, as the time and money required could cause problems in all
functional areas, threatening survival of the business.
Rapha should be able to make specially designed shoes for each market segment and, with
its brand image, it should be able to charge high prices, leading to high profit per unit. Niche
marketing requires high costs of market research and product differentiation. Rapha may or may
not be able to afford this. Adidas might also try to enter niche markets and then, because Adidas
has cost benefits, Rapha might struggle to survive.
An overall evaluation/conclusion is needed, which might consider the importance of the objectives
of the owners/directors of the business and the brand image they want to build up and maintain
for this business.
be different.
Coursebook answers
Chapter 18
Business in context
Benefits:
• Relatively cheap form of market research.
• Can be up-to-date.
• Helps identify trends in the market.
• Provides a basis for further primary research.
• Less time-consuming than primary research.
Problems:
• May not provide a representative sample as it is a self-selecting group of commentators.
• Not all consumers participate, e.g. elderly consumers are underrepresented.
• Not designed for the specific needs of the business so it may need to be supplemented by primary research.
Activities
Activity 18.1
• IKEA will be able to predict the impact of demographic changes in society on its sales. For
example, as IKEA knows that its core customers are aged between 25 and 50 years old, it can
analyse demographic projections to see if this core group is increasing or decreasing in size. Such
knowledge will contribute to decisions about the marketing mix.
• Understanding customers will help IKEA to design products and store layouts to appeal to them.
Research will also guide decisions about other elements of the marketing mix. For example, IKEA
can identify the importance of designing good-value products that are also fashionable. This
knowledge will help reduce the risks associated with new product launches.
Activity 18.2
1 High GDP per capita suggests the exporter might use premium products to target the market; the size
of market at $1.3 billion suggests that there might be scope for the exporter’s products; the increasing
trend of low-fat and health-food products on offer will help identify the type of food to sell; retail food
sales have grown 20% between 2013 and 2019 and this might be extrapolated to forecast future sales.

3 Data was not gathered for specific purpose so may not be fit for purpose, reducing its benefit and not
providing a full picture of the specific market that the business is targeting. Data is limited and does
not provide enough information regarding the target market. The information does not take into
account external influences that might impact on the future of this market, so the business cannot be
confident that these figures will be replicated.
Evaluation could consider which limitation is likely to be most important in this case or could
introduce a new limitation such as the absence of qualitative data. Qualitative data, based on primary
research, from consumers that provides an insight into why they shop where they do could be very
important, but this is not provided in the data given.
Activity 18.3
• Research reduces the risk of failure. Carlos needs to identify likely demand for his restaurant or
takeaway. Important decisions about the marketing mix need to be taken, including which style
of cuisine to sell to locals and tourists. Without conducting market research, Carlos will not
understand the local market and he is therefore more likely to make inappropriate decisions.
• Research will explain existing patterns of sales. For example, it will identify why the well-known
fast-food chain recently closed its outlet in the resort. There may be no takeaway in the area
because there is a lack of demand.
2 Demographic data. For example, age distribution data could help Carlos determine whether to
decorate the restaurant to appeal to younger people.
Income data. This may help set appropriate prices for the menu.
3 Advantages:
• Secondary research is easy to collect and often cheap. Data is readily available (particularly from
the government), therefore the information can be acquired quickly.
• Demographic data for the coastal area may help assess Carlos’s target market, e.g. young or old.
• Market intelligence reports provide detailed information about the market and will identify key
national trends in the restaurant trade.
Disadvantages:
• Market intelligence reports are relatively expensive for a business start-up to purchase.
• Secondary data was collected for some other purpose. Therefore, much of it will not be applicable
to the situation Carlos faces in the small coastal resort. It is unlikely that Carlos will be able to
identify whether Spanish cuisine could be successful in the resort.
• Secondary data is often out of date. Census data may be collected only every ten years.
• It is not always possible to validate the accuracy of secondary data.
Evaluation may focus on:
• The relative cost of data compared to its accuracy for Carlos’ needs.
• Secondary research is often a useful starting point, helping to identify information that is needed
from subsequent primary research.
• Primary research, although relatively expensive, is needed to answer the questions that Carlos
needs to ask.
Activity 18.4
1 The median of an even number of results is the mean of the middle two results when data has been
placed in order. In this case, these two middle results are 8 and 10, so the median = 9 hours.
2 The number of results less than 9 is equal to the number of results more than 9.
Activity 18.5
1 a 120 ÷ 20 = 6
b There are two modal results of 4 and 7.
c When placed in rank order, the middle two results are 5 and 6, so the median = 5.5.
d Mean: the arithmetic average. This could be useful as it would enable calculation of the cost of
promotion if it is based on the number of visits to a petrol station.
Mode: the value that occurs most frequently. This would be of limited value to planning the new
promotion campaign.
Median: the middle value. The median is the most important value when the data has several
values that occur frequently, and several relatively high values. The mode will not give a unique
answer and the mean will be skewed towards the higher values.
Activity 18.6
1 a 3
b 36 ÷ 64 × 100 = 56.25%
2 a 0.11 × 200 = 22
b 0.34 × 200 = 68
c 0.125 × 200 = 25
3 a Thursday. It has the lowest number of customers.
b 0.25 × 28 × 10 = $70 in vouchers.
1 Primary research data is researched for a specific purpose. Secondary research data already exists as it
was not collected for the specific use of one business.
2 Secondary research will help to identify past data and trends, establish market size and the number of
competitors. Therefore, it may enable the expense of primary research to be avoided if the secondary
data suggests unfavourable market trends.
3 It might be inaccurate because it is out of date. Secondary data was often collected some time before
use and this means that, for example, market data is misleading.
4 Primary research is designed specifically to meet the needs of one business so will be focused on
collecting data required by that business for decision-making.
5 Learners’ answers will vary, e.g. the sample used may not be representative of the whole population the
business is interested in.
6 It can influence the sample used and the type of consumers that should be included in the sample.
7 As the whole population is usually too large to be surveyed, a sample reduces the cost of
data collection.
8 Disadvantage: the sample may be too small to be representative of the target market and therefore the
data collected might be of limited use.
9 The information provides more in-depth understanding of customer motivation, e.g. why they buy a
particular brand rather than another one.
10 Qualitative research is based on non-numerical opinions and, in contrast, quantitative data is based on
numerical results.
11 Quantitative gives results for statistical analysis, e.g. on average, how many times consumers visit a
supermarket each week. Qualitative gives the reasons behind consumers’ decisions, e.g. to purchase
from one supermarket rather than a competing one.
12 Size determines whether the sample is representative of the population.
13 When considering launching a new product. There may be a lack of relevant secondary research data
available if no similar product is on the market.
14 Learners’ answers might include one of: average sales by store size, number of customers passing
possible store locations, age demographics of area.
15 Learners’ answers might include one of: sample size is too small to provide statistically valid data;
the sampling method is not random; the question design is leading and therefore influences
respondents’ answers.
16 a 25% of 40 = 10
b 5% of 40 = 2
17 The mode identifies the most frequently purchased products or size of products.
18 Learners’ answers might vary, e.g. the range of sizes of clothes bought by consumers would help a
business order inventory by size.
Essay questions
1 a Learners’ answers might include two of: to reduce the risk of starting a business; as part of a
business plan to support application for loans; to reduce the risk of new product launches; to
predict future changes in demand and therefore set targets for sales and production; to understand
patterns in sales of existing products and market trends, and influence marketing tactics. Learners
should apply and explain any two points to the context of an entrepreneur starting a business.
b Detailed market research can help a newly launched product be successful by, e.g. identifying the
needs of consumers in the target market; ensuring the product has been designed to meet these
needs; pricing the product in line with what consumers have indicated they are prepared to pay.
However, in evaluation, there are many reasons why detailed market research may not prevent a
newly launched consumer product from failing. Analyse at least two reasons why market research
data might not prevent a new product from failing to achieve sales targets.
An overall conclusion or judgement is needed.
2 a Learners’ answers will vary, but could include any two of:
Primary research
• It is the collection of first-hand data, original information gathered by the firm or on behalf
of the firm, e.g. a supermarket carrying out a survey to establish customer needs.
• The data collected has never been published in any form.
• The data will be directly related to a firm’s specific needs. A consumer survey will be designed
to discover specific aspects of consumer needs relevant to the firm.
• Primary research is typically expensive to collect. This is because it requires significant labour
input and expertise if the results are to be trusted.
Secondary research
• This is the collection of data from second-hand sources, e.g. a supermarket using government
statistics on the demographic profile of a particular region.
• It is pre-existing data that has already been published in some form. Data may, for example, be
found on the internet, in libraries or sourced from the government.
• Usually the data has not been collected to meet the specific research needs of the firm – it was
collected for some other purpose. Trade magazines publish information of general interest to
specific sectors.
• Secondary research is relatively cheap to collect.
b Secondary research data could provide information about the demographics of the area; the
performance of existing franchises in the chain; the number of competitors; trends in the market
for fast food. This information would help reduce the risk of opening the franchise and provide a
base for further primary research.
Evaluation should include an assessment of why secondary research might be inadequate in this
case, suggesting that primary research might be necessary too.

1 Cosmos
a i High cost.
ii The group of people from the target population selected to take part in market research.
b i 6 ÷ 20 × 100 = 30%
ii Learners’ answers will vary, e.g.:
Insufficient surveys sent out. Posting 20 surveys will not gain a large enough sample. If the
sample size is too small then the results are unlikely to be representative. Postal surveys
typically have a high rejection rate so a representative sample is less likely.
Surveys were not sent to a representative sample. Cosmos wanted data to help create a sporty
and youthful image. However, questionnaires were not sent to the target market and included
elderly respondents.
c Secondary research could have limitations such as:
• The market and demographics of consumers seem to be changing, which will make existing
secondary data out of date quickly. Cosmos should not base important decisions on data that
is not as up-to-date as possible.
• There are several large competitors. Secondary data, which has not been collected for Cosmos’
particular needs, will not provide Cosmos with details of the reasons why consumers might
prefer to buy competitors’ drinks. This data could only be gathered from primary research.
• A face-to-face questionnaire or survey using judgement sampling. The interviewer would choose
appropriate respondents, e.g. young and/or sporty people. This would enable Cosmos to find
out whether the image of its drinks was youthful in the eyes of the target population. Using a
questionnaire would enable quantitative data to be collected. The sample needs to be large enough
to give Cosmos some confidence in the results. However, unless a probability sample is used, it is not
possible to identify the degree of confidence in the results. Conducting a random sample may be
difficult as Cosmos would need a database of the target population from which to draw respondents.
• A focus group of young people. This would allow Cosmos to collect more qualitative data
about their drinks and the competition. In a focus group, more in-depth information is collected
that could indicate why advertising was not more successful, whether the taste of the drink
was right, the quality of the packaging and whether the image was positive. However, running
a focus group successfully requires a skilled market researcher who is able to pursue relevant
lines of questioning and avoid unduly influencing the group. This makes focus groups relatively
expensive and the information collected is unlikely to be representative as the sample is so small.
• In-depth interviewing. This would also collect qualitative data as it is less structured than
using a simple questionnaire. This is time-consuming and labour intensive, therefore it is
relatively expensive. However, the data collected should reveal much about consumers’
impressions of Cosmos’s products and help explain why Cosmos is being less successful.
Evaluation should justify which primary research technique is suitable. Justification may relate to:
• Relative cost and ease of implementing the technique.
• Likelihood of gaining representative data.
• The merits of qualitative versus quantitative data.
• Timescale for collecting the data.
2 GCB
a i It provides reasons for statistical results.
ii A description of a business’s typical consumers, including demographic and psychographic
characteristics.
b i Proportion of total sales: 3 000 ÷ 11 000 × 100 = 27%
Proportion of total sales revenue: 300 000 ÷ 800 000 × 100 = 37.5%
ii It is a high-value product so although sales units are only 27% of total sales, the revenue from
this product accounts for a higher proportion of total revenue.
c Market research can be used to understand the needs of customers and therefore influence the
marketing tactics used by a business. It is particularly useful in this case to understand the different
needs between household consumers and commercial customers.
Research can also identify trends in the market and help predict future demand changes.
Researching the changing demand patterns between hand-powered mowers and engine-driven
mowers would help GCB analyse the reasons for changing its product portfolio.
d Learners’ answers will vary, e.g:
Secondary research. This should be done before primary research as it will help identify trends and
the scope of the necessary primary research. The following resources could be used:
• Trade association and magazines. If GCB is a member of a trade association, it will have
access to information from the association. This is likely to include data on sales in the market
segment that GCB is considering.
• Market intelligence reports. These can be expensive but are the result of professional market
research. Organisations such as Mintel will publish reports into consumer and industrial
markets, including the gardening sector. Such a report will provide detailed background
information on market size and growth.
• Government data. GCB may be interested in data on the economy and predictions for future
economic growth.
Primary research. This is typically more expensive and time-consuming to collect but is specific to
GCB’s needs. GCB’s primary research will be constrained by the size of its marketing budget and
the time available to conduct the research. It would be important to get a representative sample of
the market it intends to enter.
• A survey could be conducted by contacting potential customers by telephone or post. Using
a questionnaire, quantitative data could be collected. This would enable GCB to evaluate the
demand for the product and the key elements of the marketing mix such as price.
• A random sample should be used if possible to ensure that results are representative.
• In-depth interviews with potential clients would be useful for gathering qualitative
information. However, this is more expensive and depends on whether businesses are willing
to participate.
Evaluation may consider the cost and time implications of the research in relation to the resources
available to GCB. Is the market changing quickly? Are competitors introducing new products?
The more dynamic the environment, the greater the importance of primary research.
be different.
Coursebook answers
Chapter 19
Business in context
Learners’ discussion might include marketing decisions about:
• Product: including five-star accommodation, educational excursions and mahout training.
• Pricing: high prices are set.
• Promotion: advertising in quality newspapers, publicity and the website.
• Place: through wholesale bookings and direct selling.
It is important to give the same unique quality image so that there is consistency in the message to
potential customers. If there is inconsistency between the different marketing elements, customers will be
confused and less likely to be satisfied if they stay at the resort because expectations may not be met. These
marketing decisions ensure that the product can be targeted effectively.
Activities
Activity 19.1
1 a A feature that differentiates the product from competition. A unique selling point or proposition.
b A name, symbol or image that differentiates a product from its competitors.
2 Facebook’s brand value could have been harmed by negative publicity such as concerns about its use
of personal data or by the increasing use of alternative social media platforms by younger people.
3 Technology: Apple has been innovative and its smartphones use the latest technology such as
facial recognition.
Design and build quality: Apple products have a reputation for product design and high-quality
components.
4 Tangible: the ‘secret formula’ used for Original Coca-Cola; customers enjoy the taste of the product
and its consistency; the classic design of its bottles, logo and use of red on its cans which make its
products instantly identifiable.
Intangible: the image and reputation that customers identify with were built by aggressive promotion
over many decades.
Evaluation may include an assessment that in practice, it is very difficult to separate these two elements
of a successful product; that the many millions of $ Coca-Cola (and its main competitors) spend
each year mainly serve to establish the intangible elements of the brand because the actual product
differences are not that great between competing cola products.
Activity 19.2
Activity 19.3
Activity 19.4
1 Profit = revenue – costs
Revenue = 6 × 400 000 = $2.4m
Total costs = fixed cost + total variable costs
= 200 000 + (400 000 × 3) = $1.4m
Profit = 2.4m – 1.4m = $1m
2 Contribution per cap = price – variable cost
= 6 – 3 = $3
3 Average total cost = total cost ÷ quantity
= 1.4m ÷ 0.4m = $3.50
Add 100% mark-up: price = 3.50 × 2 = $7
4 Factors to consider might include:
• Responsiveness of demand to a change in price. This will affect the level of demand if the price is
increased. If demand is not sensitive to price change, an increase in price will increase revenue. If
demand is responsive, an increase in price will reduce demand significantly and revenue will fall.
• The degree of competition. The more competitors there are, the more likely it is that demand will
be responsive to price change.
• Fixed costs and profit margin. A reduction in demand will reduce the capacity utilisation and
therefore increase the average fixed cost per hat sold.
• Likely reaction of competitors to the increase in price. If competitors increase their prices, there
will be less impact on the demand for Hartwood hats.
• Spare capacity. At a price of $6, HH was left with spare capacity of 100 000 caps.
• Contribution pricing can be used to ensure that variable costs are covered with a contribution
made to fixed costs. This can be used to increase demand and increase capacity utilisation.
Evaluation and recommendation might focus on the objectives set for HH. If the objective is to
increase market share, the marketing manager will prefer contribution pricing. In contrast, if HH has
relatively few close competitors or its product quality is well-recognised, cost-plus pricing might be the
better recommendation.
Activity 19.5
1 Airlines use dynamic pricing by offering seats at a price that changes according to market conditions
and the customer’s ability to pay. When purchasing online, consumers can be separated and airlines
can vary the price according to demand patterns or knowledge that they have about a particular
consumer and their ability to pay. This could be based on the type of computer someone has,
location or demographic information, and so the airline shows a different price to different groups of
consumers. In the case of airlines, this is also based on time. Price changes are made according to how
full the flight is and how close to the departure date a consumer enquiry is. As airlines have significant
fixed costs, and marginal costs for each seat sold are low, it is important to fully utilise capacity to
increase revenue and profit.
Dynamic pricing is a form of price discrimination. It is an effective way of increasing profit for
airlines. Evaluation might include an assessment of the likelihood that it could result in consumer
dissatisfaction as individuals may pay very different prices for the same service. Therefore, consumers
who pay higher prices may feel ‘cheated’.
2 Louis Vuitton sets prices at a level that matches consumers’ views about the product’s perceived value.
Louis Vuitton handbags and fashion accessories are perceived to be the height of fashion and are
purchased by film stars and other rich and famous influencers. Its brand value enables prices well above
the cost of manufacture to be charged, supported by the use of exclusive channels of distribution.
Therefore, this is a form of psychological pricing and adds to the profit the business makes.
Evaluation could include a consideration of whether psychological pricing might need to be changed
for another form of pricing during a long and serious world recession which reduces consumer
incomes substantially.
Activity 19.6
Activity 19.7
This can be looked at from the point of view of Levi’s and other key stakeholders.
Levi’s should limit sales:
• Levi’s has carefully developed a brand image of being a premium-priced brand. Developing the brand
has been expensive; Levi’s investment in building its brand requires high prices to provide a suitable
return on the investment. Tesco threatens that brand image by selling the product at low prices.
This will place downward pressure on Levi’s prices and that will reduce its profit.
• Levi’s core responsibility is to its owners and it should be able to choose which companies it supplies in
the pursuit of profit. Levi’s should be free to restrict supply to protect its profits.
• Tesco may have infringed Levi’s trademark rights and may therefore be acting illegally.
• If Levi’s has control over its brand, consumers can vote with their spending power if they are unhappy
with Levi’s setting high prices.
Levi’s should not limit sales:
• Limiting sales to drive up prices is a form of exploitation of the consumer. It reduces consumer welfare
as the consumer has to pay a higher price than would be set if there were fair competition. Tesco is
simply responding to a legitimate demand from its customers for low-priced branded products.
• Levi’s seems to be using price discrimination against its European customers. Is this fair and will
consumers react against Levi’s?
• The argument that ‘people want to experience a premium brand like Levi’s in the right environment’ is
dubious. Consumers are likely to appreciate the lower prices that Tesco offers even if its facilities are
not as good as those of fashion retailers.
Evaluation may contrast the rights of Levi’s to pursue profit by protecting its brand against the rights of
the consumer and Tesco.
1 The four key decisions on product, price, promotion and place that must be taken to enable the
effective marketing of a product.
2 A tangible attribute is a physical aspect of a product such as its appearance, often reflected in the type
and style of packaging used.
3 To ensure a consistent message to customers. A high price will be charged to convey the quality of the
product and this should be supported by distribution in exclusive retailers and promoted in magazines that
are read by high-income groups. The product needs to be fashionable and made to a high standard of quality.
4 Non-physical aspect of a product such as its image.
5 Learners’ answers will vary, e.g. it has a major impact on the quantity sold and therefore market share;
it determines whether the costs of production are covered and therefore whether a profit is made.
6 Analysing the range of existing products of a business to help allocate resources effectively
between them.
7 To meet a business objective of gaining market share by pricing at a level no greater than that of
competitors, rather than focusing on profit per unit.
8 Pricing conveys information about quality, positioning of the product in the market and image.
Therefore, it is important that other aspects of marketing-mix decisions are consistent.
9 Setting a price by calculating a total unit cost for the product and then adding a fixed profit mark-up.
10 Setting a price at a level which matches consumers’ views about a product’s perceived value.
11 By reducing price, it may be possible to attract new customers or appeal to a different target market.
12 Learners’ answers will vary, e.g. in a competitive market new products are needed to differentiate from
competitors; new product development will add innovative features to consumer products, and create
repeat sales, and therefore make older products appear dated.
13 Learners’ answers will vary, e.g. some consumers will be able to purchase the product at a lower price;
price discrimination increases profits, which can be re-invested to improve the product or service.
14 It identifies products according to four categories based on market share and market growth. This can
focus managers on which products need further marketing support or should be divested, helping to ensure
that a business has a balanced product portfolio and is therefore not overdependent on one product.
15 Learners’ answers will vary, e.g. use of promotion to attract customers such as advertising on
television; pricing to convey target market, e.g. discount supermarkets charge low prices.
16 Price implies quality of product to the consumer and the target market, e.g. luxury car-maker Jaguar
will have a premium price, but a budget hotel room will have a low price.
17 Train travel. Full-cost pricing is used at peak times as trains will be full. At off-peak times, there is low
demand, so contribution pricing is used and a lower price is charged. The aim at off-peak times is to
cover variable costs and make a contribution to fixed costs, which have to be paid anyway.
18 Airlines have a fixed number of seats to supply and prices change to reflect availability. If demand is
high and only a few seats are left, price will increase, increasing total revenue from each flight.
19 Skimming is setting a price high to attract early adopters of a new product (e.g. Apple iPhone), but
penetration pricing is setting a price low to enter a mass market (e.g. a new chewing-gum brand).
20 When customers are enticed by a loss-leader, they make other purchases as well. For example, a
supermarket may set the price of bread or rice below cost to attract customers, who then purchase
other products as well.
Essay questions
1 a Answers may include comment on the following issues:
• Define marketing mix. Each element is important in contributing to the achievement of
marketing objectives.
Learners’ answers will vary but should include an analysis of two of:
• Price is important in determining the demand for a product. There is an inverse relationship
between quantity demanded and price.
• In a market in which there is significant competition, price will need to be set competitively.
However, if price is set too low, consumers may lose confidence in the product.
• If there are groups of customers with different demand characteristics and markets can be
kept separate, price discrimination will be appropriate, e.g. when setting train fares. Price
discrimination helps increase revenue.
• Pricing decisions can support the other elements of the marketing mix to ensure that a
consistent marketing message is given to consumers. Price can help establish the psychological
image and identity of a product.

• Cost of production: this is the bottom line for any firm to make a profit.
• Marketing objective: if it is to increase market share rapidly, it may need to use
penetration pricing.
• If the phones have a USP, this could allow price skimming to be used.
• Market conditions, such as the number and closeness of competitor products.
• Ensuring an integrated marketing mix. Premium products will have premium prices.
• Economic conditions. If the economy is growing and demand is high, higher prices can be set.
Evaluation might include the relative importance of these factors for a new range of smartphones.
This might depend on the brand image and the target market. The level of competition is likely to
be a major factor in this market.
2 a Learners’ answers will vary, e.g.:
Brand image distinguishes a product from its competitors. Effective branding is a way of meeting
customers’ intangible expectations of a product. This enables the business to gain more control
over pricing and set a higher price without losing customers.
A strong brand image can encourage repeat purchase. The customer is less likely to even consider
purchasing competitor products. Brand loyalty can be a very powerful factor influencing consumer
behaviour.
b Answers may include comment on the following issues:
• Definition of the product life cycle. This is the theory that all products follow a similar life
through introduction, growth, maturity and decline. Analysing a range of products by using
the product life cycle can help firms make appropriate marketing decisions.
• Identification of the different stages of the product life cycle and a brief outline of each.
• It is a competitive industry and competitors are constantly developing new models. This also
contributes to a relatively short life cycle.
• Therefore, knowledge of the product life cycle is beneficial, as it reinforces the importance of
having to constantly update products to remain competitive.
• It will also assist with:
• planning marketing-mix decisions such as new product launches and price or promotion
changes.
• identifying how cash flow might depend on the cycle
• recognising the need for a balanced product portfolio. The car manufacturer needs to
constantly have products under development so that they are ready to be introduced onto
the market as existing products enter the decline phase.
• Learners could illustrate these points on a diagram as shown below (not a requirement).
This will ensure that cash flow remains balanced.
Sales ($)
A B C
Time
• However, marketing decisions will also depend on:

• competitors’ actions
• the state of the economy
• the marketing objectives of the business.
Evaluation: the product life cycle is an important tool for assessing the performance of the firm’s
current product range. It is an important part of a marketing audit – a regular check on the
performance of a firm’s marketing strategy.
However, the product life cycle is based on past or current data – it cannot be used to predict
the future.
Product life-cycle analysis needs to be used, together with sales forecasts and management
experience, to assist with effective product planning.

1 Horizon Software
a i Maturity.
ii Setting a high price for a new product that is unique in some way and stands out from
competitor products in the market.
b i Total unit cost = total cost ÷ quantity = (400 000 + 200 000) ÷ 50 000 = $12
With a 50% mark-up, the price will be 1.5 × 12 = $18
ii This could make the price more competitive as only the variable costs are covered plus a
contribution to fixed costs and profit. For example, selling price = unit contribution + average
variable costs = 1 + 4 = $5.
c Introduction: price skimming to take advantage of the superior software the product offers and
the initial lack of direct competition. Promotion may be informative to make customers aware of
the product and increase sales.
Growth: price may be kept high if there is still a lack of products imitating Space Traveller.
However, low take-up of sales may lead to prices being reduced to encourage sales and will mean
that promotions will need to become more persuasive.
Maturity: as growth of sales starts to slow and competitor products emerge it may be necessary to
reduce price. Pricing will have to be competitive to prevent a decline in sales.
Decline: in this market, sales may start to decline rapidly unless extension strategies are used.
Extension strategies will focus on improved versions of Space Traveller. When the product does
move into decline, pricing is likely to be reduced further in order to sell off stock.
• The life cycle of computer games is very short so it is important to recoup development costs
quickly before new competition enters the market. Therefore, a high price should be set to take
advantage of the product’s initial uniqueness in the market.
• New competitors are entering the market virtually every month so there is only a short
window within which Horizon’s product will have a competitive advantage. Therefore, a high
price should be charged.
• The software design for Space Traveller is superior to most of the competition. This quality
will support a skimming strategy.
• Responsiveness of demand to a high price will be important. It will depend on factors such as
the extent to which Space Traveller has a unique selling point.
Evaluation might include:

• A high price will reduce sales volume and consequently unit fixed costs will be greater.
• A high price will result in lower sales growth and thus prevent Horizon Software from taking a
substantial market share. The lower take-up of the game may reduce consumer interest in later
improved versions of the game.
• An overall conclusion or evaluation is needed, such as a clear recommendation with a
justification why other methods such as penetration pricing are rejected.
2 Jupiter Confectionery
a i Selling to a new market.
ii Analysis of the range of existing products of a business to help allocate resources effectively
between them.
b i 2019 to 2020: ((123 000 – 120 000) ÷ 120 000) × 100 = 2.5%
2020 to 2021: (1 000 ÷ 123 000) × 100 = 0.813%
ii Maturity. Growth of sales is slowing. Between 2020 and 2021 sales growth was only
0.8%. Therefore, it appears that sales have almost reached their peak. There is significant
competition in the market with many substitute products available which also suggests this
product is in the maturity phase.
c The analysis shows that Jupiter Confectionery will not have products in the growth phase of the
product life cycle to replace the sales of its products that are entering decline. An unbalanced
product portfolio could result in declining overall sales in the future.
The analysis also encourages the business to take decisions about different products in the
portfolio, e.g. whether the Mercury product should be dropped altogether.
d New packaging, new sizes. New packaging for Sun is potentially a cheap extension strategy to
employ to regain consumer interest. As the product is over ten years old, the packaging may
appear dated and a new design could revitalise sales. Launching the product in new box sizes may
also encourage new users and more frequent use. These strategies involve no fundamental change
to the product.
Reposition the product. For example, it may be possible to develop the product to contain less
fat and sugar. Therefore, the product could be marketed as a healthier alternative to competitors.
Healthy eating is a growing market. However, it may be difficult to market Sun as a healthier
alternative because it is chocolate. It is primarily an indulgence product and reducing its fat
content may reduce its appeal if flavour is compromised.
Evaluation: in both of these strategies, market research plays a vital role. The extension strategy
adopted may depend on an assessment of the resources available to Jupiter and the actions of
competitors with similar products.
3 FarmGate
a i It helps to retain market share.
ii A market that is well established and in which sales growth has peaked.
b i $28m + 10% = $30.8m; $30.8/$95m = 32.4%
ii Two brands have a high market share. Learners’ answers will focus on one:
• Gold Seal milk is a cash cow. It has a high market share in a mature market. There is no
or only low market growth.
• Hi Energy spread is a star. It has a high market share of 31%.
A high market share might mean that one of these brands is a market leader in its own market
segment and this fact could be used for advertising and promoting the product.
c Using the Boston Matrix enables FarmGate to analyse its product portfolio, which will help make
decisions about future support for its products. For example, FarmGate can identify that Churn
butter is a ‘dog’ – it has low market share and the market growth is negative. Therefore, FarmGate
may decide not to invest in Churn butter and allocate resources elsewhere.
Secondly, FarmGate can use the matrix to plan which future marketing strategies to take next.
For example, Lo Fat yoghurts may be classified as a problem child – it is in a fast-growing market
but has low market share. FarmGate may need to increase marketing expenditure on Lo Fat
yoghurts to improve its market position.
d Learners’ answers will vary, e.g. Lo Fat yoghurts. The strategy adopted will aim to build Lo Fat
yoghurts’ market share. Answers may consider the following points:
• Marketing objective. Increase sales by x% above the market growth rate.
• Marketing mix. Secure more distribution outlets to increase availability of Lo Fat yoghurts.
Below-the-line promotion may be used to support the place objective, e.g. offering point-of-
sale displays and discounted prices to retailers. Above-the-line promotion through advertising
the product during health-related programming on TV and/or use of specialist magazines
focused on health (advertising decisions will depend on the marketing budget available).
• Penetration pricing strategy. Although the product was launched two years ago, it may still be
necessary to use a penetration pricing strategy as the objective is to build sales rapidly.
• Develop the product to maintain consumer interest by developing new flavours or launching
new product sizes.
• Evaluation could include the need to measure sales and market share very frequently so
that the impact of the new marketing strategy can be checked on – and that further strategic
changes might be needed if market share does not increase.
4 Dell
a i Level of competition.
ii Setting a low price in order to increase sales.
b i 200 × 1.25 = $250
ii Competitor prices. As competitors produce substitute products, Dell will take into account
the price of competitor computers. If Dell sets price too high, consumers may switch to
buying other brands.
c Learners’ answers will vary, e.g.:
• Increased revenue as demand appears to be responsive to price changes. The strategy will
improve its reputation for value.
• Further increased market share and thus enhanced influence in the market.
• As one of the world’s largest computer manufacturers, Dell will benefit from economies of
scale. Dell’s price-cutting strategy passes on this benefit to the consumer. This will increase the
pressure on smaller manufacturers to cut prices despite having higher costs. Therefore, smaller
manufacturers will see profit margins eroded and may be unable to compete. Dell’s strategy
may destroy competition. If competition is driven out of the market, Dell will be able to enjoy
greater profit in the long term.
• Competitors that offer a wide range of products and many low-cost computers may be forced
to cut prices to remain competitive in the market. It would be important to maintain a price
advantage over competitors. Therefore, such competitors would also need to focus on reducing
the cost of manufacture so as to maintain profit margins.
• Alternatively, competitors may focus on the premium end of the market and aim to
differentiate products through offering a high specification. Therefore, it would be possible to
charge premium prices for these improved products.
• Promotion may be used to build brand loyalty and avoid having to cut prices.
• Evaluation could include an assessment of the reaction of competitors depending on a range
of factors, including brand loyalty, how sensitive demand is to a change in price and the ability
of the business to reduce costs of manufacture.
be different.
Coursebook answers
Chapter 20
Business in context
Importance of digital promotion
• They wish to appear to be trendy and technologically advanced.
• The target market is focused on younger consumers who are more likely to use social media.
• Digital promotion can be cost-effective and much cheaper than traditional forms of advertising.
Personal communication
• Email can be used to confirm purchases and inform individuals about new products.
• Text messages can be sent to subscribers.
• Apps can be used to push messages to consumers’ smartphones.
Stop promotion and reduce prices?
• Reducing the price will reduce the profit margin and may result in price wars with competitors.
• Demand may not be responsive to a reduction in price and, therefore, although sales might increase,
there would be no increase in revenue.
• Promotion is expensive and not guaranteed to be successful.
• Promotion is necessary to react to the promotion of other businesses.
• Promotion helps keep a product in consumers’ minds.
Activities
Activity 20.1
1 As businesses spend so much money on promotional campaigns, they need to know whether that
spending has had the desired effect in terms of impact on, among other things, branding and sales.
If no attempt is made to measure effectiveness, businesses may be wasting valuable resources on
campaigns that fail to achieve business objectives. With measurement of effectiveness, businesses can
learn from successful campaigns and improve the targeting of marketing.
2 The evidence suggests that focusing on one form of promotion is less effective than taking a multi-platform
approach. There may be diminishing returns from spending on a particular form of advertising, i.e. the
benefit from each extra dollar spent decreases and may even become negative. Consumers may tire of seeing
the same advertising message constantly and there may come a point where more advertising is detrimental.
Businesses such as Sony and Samsung have such large advertising budgets that the money is best spent
across a range of different promotional platforms. This may enable greater coverage of the target market.
Evaluation could include a consideration of the need for detailed market research on the companies’
consumers and on the influence that different forms of promotion have on their buying decisions.
Market research is often at the root of most marketing decisions.
Activity 20.2
1 (855 − 623) ÷ 623 = 37.2%
2 Digital forms of advertising are cheaper than traditional advertising on television and in national
newspapers. TV adverts can cost (in 2020) $8m to film and $0.4m to show for 30 seconds on major
TV channels. A start-up adventure holiday firm lacks the finances to pay for this approach. Digital
advertising is targeted and cheap. For example, pay-per-click marketing on a business website costs (in
2020) around $10 000 and search engine optimisation can be bought for a further $10 000.
• Size of the marketing budget. The larger the budget, the greater the range of promotional options.
A significant budget will be required for national television advertising.
• Target market. If the target market is younger people, digital promotion through Instagram may
be appropriate, whereas an older target market may require more traditional forms of advertising.
• Type of message that needs to be communicated. For example, if detailed information must be
communicated, written forms of communication will be more effective (e.g. in newspaper adverts).
• Nature of the product. This may mean that there are legal constraints in particular countries (e.g.
tobacco advertising).
• The other elements of the marketing mix. If the product uses premium pricing, this will influence
the choice of advertising (e.g. premium perfumes might be advertised in glossy magazines).
• Evaluation could include an assessment of which factor is likely to be most important in the
different countries’ markets that the multinational sells to.
Activity 20.3
• Limited budgets. Shop managers are faced with a choice between a wide range of sales promotion
techniques. It is important that limited budgets are spent in the most effective way possible.
• There is little point in spending money on a sales promotion technique if it does not deliver the desired
benefits. It is essential that marketing objectives are met by the chosen form of sales promotion.
• Different techniques offer different potential benefits. For example, in-store displays were felt
to encourage consumers to try a product for the first time whereas loyalty cards encouraged
consumers to purchase from just one store. Therefore, shop managers need to compare cost and
effectiveness in achieving their particular goals.
• Sales promotions cost money and the expenditure may need to be justified in terms of the
outcomes they achieve. Shops aim to make a profit, so budgets need to be justified.
2 Learners’ answers will vary but should try to evaluate options in terms of cost to the supermarket
against the achievement of the objective set. Two potentially relevant techniques:
Buy one, get one free (BOGOF):
• This encourages multiple purchases.
• The major disadvantage of BOGOF offers is the impact on gross profit margins. It will cause a
substantial reduction in gross profit.
• Current sales are likely to increase substantially and revenue in the short term will be higher.
However, future sales are likely to be lower as consumers have stockpiled the cereal. As cereals
have a relatively long shelf life, there is little danger of the cereal passing its best-before date, so
consumers are unlikely to over-purchase the product.
• As the cereals are highly profitable, BOGOF may be justified as a strategy because profit can still
be made. The offers may draw customers into the supermarket and lead to an increase in spending
on other products.
Price promotions:
• The supermarket offers a temporary reduction in the price of the cereal.
• The price discount will encourage existing consumers to buy more of the cereal and new customers
to purchase it, as it now appears more competitively priced. New customers may continue to
purchase the product in the long term even after the discount is removed.
• Existing consumers will bring forward their purchase of the product. After the discount, sales may
be lower as customers have stocked up on the product.
• A price discount will reduce the gross profit margin on each box of cereal sold.
Activity 20.4
1 To support the brand image. For Zao Makeup, the packaging must have a low environmental impact
so uses bamboo rather than plastic.
To protect the product. Consumers may use the product over an extended period and therefore it is
essential that the packaging prevents any deterioration in the contents.
2 Benefits:
• This is an example of the growing influence of corporate social responsibility. Increasingly,
consumers are concerned about the impact of products on the environment. Therefore, a business
can gain a competitive advantage by using recyclable packaging.
• This improves the marketing of the product to the consumer.
• Higher pricing may be possible.
Disadvantages:
• Recyclable packaging may be more expensive and therefore increases price to the customer.
• It may not be as effective at protecting the product. Plastics are particularly effective for storing
and protecting food products.
• Recyclable packaging is not necessarily more energy efficient and therefore can be more harmful to
the environment.
Evaluation could include: As with so many CSR-based decisions, the increase in costs may be largely
short term but the potential marketing and reputation benefits could be long term. Much will depend
on the cost of using recyclable materials and consumer expectations regarding the product.
Activity 20.5
1 Social media was able to reach a large potential audience, resulting in more than 166 million social
impressions. The campaign was relatively cheap as it only required selected music fans to be given
wi-fi-enabled cameras. It fits in well with Nikon’s target market, which is technologically aware.
2 Arguments for importance: this strategy matches the objective to make the Nikon brand appear more
accessible and not just associated with professionals. Supermarkets have a very high footfall. They
provide a convenient location for consumers to purchase.
Arguments against importance: it may appear to cheapen the brand image away from being a specialist
product. Supermarket employees are unlikely to be knowledgeable about the product, which is
important when choosing a camera.
Evaluation: it depends on the target market, price range and desired image.
Activity 20.6
1 Mix A: advertised on radio only. Radio may be poor at conveying the qualities of a sports car.
Mix B: sold only over the internet. Low-income families are less likely to have access to the internet or
credit cards.
Mix C: low price. This is a fashionable hairdressing salon in a wealthy part of the city and the rest of
the mix supports high prices.
Mix D: product. A fast-food restaurant is less likely to support the other elements of the mix, such as a
skimming price strategy.
2 Mix A: an expensive sports car should be advertised in business magazines as these will be read by
individuals with higher incomes.
Mix B: a range of furniture for low-income families should be sold through discount furniture retailers.
These retailers will attract low-income families.
Mix C: a hairdressing salon using well-known stylists should charge high prices and offer no discounts,
to convey a message of exclusivity.
Mix D: a fine-dining restaurant serving locally produced seasonal food would be more likely to attract
the target market of business executives.
Activity 20.7
1 Advertising is paid-for communication, with potential and existing customers, to inform and/or
persuade. Sales promotions are in-house incentives to generate increased sales, e.g. BOGOF.
2 Learners’ answers will vary, e.g. to promote a new offer on the existing product; to reinforce brand
image, which helps maintain customer loyalty; to persuade new customers to purchase.
3 Learners’ answers will vary, e.g. compare sales before and after the promotion, if there are no other major
changes, e.g. competitors increase promotion; survey customers to get feedback on the promotion.
4 Learners’ answers will vary, e.g. a poorly designed advert results in a negative impact on the brand
image; too-frequent advertising creates annoyance amongst customers.
5 Branding can increase the perceived value of a product in the minds of consumers. It can make it a
‘must have’ product. This helps to reduce the responsiveness of demand to higher prices as customers
are willing to pay more.
6 Learners’ answers will vary, e.g. using consumer awareness data to identify consumer recall and awareness
of promotions; using consumer panels to get qualitative feedback on the impact of promotions.
7 Learners’ answers will vary, e.g. personal selling uses a salesperson to sell to individual customers;
direct mail is sent by post to customers and potential customers.
8 Learners’ answers will vary, e.g. to regenerate interest in a product which has been on the market for a
long time; to persuade consumers towards alternative uses, e.g. eating breakfast cereal as a snack when
watching TV.
9 They are small and relatively inexpensive promotions in stores that often result in increased impulse
purchases, e.g. sweets.
10 Learners’ answers will vary, e.g. it attracts customer attention by its design and colour; it helps a
product stand out from competitors; it provides valuable information, e.g. ingredients of a food
product or allergy information.
11 Public relations in the form of deliberate use of free publicity provided by newspapers, TV and other
media communicates with the public and promotes a positive image.
12 Learners’ answers will vary, e.g. online advertising using pop-up banners or placing advertising on other
websites; email marketing to communicate with customers (e.g. notifications about new products).
13 Learners’ answers will vary, e.g. to break down bulk; allow smaller retailers to enjoy some economies
of scale.
14 Learners’ answers will vary, e.g. logistical difficulties regarding secure payment systems, cost and
administration of deliveries and returns of unwanted/faulty products; difficulty of getting noticed,
unlike with fashion in a physical market.
15 Brand image could be improved by the business taking socially responsible decisions such as using
recyclable packaging for cosmetics or a car manufacturer making only electric vehicles. Many
consumers will have a higher rated opinion of the brand.
16 Learners’ answers will vary, e.g. place – virtual market with downloads; price – priced per track
to download.
17 Learners’ answers will vary:
Physical market, e.g. retailer (bike shop). Advantages to business: personal touch; able to persuade
customer; sell additional items. Advantages to customer: customer service; advice; can physically see,
touch and try bikes.
Virtual market, direct from the manufacturer. Advantages to business: lower overhead costs; reaches a
potentially larger target market. Advantages to customer: fewer intermediary mark-ups; might be able
to mix and match or tailor-make more easily; convenient: constantly available; delivery available.
18 It might use point-of-sale displays in retail stores to ensure that shoes are seen by customers.
19 Digital distribution is distribution to consumers by a digital means, e.g. streaming and downloading of
content. Physical distribution moves the physical product to the consumer directly or through channel
intermediaries such as retailers.
20 Learners’ answers will vary, e.g. the cost is lower so the business can save money on promotion; it may
be more suitable due to the target market for the product, e.g. younger consumers.
Essay questions
1 a Advertising is above-the-line promotion and makes use of media to communicate the promotional
message. The media used for advertising include television, cinema and newspapers.
Advertising can be categorised as being either informative or persuasive:
• Persuasive advertising tries to create a distinct image for the product and contains little or no
information about the physical aspects of the product.
• Informative advertising provides information about the product. Adverts for computers often
focus on technical details such as memory size and processor speed.
Direct promotion is a form of below-the-line promotion so does not use a paid-for medium.
Methods include direct mail, telemarketing and personal selling. Personal selling is often used for
industrial products so is a key feature of business marketing.
b There are a number of techniques that can be used to determine whether promotion campaigns
have been successful including:
• Analysing sales before, during and after the campaign. However, an increase in sales does
not mean that the campaign has been successful. There are many other influences on demand
including the marketing decisions of competitors.
• Market research. Firms can use consumer panels to monitor the views of a small group of
consumers over time. This will enable changes in consumer opinion to be identified.
• Response rates to advertisements:
• Money-off coupons in magazines and newspapers can be tracked to identify the take-up
on a particular offer. This provides a direct measurement of the impact of the promotion.
However, it doesn’t identify whether those consumers using the voucher would have
purchased the product anyway.
• Websites can record the number of ‘hits’ received (i.e. how often an advert has been
viewed). However, just because an advert has been viewed, does not mean that it will lead
to a purchase.
• Consumer awareness data. This is published by market research agencies based on consumer
recall tests of advertisements. This gives good feedback on whether the advert has been seen
and remembered.
Evaluation: despite these techniques, it remains difficult to quantify the success of promotion due to the
large number of external factors including changes in the economic environment; changes in consumer
tastes; promotional activity of competitors; changes to the price and product of competitors.
The success of promotion cannot always be judged on the basis of short-term sales; promotion
may have much longer-term benefits for the business.
2 a Learners’ answers will vary but should include two of: e-commerce is increasingly popular,
especially with younger target markets, e.g. the success of ASOS or a similar online retailer; it
reaches a wider audience, e.g. opportunity for worldwide sales; customers can shop at any time,
which increases convenience, plus they can use stores for click and collect or returns.
b Arguments for: it creates brand awareness and brand image, which is important when spending
on expensive goods such as a car. Image is important when choosing a car because it gives an
indication of personality and lifestyle.
Arguments against: the product is important as the consumer will want specific features and
functions as well as assurance about quality and safety. Price is important as it is a highly
competitive market with many makes and models of car to choose from.
Evaluation: it depends on the main influences on customer behaviour, e.g. whether they are more
price- or image-sensitive.
3 a Learners’ answers will vary but should include examples and analysis relating to two of the
following points. Packaging supports promotion of a product by:
• providing information on the product to consumers
• reinforcing the branding through the design and colour of the packaging
• attracting the attention of consumers through use of colour and materials
• protecting the product from damage
• helping to give the product a USP
• enhancing the environmental credentials by using recyclable packaging.
b Learners’ own answers but must be clearly based on a business (or industry) and should include
both the benefits and limitations of digital marketing. Both promotion and place should be
considered in the evaluation.

1 Penang Golf Kit (PGK)
a i It informs customers.
ii The name given to a product or range of products by a business.
b i ($5/$45m) × 100 = 11.1%
ii It may not be very well targeted at golf players even if undertaken during sports events, so it
may be less effective than, for example, direct marketing to members of golf clubs.
c Learners’ answers will vary, e.g. it is a low-cost method of targeting the market with relatively low
fixed costs; PGK wishes to target young golf players and they are more likely to use e-commerce
than PGK’s traditional customers; e-commerce is an effective way of reaching a worldwide
audience, allowing PGK to increase global sales; PGK can easily measure effectiveness as the
number of clicks or visitors can be recorded for different web-based promotions; e-commerce is
convenient for consumers to use, so should increase sales.
d National golfing magazine:
• The 12 adverts would cost $496 000, including the preparation of the advert.
• This would reach 250 000 readers so the cost is about $2 per reader.
• This option has the advantage of being more specifically targeted at golfers. Readers are likely
to be interested in the adverts for equipment and clothing, and less likely to ignore the advert.
• However, as the age profile of the readership is not known, this might not be effective at
reaching the target market.

TV advertising:
• This would use up virtually the whole budget as 20 adverts cost $0.5m and the production
costs are $0.4m. However, once produced the advert could be re-used at a later date.
• Coverage during the Saturday football match of the under-21 age group is 1.25m and for the
Friday evening slot it is 1.5m.
• Viewers are likely to be sports fans but football may appeal to a slightly different demographic
than golf.
• TV offers the benefit of moving images and sound. This can make the message more effective,
particularly as it is sports-related.
• Channel-hopping reduces the impact of TV adverts as viewers switch channels.
Sponsorship:
• Tim Lui is popular with young golfers so this could be effective at attracting the target
audience to purchase equipment and clothing.
• It would use 30% of the budget so leaves money for other forms of promotion.
Digital promotion:
• Minimum cost is $250 000 plus the average $7 pay-per-click fee. It would be easy to measure
effectiveness and use of Twitter and Facebook could target younger golfers effectively.
Evaluation will need to balance the cost, coverage of the target audience and likely impact of each
form of advertising. The budget is limited and for coverage of the target market it would appear
that a combination of digital promotion, sponsorship and some magazine advertising might be
possible. This uses more than one form of promotion and could therefore be more effective.
2 Apple
a i Potential consumers will be aware of the product’s image.
ii Range of selling and marketing activities that use the internet.
b Customers can see product demonstrated. The retailer will offer after-sales service to consumers.
c Learners’ answers will vary, e.g. e-commerce has global reach and low fixed costs, so offers greater
cost-effective coverage of the global market. It may be more effective for reaching the new target
market.
Selling through retailers enables customers to see and touch the products. Some customers may be
unwilling to purchase without having the product demonstrated.
d Advantages of Apple owning its own retail stores:
• Retail outlets can focus on Apple products alone.
• Apple has more control over the way its products are sold, e.g. positioning of in-store displays
and the design and layout of the retail stores. This provides a good brand-building platform
for Apple.
• Apple is able to ensure that staff are trained to demonstrate products and give consumer
advice. The ‘Apple Retail Store Experience’ gives consumers the chance to try out all products.
Apple is able to offer highly trained staff to deal with technical questions. This enhances
customer service and offers significant added value to the business.
• Apple can absorb the profit margin that would normally go to the retailer.
• Retailing its own products can be used as leverage in negotiations with other retail partners as
Apple is less dependent on them.
• Apple gains access to consumer data.
Disadvantages of Apple owning its own stores:

• The company has limited direct retail experience. Apple will have to recruit and train staff for
the retail outlets. Apple’s expertise is in innovating products and manufacture, not retail.
• Companies selling Apple products will face direct competition from Apple stores. The article
refers to the danger of Apple coming into conflict with retail partners such as CompUSA.
• The cost of acquiring suitable retail outlets and refurbishing them to Apple’s design standards.
The store will have to look innovative to match the image of the business.
• High fixed costs of running the stores.
An overall conclusion/judgement is needed as evaluation, based on learners’ balancing of the
arguments given. For example, is it more important to offer technical experts giving pre- and after-
sales service face-to-face or is it better to sell Apple products at lower prices?
be different.
Coursebook answers
Chapter 21
Business in context
Why is it important for businesses to develop new products?
• To gain a competitive edge to be able to compete with competitors.
• To replace products nearing the end of their life cycle.
• To increase sales and meet customer needs.
• To enter new markets.
The importance of protecting a new development with a patent:
• R&D is expensive, so a patent gives protection from other firms copying the idea. If copied, the
business loses its competitive advantage.
• It enables the business to recoup the cost of investment. Demand will be more price inelastic if a
product has a USP.
Activities
Activity 21.1
1 Percentage change in quantity = (200 − 300) ÷ 300 × 100 = −33.3%
Percentage change in price = (5 − 4) ÷ 4 × 100 = 25%
PED = percentage change in quantity ÷ percentage change in price = −33.3 ÷ 25 = −1.33
2 Product B is price elastic in demand for the price change of $4 to $5. Demand is responsive to a change
in price. The change in price leads to a more than proportionate reduction in demand. Revenue will fall
as a consequence of the price change. Revenue falls from $1 200 to $1 000 per week.
Activity 21.2
• Price elasticity of demand measures the responsiveness of quantity demanded to a change in price.
PED = percentage change in quantity ÷ percentage change in price.
• The demand for Product A is price elastic. Demand is sensitive to a change in price.
• The demand for Product B is price inelastic. Demand is not sensitive to a change in price.
• The demand for Product C has unit price elasticity. A change in price causes a proportionate
change in quantity demanded.
2 Demand for Product A will fall by 30%. Sales revenue will fall.
Demand for Product B will fall by 5%. Sales revenue will increase.
Demand for Product C will fall by 10%. Sales revenue will not change.
Activity 21.3
1 Percentage change in quantity = 0.15m ÷ 1.5m × 100 = 10%
Percentage change in price = (1.20 − 1.50) ÷ 1.50 × 100 = −20%
PED = percentage change in quantity ÷ percentage change in price = 10 ÷ −20 = −0.5
Demand is price inelastic and is not responsive to a change in price. The price decrease leads to a less
than proportionate change in demand.
2 Revenue = price × quantity
Revenue before the price decrease = 1.5m × 1.50 = $2.25m
Revenue after the price decrease = 1.65m × 1.2 = $1.98m
Revenue fell by $270 000 as a result of the price decrease. This is because demand is price inelastic and
the price decrease led to a less than proportionate increase in demand.
• Competitor newspapers may have reduced their prices in response to the price cut at the Daily Times.
• The price cut may have attracted new readers to try the Daily Times but these customers may have
found that the paper did not meet their requirements. After a few weeks, the new customers would
start to purchase their original daily newspaper once again.
• As demand appears to be price inelastic, it would be unwise to cut price further. A further price
cut would lead to a further reduction in revenue.
• It could start a price war with competitors. This would be damaging to the revenue of the Daily
Times. The financial strength of the Daily Times in relation to competitors will determine whether
or not it can destroy competitor titles through aggressive pricing policies.
• The Daily Times should conduct market research to identify customer needs. The content of
the newspaper may need to change to reflect the needs of readers. This response will be more
time-consuming to implement.
• The Daily Times may be in the decline phase of its product life cycle. There may be a need for
suitable extension strategies, e.g. a redesign of the newspaper to revitalise its image. This may be
expensive and any redesign should be supported by appropriate market research.
• Promotional activity could be used to boost sales, e.g. competitions may be run. These may have a
beneficial short-term impact but are they likely to stop the long-term decline in sales?
Evaluation might consider the cost of different strategies and the immediacy of their impact on sales.
Activity 21.4
1 Promotional spending elasticity of demand = percentage change in quantity ÷ percentage change
in price
Technical toys = 12 ÷ 10 = 1.2
Games and puzzles = 6 ÷ 10 = 0.6
2 Forecast economic growth of 6% could result in an increase in household income. If incomes rise,
that should benefit sales of technical toys more than games and puzzles, as demand for technical toys
is more income elastic. A 6% increase in income would increase sales of technical toys by 7.2%, other
things being equal.
Technical toys also have a higher promotional spending elasticity of demand; demand is more
responsive to a change in promotional spending for technical toys than for games and puzzles.
Therefore, if the marketing manager wants to increase revenue, it would be better to focus the
promotional budget on technical toys. However, the marketing manager should also consider the
relative size of each market. For example, if the sales of games and puzzles are much higher than
technical toys, a small percentage increase in sales of games may be much greater in dollar terms
than a larger percentage increase in sales of technical toys.
Evaluation could include a recognition that the objectives of the business will also be important in
determining the allocation of promotional spending. In addition, sales performance must be measured
regularly to recalculate elasticity results, which can change with changes in external factors.
Activity 21.5
Activity 21.6
• Economic problems undermined demand within this segment of the drinks market. Consumers
will have traded down from the more expensive smoothies to regular juice drinks.
• It is a very competitive market with well-established brands such as Innocent. It was therefore
difficult for Nestlé’s new product to build sufficient sales.
• Nestlé is a large corporation and this might make its researchers more distant from the market.
Innocent is a much smaller organisation and therefore closer to its customers and consumers.
• Packaging was not appropriate. The lack of trial-sized bottles could have deterred consumers from
trying the drink.
• New product development can give a competitive advantage. There are many examples of
successful and profitable developments, e.g. instant coffee.
• It may differentiate products from those of competitors and therefore gain greater control
over pricing.
• New ideas can add value.
• Food preferences change over time. Firms need to develop new products to satisfy consumer desire
for trying new foods.
• Existing products may be in the saturation phase of the product life cycle. Nestlé must maintain
a balanced product portfolio so that as old products enter decline there are new products in the
growth phase.
• Market research to ensure that products being developed will meet customer expectations.
Products are more likely to succeed if they coincide with consumer trends, e.g. natural, healthy
products that consumers are demanding. Nestlé is aiming to improve its innovation by using small
innovation units that have greater independence from the central organisation. This gives the units
greater freedom over what they innovate.
• Test marketing to evaluate the product before a national launch. This gives an opportunity to
assess customer reaction to the product and make suitable changes.
• Appropriate marketing mix including price and promotion. New products may need support from
extensive promotion to raise customer awareness. A sufficient marketing budget will be needed.
• Evaluation could include a discussion of the nature of the market the business operates in. The
faster this market is changing and the more competitors there are, the more likely new products
will not succeed in meeting sales targets.
Activity 21.7
• The government has directly contributed $15m toward the $200m cost of the R&D. This is 7.5%
of the total cost. It is a subsidy and significantly reduces the cost of the research to Airbus.
• The government provides legal security to Airbus through the patent system. This will protect
Airbus’s investment as it will prevent other firms copying the design.
• To protect engineering and scientific jobs in Wales (an area of relative deprivation in the UK).
Without the subsidy, Airbus may not undertake as much research.
• Protecting engineering and scientific jobs will ensure that the UK remains at the forefront of
technological change.
• To improve the competitiveness of Airbus in the airline market. The R&D will help win contracts
to supply aircraft to airlines around the world. This will generate export earnings for the UK and
help protect the jobs of production workers at Airbus factories in the UK.
• The development of new materials may benefit other industries. Although new materials will be
patented, other firms will be able to pay royalties to Airbus for their use.
• The aircraft industry may be viewed as a strategic industry within the UK and of national importance.
3 Successful R&D will create innovative products that give businesses a competitive edge. For example, the
lighter wings developed by Airbus will make aircraft more fuel efficient and therefore more attractive to
airlines. This will increase demand for Airbus aircraft. Increased sales should increase profit.
Innovation may also reduce the costs of manufacture. Therefore, prices can be reduced and more sales made.
Evaluation could include a discussion that, although research can produce innovative and profitable
new products, this is not guaranteed. Reasons why research might not result in the anticipated benefits:
• The improvements made to a product may not be sufficient to give it a decisive competitive edge.
• The cost of the development may be too large and therefore the product is not able to recoup the cost.
• R&D often takes years. In dynamic consumer markets, consumer tastes or the economic
environment may change, making the product redundant. By the time Airbus has developed the
new aircraft, there may be no market for it.
• There may be no market for the product developed. If there is poor market research before
undertaking research, the end product is less likely to succeed.
• There is no guarantee that R&D will even lead to the development of a working product.
• Other firms are undertaking R&D at the same time and may find solutions first.
Activity 21.8
1 Sales follow a quarterly pattern. Using moving totals made up of four and eight results enables a
centred quarterly moving average to be calculated.
2 Year/quarter Sales ($000) Four-quarter Eight-quarter Quarterly Seasonal

moving total moving total moving average variation
2018 Q1 20
Q2 18
Q3 16 19.25 −3.25
Q4 22 76 19.75 2.25
2019 Q1 22 78 154 20.25 1.75
Q2 20 80 158 20.75 −0.75
Q3 18 82 162 21.5 −3.5
Q4 24 84 166 22.25 1.75
2020 Q1 26 88 172 22.75 3.25
Q2 22 90 178 23.25 −1.25
Q3 20 92 182 23.75 −3.75
Q4 26 94 186 24.5 1.5
2021 Q1 28 96 190 25.75 2.25
Q2 26 100 196 27 −1
Q3 26 106 206
Q4 30 110 216
3 Graph showing sales forecast to 2022:

35
Line of
30 best fit
25
20
Sales ($000)
15
10
0
3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
2019 2020 2021 2022
4 Q1 = (1.75 + 3.25 + 2.25) ÷ 3 = $2 417; Q2 = − $1 000; Q3 = −$3 500; Q4 = $1 833
5 Q1 = 28 200 + 2 417 = $30 617; Q2 = 28 900 – 1 000 = $27 900; Q3= 29 700 – 3 500 = $26 200;
Q4 = 30 200 + 1 833 = $32 033
• With sufficient data, predictions can be made for extended future time periods. This could help
Sodhi plan for future cash flow and stock requirements. However, the further into the future a
prediction is made, the lower the probability of it proving accurate.
• Time series analysis relies on past data and on the trends identified continuing into the future. It is
based on a process of extrapolation, making predictions using past data. Sales patterns, therefore,
need to be stable for the technique to be useful. However, there are many factors that will change
demand that the analysis cannot account for, e.g. the impact of a new competitor, a change in the
economic climate, a change in consumer tastes.
• Time series analysis needs to be used alongside other more qualitative methods to reduce the risk
of inaccurate forecasts.
1 Mauritius Hotel Company (MHC)
1 Promotional elasticity of demand = percentage change in quantity ÷ percentage change in promotion
For hotels, the percentage change in demand = (60 − 50) ÷ 50 × 100 = 20%
The percentage change in promotional expenditure = (3.0 − 1.5) ÷ 1.5 × 100 = 100%
Therefore, the promotional elasticity of demand = 20 ÷ 100 = 0.2
For restaurants, the percentage change in demand = (15 − 10) ÷ 10 × 100 = 50%
The percentage change in promotional expenditure = (1.0 − 0.8) ÷ 0.8 × 100 = 25%
Therefore, the promotional elasticity of demand = 50 ÷ 25 = 2
2 Advantages of change:
• The promotional elasticity of demand for the hotels is only 0.2. Demand has not been responsive
to the increased promotion. Promotion has doubled but revenue has only increased by 20%.
• MHC may benefit even more from a different form of promotion, i.e. promotional elasticity
of demand could be higher.
• The increase in revenue may not necessarily be the result of the promotion.
Disadvantages of change:
• The promotion for the hotels has been successful in increasing revenue by $10m. This is a
substantial increase in revenue and far exceeds the increased promotional cost of $1.5m.
• The promotion may have increased profit generated by the hotels. This will depend on the
additional costs of providing the service to the increased number of customers.
Repeating the promotional activity for the hotels may have an increased effect in 2022.
• Competitor spending on promotion. Competitor hotels in Mauritius and other tourist
destinations may be spending heavily on promotion in the same countries as MHC.
Restaurants in Mauritius may not have increased their promotional activity, so increasing the
effectiveness of the promotion undertaken by MHC.
• External factors may have influenced the eventual revenue outcomes. For example, an increase
in incomes in Mauritius would help increase custom to the restaurants. An appreciation of
the Mauritian rupee would make it more expensive for foreign tourists to travel and stay in
Mauritius, which would counteract the positive impact of the promotion. Low economic growth
in the countries in which MHC promotes itself would also impact negatively on demand.
• If over time MHC collects data on the effect of promotion and it consistently produces the same
elasticity result, this will provide useful data on which to base future promotional spending decisions.
• Estimating the promotional elasticity of demand for future promotional activity is difficult as
a firm cannot be certain how consumers will react to promotion.
• Changes in the external environment will also have a significant impact on the outcome
of a promotion.
• A firm must also take into account the absolute impact of promotional activity on sales,
not just the relative impact. For MHC, additional promotional expenditure of $1.5 million
contributed to an increase in revenue of $10m.
• There may be long-term benefits to promotional expenditure not reflected in short-term
increases in demand.
• Just because last year’s social media campaign for the restaurant side of the business was
successful does not mean that it will be as successful next year.
Evaluation: calculation of promotional elasticity of demand is useful for businesses to consider in
making marketing decisions but it would be unwise to base major marketing decisions on elasticity
results alone.
5 To forecast sales, MHC uses quantitative analysis, e.g. time series analysis, and a panel of experts,
which is a qualitative technique. Combining these techniques should provide a high-quality forecast.
However, in evaluation, MHC operates in a competitive and dynamic market. It is therefore highly
likely that forecasts will prove to be inaccurate as so many variables can change, e.g. the exchange rate,
price and promotion of competitors, economic growth and unanticipated external shocks such as the
COVID-19 pandemic of 2020.
2 GlaxoSmithKline (GSK) – one of the world’s big researchers
1 The process includes:
• Consideration of a range of ideas for new product development to eliminate ideas that lack
commercial potential. New product development is risky and often expensive so the business
has to focus on ideas with the potential to be commercially successful.
• Development of the concept by considering key questions about the features of the product
and the target market.
• Business analysis of the likely costs, sales and profits to ensure that the concept is viable.
• Developing a prototype of the product and testing it to ensure that it meets performance
targets. Feedback is often taken from focus groups so that the product can be adapted to meet
consumer expectations.
• Test marketing, by launching the product to a small part of the market, is used to get further
feedback from actual consumers. This reduces the risk of a full-scale launch as test marketing
can identify weaknesses which can be corrected before the full launch.
• Inventions generate new product possibilities. The potential to make huge profits from
blockbuster drugs is considerable. Premium prices and high profit margins can be enjoyed if
effective new medicines are developed.
• For GSK, 65% of sales come from just ten medicines. As GSK’s sales are over $50bn, that
represents sales of over $3.25bn per medicine. This indicates the impact of successful drug
development on company sales.
• The scale of profit possible selling pharmaceuticals is shown by the $7bn made by GSK. These
profits and sales depend on developing new drugs.
• GSK is under pressure to increase R&D from two key sources:
• It needs to find new drugs to replace drugs that are coming to the end of their patent.
Without patent protection, cheaper generic drugs will reduce the revenues of GSK.
• GSK faces tough competition from competitors such as Pfizer. If Pfizer develops new and
effective drugs, this will damage GSK’s sales.
• The case of Breon highlights the risk involved in R&D. GSK cannot be certain of the
outcome of research and GSK’s share price fell with the announcement that Breon failed to
achieve the expected health benefits in trials.
Evaluation may consider the external constraints that pressure GSK to spend more and more on
R&D. If GSK is to remain a leading player in the pharmaceutical industry, it would appear to be
essential that it undertakes significant research. However, it will not guarantee success.
be different.
Coursebook answers
Chapter 22
Business in context
Importance of producing a range of drinks specifically for the Indian market:
• India is one of the biggest markets in the world so the potential for sales is significant. The economy is
growing rapidly and Coca-Cola wishes to establish its brand to take advantage of rising income.
• Differences in customer preferences for soft drinks compared to other countries. Coca-Cola needs to
produce different products to match consumer tastes in India.
• Regional differences in tastes within India mean that just producing a few products will not
satisfy customers.
• Income levels make Coca-Cola unaffordable for some groups. Having a range of drinks enables
different market segments to be targeted.
Other elements of the marketing mix for the Indian market:
• Prices of some products will need to be affordable to lower-income groups.
• Promotion may need adapting to meet local regulations and be suitable for Indian culture. It will need
to reflect the ownership of different technologies in India, such as smartphones and televisions.
• Distribution is likely to be different. India has a large number of small businesses. Supermarkets are
less prevalent than in countries such as the USA.
Activities
Activity 22.1
1 Marketing planning is an essential part of the overall business plan for EV. It will help ensure that the
marketing-mix tactics are appropriate for adventure holidays.
• EV has not paid for promotion previously so it needs to plan to reduce the risk of its new
marketing strategy failing. A clear objective of 15% sales growth has been identified and a
marketing budget set. This will prevent overspending, which is very important for a small business.
• Planning marketing activities helps to give clear direction to other functional activity within the
business. For example, Hugo and Marie can ensure that EV has sufficient mountain guides for the
increasing sales.
2 Marketing objectives are to increase sales by 15% each year and achieve a market share target of 50%
in Country Y.
Marketing strategy. Consistency is important. EV should continue to use a low-price strategy as
it wishes to penetrate the market. EV’s product should also remain the same: adventure holidays
targeted at foreign visitors to Country Y. The major change is in promotion. EV will have to increase
promotional spending. Promotional methods must be feasible within the budget of $150 000. As a
small business trying to target foreign visitors with a limited budget, this suggests a range of digital
forms of marketing. EV can use the internet as it allows communication with potential customers
at relatively low cost. This includes building a website to sell directly to customers and pay-per-click
advertising, which will help monitor effectiveness. EV should set up pages on Instagram and Facebook,
with regular updates of information and photographs to increase social media activity and word-of-
mouth advertising. EV should partner with an online travel agency specialising in outdoor adventure
holidays to provide a platform for reaching a larger audience.
Activity 22.2
1 Zappo should consider the growth rate of the energy drinks market in different countries in order to
identify markets with significant sales potential. GDP per capita may be important as energy drinks
are not a necessity and more likely to be successful in countries with growing incomes. Exchange rate
stability is an advantage for planning and estimating sales. The number and strength of competitors
will impact how much promotion is required to penetrate the market and also affect pricing and
therefore profit potential.
2 The suggested marketing strategy might analyse and evaluate the importance of integrating each of the
following elements:
Product:
• Zappo might want to keep the packaging the same in most countries to maintain a consistent
global image. However, Zappo should consider different flavours to account for national
differences in tastes.
Price:
• Penetration pricing might be favoured to enter a new market.
• The degree of competition from established energy drink brands in the market will influence
pricing. If the market is highly competitive, Zappo might not be able to set a higher price than
the competition.
Promotion:
• Zappo might use national sporting celebrities in each country rather than European sports stars.
European sports stars might be unknown in many countries.
• Promotion through social media might be used rather than advertising on television. This depends
on relative cost and levels of TV ownership versus smartphone ownership.
Place:
• Distribution channels will affect the availability of Zappo’s energy drink to the target market.
Using sports clubs and gyms precisely targets the product but distribution through supermarkets
and other retailers may be necessary to increase sales. This will depend on the shopping culture of
consumers in the country.
Activity 22.3
Activity 22.4
• Growth is a common objective for businesses to adopt. Domestic markets may be saturated and
offer no further prospect of growth. By operating in international markets, the potential for
growth increases. Cartridge World has used international marketing to expand rapidly and now
has over 1 300 stores worldwide. The UAE is an important growth market for Dunkin’ Donuts.
• Spreading risks. A presence in international markets reduces the dependency of the business on
the domestic market. Therefore, if there is a decline in sales in the home market due to worsening
economic conditions, the businesses may still have good sales growth in other markets.
• Cultural differences. The UAE is an Islamic grouping of states so there will be differences in what
is acceptable with regard to advertising. Adverts used by Dunkin’ Donuts in the USA may be
inappropriate for the UAE.
• Legal differences. There is increasing concern in many countries about unhealthy food products
with a high sugar content. For Dunkin’ Donuts, this might constrain its advertising and require
changes to the product.
• Franchising reduces the capital cost of expansion. As the franchisee has to invest money to
purchase or lease premises, fixtures and fittings, and pay fees to the franchiser, it significantly cuts
the cost of expansion for the franchiser. Yogen Fruz does not have to pay the high capital costs of
setting up its own subsidiaries.
• Franchising facilitates rapid expansion in international markets, as less capital is required.
Cartridge World has grown rapidly to over 1 300 stores in 36 countries.
• Benefit from the local expertise of the franchisee. This also contributes to rapid growth, as the
franchiser does not have to spend as much time assessing the needs of the local market. The local
knowledge of the franchisee will help ensure that the marketing of products is appropriate for the
local market.
• The franchiser receives a steady stream of income from the share of profits or revenue paid by
the franchisee.
• Risk reduction. The risk of opening the franchise is shared with the franchisee.
The disadvantages of franchising include: profits go to the franchisee; the franchisee has to be
monitored to ensure that the brand image is not undermined.
Evaluation may comment on the most important advantage with reference to the case material.
Cartridge World appears to be motivated by the opportunity for rapid growth. Yogen Fruz seeks to
benefit from the reduced capital cost and local expertise.
4 Takeover of locally based businesses. This is a high-cost entry strategy and risky. There can be cultural
differences in how businesses operate and technology may be difficult to integrate. It is therefore
difficult to find a suitable target for acquisition. However, following the takeover, it is the quickest way
of entering the foreign market and gives an immediate and potentially substantial share of the market.
Advantages also include: no sharing of profits; existing management has knowledge of the market;
distribution channels are already in place.
Export through intermediaries such as agents. Agents have local market knowledge to aid marketing
of the product. This reduces the cost of distribution as the agent takes responsibility. The exporting
firm will not need employees to work in the foreign country, which reduces the costs of entry. However,
there is a loss of control over marketing and the intermediary will take a share of profits through a
commission. The intermediary will also be selling other products so has less focus on the sales of
one business.
Evaluation might focus on the extent to which the business wishes to retain control over its brand
image and profits.
1 McDonald’s – pan-global strategy or global localisation?
• Growth is a common objective for businesses to adopt. By operating in international markets,
the potential for growth is increased. Growth rates in the USA may have slowed by the 1970s,
so in order to maintain McDonald’s sales growth it was necessary to move into international
markets.
• The domestic market may have been saturated and offered no further prospect of growth.
• To build shareholder value through increasing the size of the business.
• Spreading risks. A presence in international markets reduces the dependency of McDonald’s
on the US market. Therefore, if there is a decline in sales in the USA due to worsening
economic conditions, the business may still have good sales growth in other markets.
• Foreign markets may offer opportunities for high profit growth. Europe has high income levels
and so would have been an attractive market. Also, there may not be much competition in new
markets where this type of fast food has not been seen.
2 A pan-global marketing strategy adopts common products, branding and promotional campaigns
across the world.
Advantages:
• Economies of scale. Purchasing costs were reduced due to the product being the same
everywhere.
• Promotional costs were reduced as the same advertising was used everywhere. There was no
need to commission different adverts in different countries.
• Economic globalisation. There are fewer and fewer differences between tastes in countries
around the world.
• The product may benefit from a common global identity. The McDonald’s logo is one of the
best known in the world, so it is a powerful marketing tool for the business.
• The highly standardised product will appeal to many tourists travelling the world.
Disadvantages:
• Cultural and social differences exist between countries. McDonald’s products may be less
popular in countries where vegetarian diets are prevalent. Therefore, McDonald’s will benefit
from adapting menus to suit local needs. For example, restaurant windows in India were
smashed as Hindus objected to the use of beef flavouring.
• Economic differences between countries are significant. McDonald’s can appear very
expensive in some less-developed countries.
• McDonald’s is closely associated with the USA. This can act as a constraint on success in
some countries. For example, in France there is a particularly strong desire to protect French
culture and identity. This made it very difficult for McDonald’s to build its market share.
In other countries, there is opposition to what is seen as American business and cultural
imperialism and the homogenisation of goods.
Evaluation could include a recognition that the benefits of economies of scale were very important
as McDonald’s was growing and becoming established. However, increased importance of national
and cultural identities now means that differentiated marketing is key to the future success of
the business.
3 Answers should try to identify local conditions that make a change in the marketing strategy worthwhile
and evaluate the importance of each one of them in a revised but integrated marketing strategy.
Product:
• Is there a need to design different menus due to cultural or religious constraints?
• Is there a significant number of vegetarians in the population? Many Hindus are strict
vegetarians and, generally, Hindus do not eat beef. Most Muslims require halal meat.
• If the restaurant is to be situated in a historic town, will the external appearance of the
premises need to be different to the standard McDonald’s look? There may be strict planning
guidelines in some localities.
Price:
• Is the product affordable to local people?
• How much competition is there from established fast-food outlets in the location?
Promotion:
• Can the product be advertised to children? In some countries, there may be restrictions on
advertising as McDonald’s is seen as contributing to the rise in childhood obesity.
• Does McDonald’s need to distance itself from its American roots?
be different.
Coursebook answers
Unit 3
General Engineering Group (GEG)
1 Research and development (R&D) enables GEG to bring new products to market, such as the
Robodigger. This can give GEG a competitive edge in the market. Robodigger’s unique selling point
would make it possible to charge premium prices and give a higher profit margin. The Robodigger
accounts for 50% of GEG’s operating profits.
R&D can also enable GEG to target new market segments by developing appropriate products. For
example, the Ezelift crane may enable GEG to sell to the consumer market for the first time. This will
diversify the business and spread risk. GEG’s sales are currently vulnerable to economic downturns.
Being able to target other markets might reduce the risk to GEG of a recession.
2 a i 33 − 32.5 = 0.5 ($m)
ii 29 − 32.625 = −3.625 ($m)
iii (7.5 + 7.875 + 8.25) ÷ 3 = 7.875 ($m)
b Time series analysis is a quantitative sales forecasting technique that uses moving averages to
identify trends in sales data and therefore enable predictions about future sales on which to base
operational decisions.
Relevant comment might include:
• There is a clear seasonal pattern of sales for GEG on which to base the four-period moving
average technique.
• GEG has sufficient past data to identify trends in sales.
• The technique can be reasonably accurate for short-term forecasts.
• The marketing director reported that, ‘We forecast seasonal sales changes with good accuracy.’
• Predictions can be used to identify the operational capacity required and employee numbers.
• The technique assumes that past trends will continue into the future. In the long term this is
not the case, as sales will be affected by the state of the economy and GEG’s success in R&D.
For example, the recession last year resulted in sales falling by 20%. Moving averages would
not have predicted this.
• For longer-term forecasts, more qualitative methods that are less dependent on past results
may need to be used. Based on Appendix 1, the impact of the recession was not predicted by
GEG’s directors.
• In making predictions, GEG would need to take into account the impact of successful
development of the Ezelift crane. Past data would not capture the effect of launching a new
product into a new market.
• Qualitative techniques include the Delphi method and jury of experts. These would be useful
in accounting for the possible impact of change in the economy.
Evaluation: the marketing director should not rely only on the moving average method when
making decisions about operating capacity and employee numbers. Qualitative factors must also
be accounted for, as they change the trends in the market.

1 Relevant comment might include:
• Ansoff classification of strategy A is market development compared to strategy B, which is
diversification. Therefore, strategy A could be considered lower risk than strategy B. However,
entering a new market abroad does have significant potential risk. This risk is reduced because the
joint venture partner has knowledge of the market.
• Joint venture reduces the cost to GEG of entering Country Y as the investment is shared.
• Strategy A has a lower cost than strategy B and a higher probability of success.
• Failure of strategy A gives an estimated $20m loss compared to the $40m loss of strategy B.
• Strategy A’s estimated profit of $40m is less than the estimated $55m profit of strategy B.
• Both strategies have a relatively high risk of failure: 35% and 45% respectively.
• Country Y is a high-income country. This could benefit GEG as it sells technologically advanced
machinery. Although it is a competitive market, GEG has been successful against imports into
Country X. This suggests that strategy A could be successful.
• The finance director is advising GEG that it needs to cut costs. This suggests that GEG may be
short of funds.
Evaluation: attitude towards risk will be very significant in this decision. Strategy A appears to be
less risky because there is less capital investment required, the probability of success is higher, losses
if unsuccessful are lower and it is market development rather than diversification. Strategy A requires
33% less investment, so is likely to be favoured by the finance director.
be different.
Coursebook answers
Chapter 23
Business in context
Can an oil and gas business ever be fully sustainable?
• Oil and gas are finite resources so will eventually be depleted if use is continued.
• Extraction and use of oil and gas contribute to global warming.
• Operations can be made more sustainable but not fully sustainable.
Benefits of measures taken by Total to the company:
• Reducing carbon footprint may attract customers to Total and so increase sales.
• Use of more efficient refining equipment and well-insulated premises will reduce costs and make
products more price competitive.
• Positive publicity from the changes made will attract customers.
• Diversification into renewable energy will protect long-term income streams.
• External changes, such as government restrictions on the use of diesel cars in the future, will require
Total to find alternatives to oil and gas extraction to generate income.
Activities
Activity 23.1
1 Rapid Pizza: 3 000 ÷ 15 = 200 pizzas per employee
Pizza to Go: 3 960 ÷ 18 = 220 pizzas per employee
Pizza4U: 6 600 ÷ 25 = 264 pizzas per employee
• Higher weekly pay may increase motivation and therefore productivity.
• Workers at Pizza4U may have a higher level of skill and/or training.
• Availability and quality of capital equipment. Pizza4U workers may have access to
better machinery.
3 Labour productivity affects labour costs per pizza and therefore the price to the customer. At Pizza4U,
the labour cost per pizza is $0.25 whereas at Rapid Pizza it is $0.30. Price is a key factor in consumer
decisions. If a business can charge a lower price, it can gain greater market share.
Activity 23.2
1 a Output produced in a given time period.
b The effectiveness of turning inputs into outputs.
2 a 2019: 50 000 ÷ 20 = 2 500
2020: 55 000 ÷ 24 = 2 292
2021: 60 000 ÷ 30 = 2 000
b Labour productivity is decreasing year on year. It has decreased by 20% from 2019 to 2021.
3 Declining productivity has caused the unit labour cost to increase from $1.20 to $1.50. This is an
increase of 25%. As Westlife has to compete with other firms in the market, an increase in costs will
reduce profitability because Westlife may not be able to pass on the increased costs to the customer.
Westlife’s major competitor has 20% lower unit labour costs and therefore has a competitive advantage.
With lower profits made, there will be less capital for re-investment and therefore new technology will
be more difficult to introduce. This will further harm Westlife’s competitiveness in the market.
4 Increase pay. Pay is a fundamental consideration for employees. The salary paid to workers has not
increased for three years. Increasing pay may motivate employees to work more productively. However,
although pay is important, many commentators do not consider it to have a long-term effect on
productivity. Herzberg, for example, classifies pay as a hygiene factor.
Increasing pay will increase unit costs unless the increase in productivity is greater than the increase in
pay. Thus, management needs to ensure that any increase in pay is linked to a productivity agreement.
Install new machinery. Some of the machinery is unreliable and causing disruption to the production
line. Installing new, more efficient, machinery should increase both labour and capital productivity.
Evaluation could include a judgement that the machinery may be expensive and Westlife may not have
the financial resources to purchase it due to its falling profitability. Installing the machinery will be
disruptive and employees may need training.
Installing new machinery is a longer-term solution to the problem. It may not be possible to achieve
the objective of increasing productivity within six months.
Activity 23.3
1 Handmade wedding cakes: job production as each cake will be made to an individual specification.
Standard loaves and bread rolls: flow production as there is a high level of demand all year round and
little variation for these highly standardised products.
Doughnuts and family cakes: batch production due to the lower level of demand and batches can be
matched to demand according to the time of the week.
2 Flow-line production might increase profitability due to the lower level of labour required as the process will
be highly mechanised. However, a significant investment in capital equipment would be required.
With consistent output rates, it should be possible to minimise stock-holding of inputs such as flour
and sugar. This would reduce costs and increase profitability.
Evaluation should include a final justified conclusion that considers the following points: is demand
for family cakes and doughnuts sufficiently high to justify the investment in a flow production line?
Demand varies through the week, therefore it would be necessary to have a production line capable of
switching between products. If there are dedicated flow lines, the cost would be greater, as one would
be needed for doughnuts and another for the family cakes.
Activity 23.4
1 Mass customisation uses flexible production lines capable of making different versions of the same
product. Caterpillar produces 11 000 engines each year and almost all are different, based on variation
of up to 20% of the 1 000 parts that go into each product. Therefore, Caterpillar is better able to meet
the differing demands of its customers. Customers will be more satisfied with the construction and
power equipment they purchase and this will increase sales and potentially profits. Answer may be
applied to Cessna using similar analysis.
2 Batch production enables a business to produce a batch of identical products but with variation between
batches. Mass customisation will make production more flexible to meet the specific demands of customers
regarding clothing. Greater variation in the cut, design and colours of items of clothing should increase
demand yet maintain high-volume output. Mass customisation may be more responsive to the rapidly
changing demands in the clothing industry. However, mass customisation will require investment in
advanced and flexible capital equipment, a skilled workforce, clothing designs with standardised elements
but some interchangeable ones, and suppliers that are able to supply variations in cloth and other supplies.
The investment required to set up mass customisation may be expensive.
Evaluation should include a final justified conclusion about the most appropriate operations method in
the context of this business.
Activity 23.5
Learners’ answers will vary.
1 Changing inputs into outputs, adding value, e.g. in manufacturing.
2 It could reduce the workforce proportionally more than the reduction in production. This
demonstrates that production levels are an absolute measure but productivity is a relative one.
3 Inverse: as labour productivity goes up, unit cost goes down because each worker is producing a higher
level of output; the cost of labour can be divided by a higher output level to give a lower average cost.
4 Marketing adds perceived value, e.g. brand image; operations adds value through the transformation
process by producing high levels of output from inputs.
5 Even high levels of efficiency and productivity might not lead to effective production if the products do
not meet customers’ wants and needs.
6 Production levels that can be maintained in the long term, e.g. by protecting the environment and not
damaging the quality of life for future generations.
7 Learners’ answers will vary, e.g. land to grow wheat; labour to sow and harvest; capital to set up
irrigation and buy equipment (e.g. combine harvester).
8 Learners’ answers will vary, e.g. training to improve efficiency, e.g. speeding up the decoration of cakes;
production line system to make bread in large quantities.
• Efficiency is concerned with reducing the time spent with each patient; speeding up the booking of
appointments; reducing waiting times.
• Effectiveness is concerned with meeting the needs of customers, e.g. providing the dental services
that clients are prepared to pay for.
10 Learners’ answers will vary, e.g. to reduce average costs of each shirt and dress in the long run as
labour costs are less and productivity is higher.
11 Learners’ answers will vary, e.g. redundancies, as some workers are replaced by machines and it may
not be possible to employ them elsewhere in the business.
12 Quality assurance ensures there are no flaws in gems, which reduces the cost of materials by reducing
waste. Job production enables bespoke designs to meet the requirements of each client, which will
enable higher prices to be charged.
a Batch production so that a range of different designs can be made but in relatively high volumes.
b Flow production so that plugs can be mass-produced. All plugs are identical.
c Job production to provide unique designs.
d Flow production. Flow lines can produce large volumes of computers. Specifications can be
altered by changing components used on the flow lines.
Essay questions
1 a Learners’ answers will vary but should include one advantage and one disadvantage:
Advantages: mass production of identical items at low unit cost is possible; low labour costs;
planning of inputs is relatively easy due to constant rate of output; quality is consistent; it
produces highly standardised products.
Disadvantages: high set-up cost; high fixed costs; work is deskilled and repetitive, resulting in
demotivation; reduction in demand will significantly increase average costs; variety of products
produced will be limited.
b Sustainable operations means that operations can be maintained in the long term.
Benefits:
• Costs are reduced as less resources are used (e.g. energy), which can give competitive
advantage.
• Reducing the use of materials can increase demand from consumers who are concerned about
the environment.
• Reduced rates of waste will reduce costs.
• It minimises the risks of negative publicity damaging sales.
Disadvantages:
• Investment may be required to make the business more sustainable, e.g. managing the
recycling of materials.
• Products may need to be changed to use recycled materials or more environmentally friendly
materials. Some materials may be more expensive.
• Redesigning products can be expensive.
• Supplies may be more expensive.
Evaluation could include: ultimately, businesses need to be sustainable to continue operations
in the long term. Analyse the reasons why customers, investors and governments might react
positively to a business adopting sustainable operations.
However, in some industries, sustainability measures will put the business at a competitive
disadvantage and, for many consumers, price is a critical consideration.
2 a Introduce more automation in the store, e.g. self-operated checkouts, as several can be controlled
by just one employee.
Give employees greater responsibility. This will motivate some workers, leading to an increase in
productivity. Workers often know how best to perform tasks as they have developed expertise from
continually repeating tasks.
b The level of demand is a critical factor. Batch production produces batches of identical products
so the demand has to exist for increased output of furniture.
• Impact on employees. Batch production will reduce the variety of work performed by workers
and will require less skill. This can be demotivating and increase labour turnover.
• Investment will be required in general-purpose machinery to facilitate batch production.
• Impact on cash flow of having large amounts of work in progress under batch production.
• Impact on prices that can be charged for furniture that is no longer unique to each
customer’s design.
An overall conclusion or judgement is required that assesses the most important factors in
selecting an operations method in this case.

1 KL Juice Bar
a i Raising price.
ii Output per employee in a given time period.
b i 1 200 ÷ 2 = 600 drinks per employee
ii Inputs including fresh fruit are used in order to produce outputs including juice drinks
and snacks.
c Efficiency: there is some evidence that initially the business had high levels of efficiency, e.g. labour
productivity was high and the juice bar was able to serve a large number of customers. Efficiency
has declined because customer numbers have fallen but the staffing levels have not. To improve
efficiency, better-quality juice machines could be purchased, thus avoiding the problem of
breakdowns.
Effectiveness: KL Juice Bar does not appear to be effective. Customer needs were not met; quality
was poor and there were long queues to be served. To improve effectiveness, better-quality fruit
and ingredients could be used. Queues could be reduced by ensuring that staffing levels are higher
at peak times of demand.
d KL Juice Bar is in the tertiary sector and provides a service. It is likely to be highly dependent on
labour to serve customers and prepare food and drinks.
However, it does use capital equipment such as the juice machines. It is possible for the business
to increase its capital intensity through purchasing more juice machines and it is possible that
preparation of snacks could be more capital intensive. It is also possible that customers could
operate the machines themselves. If that was popular, KL could operate self-service only to cut
down on the number of workers employed. However, the business should remain labour intensive
if face-to-face contact with customers is considered to be essential to meet customers’ needs
and wants.
Evaluation should include a justified conclusion about whether to switch to capital intensive
methods in the context of this business.
be different.
Coursebook answers
Chapter 24
Business in context
• To enable production or to meet customer demand.
• Because demand is unpredictable.
• Because suppliers may be unreliable.
It would be difficult to manage with zero inventories because:
• Smaller and shorter production runs are required.
• Products could only be made to match demand.
• There would be no buffer inventory to allow for late deliveries or changes in demand.
Activities
Activity 24.1
1 a Ingredients for drinks (e.g. coffee, milk, sugar, juice); ingredients for food (e.g. meat, vegetables,
herbs, spices); other durables (e.g. napkins, soap).
b Hard disc drives, cooling fans, motherboards, keyboards, mice, screens, flash drives, blank CDs,
accessories, cables, batteries.
c Paper, pens, board pens and wipes, textbooks, student diaries, batteries.
2 Café: the expected number of daily customers; the shelf life of food ingredients; size of storage
facilities (e.g. fridge); lead time of delivery; discounts available for buying in bulk; cost of delivery.
Activity 24.2
• The size of Saiko’s storage facility. This imposes a physical limit on inventory holding.
• The cost of storage particularly if inventory requires special storage conditions. For example,
inventory may need to be kept refrigerated; this is expensive. The cost of insurance may also
increase as inventory is held above a certain limit.
• The risk of wastage and obsolescence. If the inventory is perishable, inventory holding would have
to be limited to avoid wastage.
2 Inventory held after delivery – inventory held at time of delivery.
900 000 − 200 000 = 700 000 units
3 Inventory is re-ordered at the point at which the diagonal inventory holding line on Figure 24.7 crosses
the re-order level and it is delivered where the inventory holding line becomes vertical. This shows a
lead time of 3.5 weeks (assuming four weeks in a month).
4 Reasons include:
• An increased level of inventory usage, as is shown by the more steeply sloping line.
• An increased level of demand leading to greater inventory usage. The increased level of demand
was not anticipated.
• The delivery in April was insufficient to return inventory levels to their maximum.
• A failure to re-order inventory in time. The re-order level was too low, given the variations in demand.
• The minimum (buffer) inventory level was too low, given the variations in demand.
5 The inventory control chart indicates that inventory usage is not consistent from one month to
the next:
• January: inventory used was 100 000 units.
• February and March: inventory usage was approximately 300 000 units per month.
• April: inventory usage started at approximately 300 000 per month before rising to a rate of
approximately 1 000 000 per month.
• Inventory usage returned to approximately 300 000 per month during May.
This variability in inventory usage will create a number of potential problems:
• Difficulty in matching inventory holding with the level of demand. JIT inventory control is less
likely to be successful.
• Needing to hold large buffer inventory to prevent the costs associated with no inventory.
• Increased costs of inventory holding to avoid running out. Costs include warehousing, insurance
and security. There may also be increased wastage costs if demand is low; this depends on the
extent to which the products are perishable or subject to quick obsolescence.
• Having to make special orders due to no inventory.
• If high inventories are held, this will lead to cash outflows and potential cash flow problems.
Evaluation: the extent to which this is a problem will depend upon a number of factors:
• How predictable are the variations in inventory usage? If they are entirely predictable, it should be
possible to keep inventory holding low. However, the ‘inventory out’ at the end of April suggests
demand is unpredictable.
• The lead time appears to be around one month, therefore a sudden increase in inventory usage (as
occurred in April) is likely to cause problems as supplies take time to be delivered.
• The reliability of the supplier. Does the supplier always deliver the right quantity of sufficient
quality on time? The delivery in April is small – was this an error made by Saiko or the supplier?
Activity 24.3
1 a The process of ordering, storing and using a company’s inventory to meet business objectives.
b Inventory that is held in case of disruption to supplies or to meet an increase in demand.
2 a Opportunity cost is the next best alternative given up. Increasing inventory from $3m to $7m
will lead to an outflow of cash, which could have been earning interest in a bank account. At an
interest rate of 10%, the lost interest, as a result of the increased inventory holding over the year, is
0.1 × $4m = $400 000.
b Batch production involves the production of identical products in groups. Every unit in the batch
goes through each production stage before the whole batch moves on to the next stage. This results
in high levels of work in progress.
3 Conditions include:
• Predictable demand of sports equipment so that output can be matched with demand.
• Replacement of old machinery to avoid the risk of machinery breakdown disrupting production.
• Reliable suppliers to deliver inventory on time.

• A change in culture from one which focuses on not running out of inventory to one which aims to
minimise inventory and to find solutions to the production problems that zero inventory creates.
4 Jack argues that the business needs to hold inventories of raw materials and components to ensure that
production of sports equipment is never held up by a lack of relevant inventory.
This approach will ensure that machinery is never idle due to running out of inventory. So if a sudden
increase in production of tennis rackets is required, there will be metal frames in inventory to allow
this. This will make it easier for Sportswise to meet customer orders quickly.
Evaluation of this approach to high inventory levels is needed and the points that could be assessed
include inventory holding costs and the risk of not selling all the football shirts during the World Cup.
A final justified conclusion is needed.
Activity 24.4
1 Benefits:
• Toyota has reduced its costs by $820m in each of the past three years as a result of using single
suppliers of major components.
• Economies of scale are possible as Toyota and Nissan purchase components in greater quantities,
so the unit cost is reduced.
• A stronger relationship with the supplier can be built, thus ensuring that the supplier is reliable.
• The supplier may become dependent on the car manufacturer; this increases the ability to
negotiate a good price.
• The supplier can be integrated into the design process, thus ensuring that new components are
suitable when launching new models.
Drawback: if the supplier has a problem (e.g. a fire), there is no back-up and production will halt.
2 Nissan has been able to reduce inventory holding of parts to an average of just 1.6 days’ worth. This
reduces the costs associated with holding inventory: less warehousing costs; less security costs; working
capital benefits (i.e. cash outflows are delayed); less handling costs as components go straight onto the
production line; space that would have been used for storage can be used for production.
However, there are potential problems. If suppliers are unreliable (e.g. if a delivery is late or contains
faulty components), production will quickly stop and machinery will be idle.
Relevant issues to analyse and evaluate include:
• Firms have to be certain that the supplier is reliable, as any disruption to supplies will cause
production to be halted as the manufacturer holds very low levels of inventory.
• The manufacturer may need to invest money in building a relationship with the supplier. Nissan,
for example, works closely with suppliers and provides management expertise to help the suppliers
adapt to the demands of JIT.
• JIT highlights weaknesses in the production process and organisations have to be flexible to be
able to solve problems. A zero-defects approach to manufacturing is necessary, as there is no spare
inventory of raw materials, components and finished goods. There is no buffer inventory to cover
for inefficient workers, inflexible people and equipment.
• It is important to be able to predict demand to avoid delays in meeting the demands of customers.
If demand is erratic, JIT is less likely to work.
• Where seasonal demand is an issue, it is more difficult to adopt JIT principles. It may be necessary
to build up inventories in advance of peak demand.
• JIT is supported by expensive IT systems. For example, Nissan has to be able to communicate its
inventory needs to suppliers on an almost continuous basis.
• Delivery quantities will be small and frequent. Therefore, delivery costs are increased. For the
system to work it may be necessary to have suppliers on site.
• Evaluation/judgement is needed about whether the impact of JIT is, overall, beneficial or
damaging to Nissan/other manufacturers.
Activity 24.5
1 a Minimum amount of inventory always held just in case.
b Inventory level at which new inventory is automatically ordered.
c Length of time between placing an order and receiving delivery.
2 a 20 units.
b 100 units.
c 1 day.
3 Production is an ongoing process. Therefore, there will always be inventory at different stages of
completion, e.g. materials and components that have been partially built into a completed unit.
4 Learners’ answers will vary, e.g. storage space that could be used for production has to be paid for;
insurance may be necessary to protect against fire and theft.
5 Working closely with suppliers in the chain will strengthen relations with them and contribute to
increasing productivity and reducing costs.
6 Learners’ answers will vary, e.g. if inventory holding costs are high, economic order quantity (EOQ)
will tend to be low; if inventory holding costs are low, EOQ will tend to be high.
7 Learners’ answers will vary, e.g. it needs excellent relationships with suppliers so that they give priority
to the regular deliveries of small order quantities just as they are needed.
8 Learners’ answers will vary, e.g. if deliveries are late, it could lead to expensive production delays
(because there are no buffer inventories) and, if production has to be stopped, wages and other costs
will have to be paid but no output will be produced.
9 Learners’ answers will vary, e.g. JIT might be inappropriate in businesses where demand can fluctuate
a lot and it is therefore difficult to forecast demand. This is because an unforeseen increase in demand
will leave the business with no inventory to supply customers.
10 Learners’ answers will vary, e.g. raw materials such as cocoa beans; work in progress such as beans
being processed into chocolate; inventories of chocolate bars ready to deliver to retailers.
11 Learners’ answers will vary, e.g. storage capacity for both raw materials and ingredients and the
finished food products; lifespan of food ingredients and finished food products.
12 Risk of shortage could cost a patient’s life as operations and emergencies are difficult to forecast
accurately.
13 It is a very competitive market so supermarkets need reliable suppliers that they can work with closely
to develop and deliver on time the type of efficiently produced goods that consumers are willing to
purchase.
Essay questions
1 a Efficient management of inventory will balance the costs of holding inventory against the cost of
inventory out. Costs of holding inventory include warehousing costs; obsolescence; opportunity
cost; impact on cash flow; loss and damage.
Costs of inventory out and small inventory quantities include:
• Lost sales.
• Idle resources.
• Frequent orders of small quantities may mean that the business does not benefit from
purchasing economies.
Efficient inventory management will help ensure that:

• Customer needs can be met but without costing too much to hold large inventory.
• Inventory wastage is minimised but production is maintained with no periods of
zero inventory.
b Learners should define JIT inventory control. A number of factors will determine whether JIT
inventory control is appropriate including:
• Predictability of demand for the firm’s soft drinks. The more predictable demand is, the easier
it is to plan inventory deliveries to meet demand.
• Seasonal demand. If demand is highly seasonal, a firm may need to build up inventories of a
particular soft drink in the period before peak demand.
• Lead time from suppliers. If suppliers have very short lead times, JIT inventory control is more
likely to be successful.
• Reliability of suppliers.
• As fruit is an agricultural product, producers cannot guarantee availability of output because
the weather and disease will influence crop yield.
• Inventory holding costs versus costs of inventory out.
• Cost of setting up the JIT system.
Evaluation: JIT benefits and problems are explained and weighed up in the context of a soft drinks
manufacturer. It should recognise that JIT may be suitable for some soft drinks manufacturers but
not others, due to issues such as location and size.
2 a Learners’ answers will vary and should include two of:
• Storage costs (e.g. warehousing rent), especially if specialist conditions are required (e.g. below
a certain temperature).
• Employee costs to manage inventory, e.g. to keep inventories, move them around, deliver them
to production plants etc.
• Insurance costs especially for high-value goods against damage, fire etc.
• Risk of loss of value through obsolete or damaged inventory.
b Define supply chain management and explain that effective supply chain management aims
to minimise costs whilst achieving excellent customer service. Manufacturing an electric car is
complex and involves managing thousands of components and car parts from multiple suppliers
around the world. By improving management of the supply chain, the manufacturer can:
• Meet customer expectations of delivering cars quickly, on time and to the appropriate quality.
This increases customer satisfaction and therefore sales.
• Reduce operating costs by using JIT manufacturing to minimise the costs of holding inventory
whilst ensuring that purchasing costs are also controlled. Also, production costs are cut as
time is saved in converting raw materials into finished products.
• Improve profitability. By reducing wasted time, improving inventory management and creating
a low-cost but efficient supply chain, business profits should increase.
• Evaluation could include an assessment of why such a manufacturer is unlikely to be
competitive or successful without effective supply chain management.

1 MFLEX
a i Inventory storage capacity.
ii Holding no emergency supplies of inventory.
b Learners’ answers will vary and should include two of:
• It increases customer satisfaction and therefore increases orders in the future.
• Customers will be able to reduce their costs and can offer better prices to consumers.
This will increase demand for MFLEX.
• Being responsive and flexible will give MFLEX a competitive advantage in the market.
• Greater sales may result in increased profitability.
c Learners’ answers will vary and should include two of:
• Build a strong relationship with suppliers. MFLEX requires reliable suppliers to ensure that
components are delivered on time. Typically, JIT producers will focus on working with one
supplier for each key component. MFLEX has signed exclusive deals with some suppliers.
Working with one supplier helps ensure that the supplier understands the manufacturer’s
needs and makes the relationship more mutually beneficial.
• Invest in IT equipment. This is necessary to facilitate communication between MFLEX,
its suppliers and customers. Using electronic data exchange speeds up the process of
ordering components. MFLEX’s production lines can be in constant contact with suppliers
to increase responsiveness.
• A zero-defects concept encourages responsibility. All 125 workers at the new factory must
take responsibility for quality, as there is no buffer inventory to fall back on. If mistakes are
made, customer orders will be delayed.
d Learners’ answers will vary but might include:
• Cyclical demand. MFLEX may have to build inventory over a long period of time in order to
be able to meet peak demand. If this was not done, the firm would need very large production
capacity to cope with peak demand. However, this would mean that capacity utilisation would
be low at other times.
• Inflation. Rapid inflation will mean that component prices rise from day to day. It is therefore
worthwhile to bring purchases forward to avoid higher costs at a later date.
• Long lead times and unpredictable demand. If demand cannot be predicted accurately
and supplier lead times are long, the firm MFLEX cannot be responsive to customers without
holding inventory.
• Unreliable suppliers. It may not be possible in the short term to find a reliable supplier.
• Bulk-buying discounts. Purchasing in bulk may secure substantial discounts that outweigh the
costs of holding inventory and these cost savings could be passed on to MFLEX’s customers
in the form of lower prices.
• Transport costs. These may be too high for frequent deliveries. This will depend on the
distance from the supplier, the nature of the supplies and the transport infrastructure.
Evaluation should include an overall conclusion or judgement about those situations in which
MFLEX and/or its customers might benefit or not benefit from using JIT.
be different.
Coursebook answers
Chapter 25
Business in context
Benefits of high levels of capacity utilisation
• Avoids investing in building new capacity.
• Spreads fixed costs over higher output and therefore reduces average fixed costs.
• Lower average costs and higher sales increase profits.
• Workers will have a feeling of job security and therefore be motivated.
Benefits and risks of outsourcing
• Reduces fixed costs of production as less capacity is required.
• Outsourcing to low-cost countries reduces variable costs.
• Lower costs increase profit margins.
• The business is more flexible to changing demand for smartphones.
• Loss of control over quality.
• Negative publicity criticising Apple for working conditions in supplier factories.
• Potential boycott of Apple products.
Activities
Activity 25.1
1 As output rises, fixed costs are spread across a bigger number of units, so unit (average) fixed cost falls.
For example:
Output 1 100 200

Fixed cost $10 000 $10 000 $10 000
Unit fixed cost $10 000 $100 $50
2 Capacity utilisation = actual output ÷ maximum output × 100

• 20 000 ÷ 50 000 × 100 = 40%
• 30 000 ÷ 50 000 × 100 = 60%
• 45 000 ÷ 50 000 × 100 = 90%
• 50 000 ÷ 50 000 × 100 = 100%
3 It means that only 75% of available capacity is currently being used.

4 (1 000 ÷ 1 200) × 100 = 83.3% capacity utilisation
Activity 25.2
1 Factors could include:
• The increase in average room price from $135 to $145.
• A reduction in the price of substitute goods, e.g. hotels elsewhere in the country or world.
• The state of the economy. A slowdown in economic growth or a recession would lead to a drop in
tourism and business activity.
• An increase in the price of complementary goods, e.g. air fares and rail fares to City A.
• A relative increase in promotional activity for other tourist destinations, such as City B.
2 Capacity utilisation = current output ÷ maximum output × 100
= 1.6m ÷ 2m × 100 = 80%
3 Factors include:
• Promotional activity by the tourism industry in City B is more effective.
• Slowdown in economic growth encourages tourists to look for cheaper holiday options.
• Price of complementary products in City B is cheaper than in City A.
• Consumer preferences change.
• The price of rooms has increased proportionately more in City A than in City B.
Activity 25.3
1 a To increase production capacity means to increase the output that can be produced in a given
time period by increasing the input resources available. GSK is increasing production capacity by
investing in Africa, building a bigger factory.
Alcoa is making cuts to production capacity by 460 000 tons per year. This means it will be able to
produce less output in a given time period.
b 460 000 tons = 11% of production capacity, therefore 460 000 ÷ 11 × 100 = 100%. Production
capacity = 4 181 818 tons.
2 Arguments for: it is important to improve cash flow and profitability; it may ensure long-term survival;
Alcoa will still have a very small amount of spare capacity; it is effective at cutting costs as they are
closing the least efficient plants.
Arguments against: commodity prices tend to fluctuate, therefore the falling prices may be short term;
it is dangerous as it takes production close to full capacity; it is difficult to reverse these decisions; it
results in substantial redundancies.
Evaluation should include an overall judgement about this decision and whether it might be very costly
and time-consuming to increase capacity again in future if demand for aluminium rises above forecast.
Activity 25.4
1 The level of output is currently less than the total maximum possible level of output.
2 Fixed costs do not change with output. Therefore, as excess capacity increases because output is
falling, average fixed costs will also increase.
3 Learners’ answers will vary, e.g. the business cannot respond to large new orders so customers may be
lost; there is pressure on resources which in the long term may lead to breakdown of machinery.
4 Learners’ answers will vary, e.g. it provides an opportunity to maintain fixed assets; for some
businesses, fixed costs are relatively low so there is no significant cost disadvantage to operating below
full capacity; it might be a common seasonal occurrence and, when demand increases again, output
will rise towards maximum capacity.
5 Learners’ answers will vary, e.g. reduce prices to increase demand; increase promotion to attract
customers; reduce capacity by rationalisation, although this is a longer-term approach to reducing excess
capacity and improving capacity utilisation.
6 Learners’ answers will vary, e.g. capital costs of expansion require significant investment and would
only be worthwhile if the problem of capacity shortage was long term; outsourcing is more flexible, so
if demand does not continue to be high the contract can be terminated.
7 Learners’ answers will vary, e.g. it could build up inventory to supply shops during the busier months
of the year when seasonal demand is high; flexible employment contracts may be used with workers so
that labour costs can be reduced when there is excess capacity.
8 Learners’ answers will vary, e.g. loss of control over quality of the finished computer, which could
lead to customers returning faulty products and damaging the brand image; increased dependency
on the outsourcing firm, so the manufacturer may not be able to control delivery time of assembled
computers if there is an increase in demand.
Essay questions
1 a In a competitive market, there is choice for customers as many substitute products are available.
Price will be more important to customers. Business must control costs to be price competitive and
therefore operating at high capacity utilisation will help minimise average or unit costs.
If the business is working at close to full capacity, an increase in demand could mean that
customers’ needs cannot be met. Customers might not wait for the product to be manufactured or
for the service to be provided, and they might purchase from a competitor instead.
b The manufacturing business might:
• Reduce price to increase demand, but this may reduce the profit margin.
• Increase promotional expenditure to increase demand.
• Decrease capacity through rationalisation.
• Increase the product range.
• Sell products to new markets.
• Analyse 2 or 3 of the above including their benefits/limitations to a manufacturer.
Evaluation should include an overall conclusion/judgement with an assessment of these questions:
Why is capacity utilisation a problem? Is it a short-term or long-term problem? How long would
it take for the costs of rationalisation (e.g. redundancy payments) to be outweighed by the cost
savings obtained from reducing capacity?
2 a Learners’ answers will vary, e.g.:
Advantages:
• Reduces average fixed costs and increases profit.
• Efficient use of capital resources. There will be no idle resources in the business.
• A busy restaurant is good for marketing the business.
Disadvantages:
• Is it sustainable? Employees may be overworked, resulting in absenteeism.
• Customer dissatisfaction due to reduction in quality of service, e.g. having to wait for a table
and orders taking longer to fulfil.
• Reduced quality of the food prepared, due to pressure of work, threatening the reputation of
the business.
b These may be considered non-core activities.

Benefits:
• The company can focus on the core activities of operating train services.
• It will make cost savings as it no longer needs to manage and employ skilled
maintenance workers.
• Specialist ticketing service businesses may be more efficient and bring high-quality
IT expertise.
• Increased flexibility. The fixed costs of office space and salaried employees are reduced and
converted into variable costs. Contracts can be cancelled or adjusted as required.
Disadvantages:
• Loss of jobs within the business. This will affect employee morale and there will be
redundancy costs.
• Quality issues. Train safety is crucial so maintenance of engines is important.
• Loss of expertise. The train operating company is vulnerable to problems if the outsourcing
company fails. It will be difficult to bring maintenance and ticketing back in-house.
• Contracts may be difficult to terminate if the outsourcing business’s performance is
unsatisfactory.
Evaluation should include an overall conclusion/judgement with an assessment of these questions:
What are the objectives of the business? Is it more important to focus on core activity (operating
trains) rather than on providing all services to customers by employing people directly?

1 Nassau Textile Manufacturing (NTM)
a i It raises fixed costs per unit.
ii Maximum output that can be produced in a given time period.
b i Capacity utilisation = current output level ÷ maximum output level × 100
2017 2021
Maximum capacity (metres) 5m 5m
Actual annual output (metres) 4m 3m
Capacity utilisation 4 ÷ 5 × 100 = 80% 3 ÷ 5 × 100 = 60%
ii Actual output has decreased and capacity utilisation has fallen to just 60%. Therefore, fixed
costs, which will be unchanged, are spread over a lower output, resulting in an increase in
average fixed costs.
c Learners’ answers will vary, e.g. higher average fixed costs will increase average costs and therefore
reduce profit margins; it is more difficult to compete in the market on price; workers may become
demotivated due to lack of work to do; there will be pressure to reduce workers’ hours of work,
which will be demotivating; it is an ineffective use of fixed assets; it can convey a negative message
to customers.
d Option 1:
• The $5m raised from selling part of the factory would help improve the firm’s liquidity and
survive the recession; a lack of cash during a recession is often a cause of business failure.
• The capital could be used to improve efficiency in the factory by, for example, purchasing new
machinery. This would help control the unit variable cost of production; at the moment, the
selling price is very close to the variable costs and therefore the contribution is too low.
• Reducing fixed costs by $1m would reduce the break-even level of output. This is significant,
as sales have fallen by $1m since 2017. Reducing overheads is critical to maintaining
profitability in a recession.
• Reducing the workforce by 50 will help reduce costs in the longer term and may lead to
an increase in productivity. However, there may be associated redundancy costs and
remaining workers may be demotivated. It is also possible that industrial action could be
taken by employees.
• Skilled workers may be lost and in an upturn it could be difficult to recruit new staff.
• Selling part of the factory will reduce the capacity towards the current level of sales. However,
if there is an upturn in the economy it will be expensive to increase capacity to meet demand.
Option 2:
• This option protects the future ability of the firm to meet increased demand.
• However, even in 2017, the firm was only operating at 80% of capacity and it is currently just
60%. Therefore, the overheads of the business will remain near $3m and the break-even level
of output will be high unless the variable costs are reduced dramatically.
• Making 100 workers redundant will be resisted by the workforce and may result in industrial
action. There could be a significant short-term cost of redundancy.
Option 3:
• This will help cut overhead costs, may increase productivity and will therefore reduce the
break-even level of output. Will the reduction in overhead costs and variable costs be sufficient
to make a profit?
• Workers may favour this option as it is protecting jobs even though there will be a loss
of wages.
• This option offers flexibility as worker hours may be altered to match demand and temporary
contracts can be terminated if there is insufficient work.
• When the economy emerges from recession, Nassau will be in a strong position to increase
production as both workers and capacity will still be available.
Recommendation/evaluation: sales have been declining for the last two years. NTM is not
profitable and this suggests that there needs to be a significant change in the business. The choice
between the three options depends partly on the long-term outlook for the business, i.e. how long
the recession will last and how much further sales will fall. The longer the recession, the more
attractive option 1 appears as this will reduce overheads significantly.
2 Airline outsourcing
a i Products and services are obtained at lower cost.
ii These are the activities that make the business run, even though they are not directly related
to producing the service or product the business sells to generate its revenue.
• Controlling quality. The in-flight retail operation may have an important impact on passenger
perception of Malaysian Airlines. If the retail operation is outsourced, Malaysian Airlines will
lose some control over the quality of the service and this could damage its reputation.
• Loss of profit. Malaysian Airlines’ in-flight retail operation offers good value. Outsourcing the
operation may lose the airline revenue and could reduce profits; the outsourcing company will
only offer a service if it is able to make a profit.
c Learners’ answers will vary:
• Increase prices to increase profit margins.
• Offer overtime working to employees to meet demand.
• Plan for the future if demand is expected to increase further.
• Recruit new employees.
• Consider outsourcing.
• Lease new planes.
• Book new landing slots at airports.

• Will there be a cost saving from outsourcing? Specialist firms providing meals, for example,
will benefit from economies of scale and can therefore offer competitive prices to airlines.
• What is the impact on quality? An outsourcing firm is specialised and therefore has expertise
in the service it offers. Quality may be improved as airlines have less knowledge of non-core
activities. However, outsourcing does not guarantee quality and there is a loss of control
over quality for the airline. Minimum service level agreements will have to be drawn up
and monitored.
• Focus on core activities. Outsourcing frees up management time to devote to the core activity
of the airline, leading to improvements in performance.
• Flexibility. The airline is responsible for fewer staff and will find it easier to respond to
changes in demand. If demand falls, contracts can be terminated. If demand rises, contracts
can be extended. However, if outsourcing fails, it may be difficult and expensive for the airline
to reopen its own operations.
• Security. Airlines have a particular need to protect security as they have much sensitive
information and there is always a threat of terrorist attack. Would using an outside business to
perform an important IT function present a security risk or would the airline benefit from the
expertise that an outside firm can offer?
• Will there be a customer backlash? Outsourcing telephone call centres may lead to customer
dissatisfaction. Outsourcing can also lead to negative publicity as it is often seen as a
cost-cutting exercise.
Overall evaluation or judgement will depend on which activity is being outsourced; the objectives
of the business; the expectations of customers (e.g. quality of product or service); and the
importance of being able to contact people directly and locally (e.g. for after-sales service).
be different.
Coursebook answers
Chapter 26
Business in context
Benefits of Trinidad and Tobago as a location for businesses
• Economic growth and rising incomes. It offers growing markets for business goods and services.
• Infrastructure, including international ports for trading goods.
• The government provides financial incentives for investment.
• Suitable climate for a range of agricultural products.
• Political stability reduces the risk of investment.
• Free-trade agreements with other countries.
Importance of location
• Location is important to all businesses as it affects costs, competition, access to customers and
availability of supplies of inputs.
• Soft drink manufacturer: location is important for access to water and energy; infrastructure for
transport; suppliers of cans and bottles.
• Hairdressing business: it is important to have customers living locally. Location also affects the cost
of premises and the number of competitors.
Activities
Activity 26.1
1 Site A: Revenue = sales × price = 25 000 × 50 = $1 250 000
Profit = total revenue − total cost = 1 250 000 – 975 000 = $275 000
Site B: Revenue = 17 000 × 45 = $765 000
Profit = 765 000 – 498 000 = $267 000
• The level of economic activity will affect the demand for and price of mobile phones. If there is
economic growth, the demand for mobile phones will increase.
• Level of competition in the market. If another mobile phone shop opens or closes, it will
affect revenue.
• Change in costs. Rental costs of premises and/or local business rates may change
between locations.
• Technological change. Changes to the mobile phones will have a significant impact on demand.
Activity 26.2
1 Site C has a much higher break-even level of output and consequently a lower margin of safety. Site D,
at current production levels, has a higher margin of safety than Site C. Therefore, based on break-even,
ICT should choose site D.
2 Learners’ answers might include an evaluation of:
• Corporate social responsibility. It is likely that the paint factory will cause a variety of pollutants
to be released into the environment. Although site D is likely to have lower environmental controls,
ICT risks damage to its brand image if it takes advantage of those lower controls. ICT may be
accused of exploiting workers if it locates in the less economically developed country and pays
low wages.
• Infrastructure. Germany has a highly developed infrastructure which will provide the necessary
support for production, e.g. reliable access to power, water and good transport links. The less
economically developed country may or may not be able to offer these benefits.
Activity 26.3
1 Rolls-Royce is a luxury brand and, although controlling costs is still important, there are other
qualitative factors that are particularly significant. Although Goodwood is an expensive location with
a high cost of land and labour, it offers distinct benefits to Rolls-Royce, including:
• Infrastructure. The proximity of a small airport enables wealthy customers to visit the factory.
Rolls-Royce customers are primarily from outside the UK, so the location provides easy access to
the factory. Unlike a mass-produced car, the customer is buying a handcrafted product and may
want to see how it is produced.
• There are exclusive venues nearby to which Rolls-Royce can take potential customers. This is part
of the promotional activity of Rolls-Royce and a way of securing orders from customers.
Rolls-Royce is a premium brand that retails at a high price and therefore the Goodwood location helps
enhance the brand image and offers the company an excellent marketing opportunity. The production
costs are therefore less important.
Evaluation should include an assessment of the importance of choosing a profitable location in
which site costs etc. did not exceed potential revenue, but that qualitative factors were also of great
significance in this case.
Activity 26.4
1 Advantages:
• To reduce costs. Toyota is a Japanese firm, where wages are relatively high. Locating factories
in countries such as Mexico will benefit from lower labour costs and fixed costs. Markets in
developing countries are also growing strongly, so locating in those countries provides better access
to customers.
• To avoid import barriers. For example, locating a factory in the European Union gives tariff-free
access to the 27 member states.
• To reduce transport costs as the factories will be closer to consumer markets.
• To reduce lead times to meet customer demands.
• Delegation of responsibility to regional managers will develop skills and enhance motivation.
• To enhance reputation in the countries in which factories are located. The cars can be marketed as
being produced locally, which is an appealing factor to some customers.
Disadvantages:
• Coordination problems. Toyota has 52 manufacturing facilities in 26 different countries. This
will create problems of coordination. Time and money will have to be devoted to ensuring that
communications are excellent between locations and head office. Head office may lose control over
the business.
• Quality concerns. It may be difficult to replicate the successful quality systems used by Toyota in
all countries due to cultural differences and attitudes towards work.
• There may be criticism of Toyota if it moves production to another country to take advantage of
lower labour costs.
• Difficulties with maintaining supply chains. Factories around the world may be dependent on
supplies from companies in one particular country. Therefore, manufacturing will be riskier as
components have to be shipped around the world.
• Toyota will have to adapt its production to meet the different legal requirements imposed by
governments in each country.
Evaluation could include an assessment of how the importance to Toyota of producing in many
centres close to major markets is greater than the potential cost savings from one huge production
plant in, e.g. Japan.
Activity 26.5
1 Labour supply is crucial to TRG as it requires English-speaking employees to be readily available.
As TRG operates phone-based customer service centres, labour is a key input and is a high proportion
of total costs. Therefore, availability of low-cost labour will give TRG a competitive advantage.
IT infrastructure is critical to TRG’s operations as its service requires telecommunications with other
countries such as the USA.
2 Advantages: well-educated workforce with English language skills, which are essential to its operations;
low-cost operations due to low wages and land costs; a supportive government; the necessary IT
infrastructure.
Disadvantages: cultural differences affect recruitment; cost of training the workforce due to lack of
management expertise.
Evaluation: other economies such as India offer some of the advantages in terms of English-speaking
workforce and IT infrastructure. However, Pakistan can offer these benefits at a lower cost.
Activity 26.6
1 Competition. Aymen may look for a location with limited competition.
Cost of renting premises. Higher rental costs will increase the break-even point.
Potential demand. This could be affected by factors such as income and education. For example, a
town with a university might be a good location for a bookshop.
2 Average costs might decrease because of economies of scale:
• Greater division of labour could increase efficiency.
• Purchasing economies. Bulk-buying books for the greater number of stores will result in discounts
from book suppliers.
• Bookworm will benefit from financial economies. Larger loans can be taken out with a lower level
of interest than the bank overdraft initially required.
• Employment of specialist managers will increase efficiency, e.g. the two brothers who brought
accounting and marketing expertise. This resulted in the business managing cash flow more
effectively and reducing its overdraft.
• Marketing economies. Advertising will be spread over more units and therefore the unit cost is lower.
• Technical economies of scale. The business is considering purchasing a new computerised stock
management system, which will help reduce administrative costs of the business and provide
more effective stock control. Such a sophisticated system will be too expensive for a small business
to purchase.
Upward pressure on average costs would result from:
• Increased levels of bureaucracy from employing more middle managers. This will increase wage
costs as well.
• Greater risk of industrial relations problems. Employees may be increasingly alienated from the
business due to its size.
• Coordination problems from the number of bookshops.
Evaluation could include an assessment of the difficulty of measuring average costs in this context and
the difficulties of actually identifying at what level of growth diseconomies outweigh economies.
Activity 26.7
HiSonic
1 The capital cost of offshoring is double the cost of expanding the existing German factory. However,
payback for the Malaysian site is two years less than in Germany. This could be because of lower
rent and wage costs. The annual profit for the Malaysian site is $1 million more than that offered by
German expansion. Break-even in Malaysia is a lower proportion of planned output. This could be
because of lower costs and better access to the Asian market.
2 Factors involved in a new operating plant in Malaysia:
• The annual profit is higher.
• Payback is two years earlier. This is important for cash flow and other investments that HiSonic
might be considering.
• The margin of safety is significantly more than if expanding the European site.
• Better access to the Asian market will increase sales in the long term.
• When production is established in Malaysia, it will be possible to move all production from
Europe and therefore reduce costs even further.
Factors involved in expanding the German site:
• Capital cost is significantly lower: 50% less than shifting production.
• HiSonic has a loyal and skilled workforce in Europe with a proven record of producing
quality products.
• Employees in Europe might view a decision to build a factory in Malaysia as the first step in
shifting all production abroad. This would affect motivation in the European factory and could
lead to industrial relations problems.
• The product’s reputation for quality might be undermined if it is produced in Malaysia.
This depends critically on consumer perception of the brand.
Evaluation: availability of finance will be an important influence. However, the higher annual profit
and margin of safety suggest that a decision to locate in Malaysia offers, in quantitative terms, the
better long-term option.
be different.
Coursebook answers
Chapter 27
Business in context
• A product that meets the quality standards set by the business, tested against set quality standards in
terms of performance.
• This will vary from one customer to another. For some, price is critical because of limited income.
However, a mobile (cell) phone will still have to meet user-defined minimum standards of reliability to
offer value for money. For some consumers, reliability will be essential as a mobile (cell) phone is an
important tool at work or might be used to increase safety for children.
Activities
Activity 27.1
1 For both businesses, a quality product is defined by the expectations of customers. For Athletic Shoes,
quality might mean that the sports shoes have only minor imperfections and blemishes when sold to
customers. However, Exclusive Footwear sells shoes at very high prices and quality requires that the
shoes have no blemishes at all. The slightest imperfection is not acceptable.
2 Training workers to improve their skills so that fewer mistakes are made and work is completed to a
more exacting standard. This could be costly and reduce productivity in the short term. However, it
could increase motivation.
Better-quality components and raw materials. These are likely to be more expensive but should
improve reliability and longevity of the finished product.
Quality circles. Organise workers into groups to consider problems in production and find solutions
to quality problems. Using the expertise of workers can be effective as workers should have a
good understanding of production processes. This can also increase motivation by giving greater
responsibility to workers.
Activity 27.2
1 a Hotel: based on the facilities included, such as swimming pool, gym, ensuite rooms and reception
opening hours.
b Fast-food restaurant: waiting time for service.
c Internet service provider: download and upload speeds; interruptions to service each month.
d Preschool for young children: staff–child ratio; floor area per child; outdoor play area.
Activity 27.3
1 If faulty tractors reach customers, the consequences include:
• Dissatisfied customers lead to declining reputation. In the long term, this will lead to lower sales as
there will be no repeat purchases. Former customers are buying imported tractors.
• Increased costs. Customers will return the tractors to be fixed or replaced. This will increase costs
as labour resources and machinery will be required to put faults right. To combat the problem of
low quality, the firm has increased the number of quality control engineers from five to eight, and
they are correcting more faults than ever before. This is an additional cost to the business and will
make it less price competitive in the market.
2 Quality control inspectors can be an effective approach to quality control and will prevent low-
quality tractors reaching customers. It is therefore a useful approach to dealing with the problems at
TTF. However, increasing the number of quality control inspectors has drawbacks. It doesn’t prevent
mistakes happening on the production line, it just discovers that they have occurred. Thus, labour time
and materials still have been wasted. Inspectors do not contribute to productivity but do add to the
costs of the business. It does not encourage workers to accept responsibility for quality.
Evaluation could include an assessment of quality assurance and whether this would be a better
approach to improving quality in this case.
Activity 27.4
• Increase in customer satisfaction. This will lead to higher long-term sales as repeat custom
increases.
• Improved reputation resulting in higher sales. Customers will recommend the hairdressers
to friends.
• Reduced need for marketing expenditure. The business cut its advertising within two months of
the changes introduced by the new manager.
• Higher prices can be charged to increase profit margins.
2 Introducing these changes would have been difficult as it required suitable quality targets to be
identified and employees may have been unsure about the increased level of responsibility placed
on them. The stylists would need to be persuaded that the feedback forms were not a threat to their
position in the firm.
In the short term, there was an increase in costs because an additional member of staff had to be
recruited to help meet the quality standards. However, the improvements to customer service appear
to have had a significant impact on repeat custom, revenue and customer satisfaction. The extra
responsibility for each stylist to meet at least one of the targets may have given a boost to motivation
as it is a form of job enrichment and shows trust in employees.
Evaluation: the increase in repeat custom and revenue, the improvement in customer satisfaction and
the reduction in advertising appear to more than justify the changes that were made by the manager.
Activity 27.5
1 Benchmarking involves a business comparing its own performance standards with those of the best
firms in the industry in order to identify how to make improvements. BP compared itself to American
companies to understand where the highest profits were made.
• Benchmarking may help motivate staff. If employees are shown that competitors are more
productive, it can motivate them to match and exceed the performance of competitors.
Benchmarking clearly demonstrates to employees what can be achieved.
• Increased competitiveness. Benchmarking against the best in the industry will help identify how
to make improvements, providing strategies for reducing costs and promoting quality. As the
benchmark is against a real company, it evidences what can be done and provides methods that
have been tried and tested.
• Increased profit. Closing the gap in performance is important. The UK government report found
that the top 25% of companies achieved profit margins five times greater than those in the bottom
quartile. Benchmarking will identify how the best-performing firms achieve higher profit levels and
enable better decisions about how to allocate resources.
Evaluation could include an assessment of these points when weighing up the significance of
benchmarking: businesses that operate in a competitive market cannot afford to be complacent. If a
company’s profitability is lower than competitors, it will become a takeover target.
Activity 27.6
1 A range of indicators could be used to measure the quality of a university’s education, including:
• Staff to student ratio. The more staff there are per student, the more individual attention students
are likely to receive.
• The percentage of students in employment after university.
• Average earnings of graduates relative to those of other workers. Higher earnings may indicate
that university graduates are better equipped with the skills that businesses seek.
• Proportion of students obtaining first-class degrees. However, it is important to consider the
qualifications of the average student when entering a university as well as the outcomes.
• The number of hours of contact time between students and lecturers per week.
Activity 27.7
• Fewer customer complaints and therefore long-term growth in sales. Customer expectations have
increased due to higher levels of income; therefore, CaribSugar’s poor-quality sugar is losing sales
to imports of sugar. Competitors may replace CaribSugar as the market leader.
• Higher-quality producers are able to charge higher prices and may enjoy higher profit margins.
2 Total quality management (TQM) requires a change in the culture of the business as it makes quality
the responsibility of all employees. All workers have to accept that the quality of the work they
perform is important. If successful, TQM virtually eliminates the need for quality inspectors and
will reduce the incidence of sugar products not meeting the specified standard. It encourages a ‘right
first time’ approach and therefore reduces wastage of raw materials. However, TQM is expensive to
introduce as employees will require training so that they can take more responsibility. TQM may be
opposed by workers as it may be perceived as increasing workload without any increase in pay.
3 Benchmarking would involve CaribSugar comparing its own performance standards with those of the
best firms in the industry in order to identify how to make improvements. CaribSugar would need to
benchmark the quality of sugar including its packaging, the consistency of the treacle and distribution.
Benefits:
• Benchmarking will help increase international competitiveness. Currently, CaribSugar is losing
market share to higher-quality imports. Over 40% of output is exported so improving quality is
vital to protecting export markets.
• It may motivate employees, particularly if they are involved in the comparison exercise.
Employees will see what is possible and may want to match the performance of workers elsewhere.
Benchmarking may identify quality systems that are not based on punishing workers; CaribSugar’s
current approach is demotivating for workers.
• Improvements in quality and delivery times will reduce customer complaints.
• CaribSugar may be able to increase prices if quality is improved.
• Benchmarking can produce results quickly as it identifies successful practices already being
used elsewhere.
Drawbacks:
• CaribSugar may or may not be able to collect relevant data from rivals.
• Benchmarking discourages original ideas as it involves copying the practices of other firms.
Evaluation: given the increasing importance of providing a high-quality product and good customer
service in this market, it is essential that CaribSugar acts quickly to improve its operations. Otherwise,
it will lose its market leadership. Benchmarking offers a potentially fast and cheap approach to
identifying how to make improvements. A critical factor will be whether CaribSugar can collect the
necessary information from the industry leader.
Wiping out defects at Wheeler’s
1 Meeting the expectations of washing machine manufacturers will help Wheeler’s gain contracts to
supply components. Increased sales will drive profits upwards. Satisfied customers will make repeat
purchases. Costs of production will be reduced if output meets quality standards first time, saving on
rework costs.
2 Just-in-time production. This range of techniques has the goal of reducing waste and therefore aims to
make better use of all resources within a business. This should help drive costs down.
Multi-skilled workforce. This is an essential element of lean production as workers have to be able to
identify problems in production and find solutions. The kaizen-style meetings require workers to make
an input to improving quality. Further, as just-in-time production is used, workers have to be more
flexible than under traditional mass production. The use of cell production helps motivate workers.
A variety of production methods is employed. Batch production gives flexibility to meet customer
demands for a variety of different products. Flow production enables Wheeler’s to reduce average unit
costs by benefiting from economies of scale in producing a large number of identical products.
Quality assurance. If customers are not satisfied with output, they will find other suppliers. To be
successful, Wheeler’s needs repeat custom, as it is a very competitive industry. Wheeler’s must ensure
that it has systems for assuring quality of its large range of products. Holding an ISO 9000 certificate is
important as some customers will only deal with certificated firms.
Evaluation could include an assessment of which of these factors was likely to have had the greatest
impact on improving quality in this case – or, indeed, whether quality only improved because they were
all introduced together.
be different.
Coursebook answers
Chapter 28
Business in context
Benefits of lean production to a business
• Workers appear motivated and take responsibility for solving quality problems.
• Products are more reliable and improved quality results in higher sales.
• JIT delivery reduces inventory holding costs.
• More flexible production meets customer demands.
• Quicker development of new models gains the company a competitive edge.
Advantages of developing new products more quickly than competitors
• Increases customer satisfaction to have newer models available.
• Results in more frequent repeat purchases.
• Toyota can keep ahead of the competition and therefore protect its market share.
• However, it reduces the time for sales to repay R&D.
• Developing new products is less sustainable as it increases the use of resources.
Activities
Activity 28.1
1 Learners’ answers will vary and could include:
Expand capacity. Finance is required to purchase new machinery and build a factory extension. More
workers will have to be recruited to produce the output. There will be costs of training new workers.
Materials and components will need to be sourced from suppliers. If the business has insufficient
retained profits or cannot access finance from banks, expansion cannot proceed. If labour is not
available, higher wages will be needed to attract workers, making expansion less profitable.
Relocate operations. Existing employees might not be able to relocate due to social ties and financial
cost. Therefore, workers with the necessary skills must be available in the new location. If the local
labour force is not suitably skilled, training will be necessary, which increases costs. Sale of the existing
factory might not cover the costs of relocating, so finance will be required.
Activity 28.2
1 Problems include:
• High inventory levels to meet customer requirements. A major competitor operates with just 10%
of the inventory held by Haisho but still meets customer needs. This means that Haisho will be at
a cost disadvantage due to its higher storage costs. High inventory levels also increase the working
capital required.
• Time is wasted getting inventory from the warehouse to the production line. This wastes human
resources and costs money.
• Product development is much slower than the Japanese competitor, taking three years compared to
around 12 months. Therefore, competitor products will be more up-to-date and this is one reason
why Haisho’s sales are not increasing.
• Capital equipment is old and it is time-consuming to switch from one product to another.
This adds costs to production and makes the firm less able to respond to demand.
2 Currently, there is a lack of departmental integration in developing new ideas. The design team does
not work with marketing and product development. The departments are separated both by physical
distance and by organisational structure. Thus, from conception to production, new ideas take too
long to develop.
If simultaneous engineering was adopted, the essential design, market research and engineering tasks
would be done at the same time rather than sequentially. This would ensure that ideas reach the market
in a much shorter time period. Haisho would be more competitive with the Japanese firm, which
develops products in around 12 months. At the moment, Haisho takes so long over developing its ideas
that, by the time products reach the market, they may be obsolete.
3 Advantages of lean production methods:
• Faster product development will ensure that Haisho’s products remain competitive.
• Reduced stockholding costs will contribute to a reduction in unit costs.
• JIT stock control will aid cash flow.
• Investment in computer-controlled machinery will enable rapid changeover from product to
product, reducing the waste of time and improving the efficiency of labour and capital. Customer
orders can be met more swiftly due to the increased flexibility and reduced time handling stock.
• Lean production aims to highlight weaknesses in the production system so that improvements can
be made.
• Greater responsibility for quality may motivate employees (refer to Herzberg).
Disadvantages of lean production methods:
• Financing the investment may be a significant problem for Haisho. Retained profits may not be
sufficient to fund the ‘millions’ required to update machinery. Thus, the firm may have to increase
its debt finance and incur increased interest costs.
• Introducing new machinery will need careful planning as it will disrupt production and have an
adverse effect on customers.
• Workers will need training in the new approach. For example, lean production seeks to utilise
multi-skilled workers to increase flexibility. Workers will also become more responsible for quality
through the adoption of a zero-defects approach.
• Workers may oppose change as they are comfortable with their specialised roles. They may also
fear job losses as a goal of lean production is to use less of everything. Thus, managing the
introduction of change will be essential.
• Reduced stock holding will expose any weaknesses in production and could lead to customer
orders being delayed.
• JIT production will require a strong relationship with suppliers and increased reliability.
• Haisho may need to be reorganised to ensure that departments can work together to implement
simultaneous engineering.
Evaluation: whether Haisho can afford not to adopt lean production techniques needs to be
considered. If Haisho continues without making changes, it may lose market share to the Japanese
competitor. The threat of low-quality, cheaper imports is also significant. By adopting lean techniques,
Haisho will become more cost competitive. Introducing lean techniques appears to face a number of
difficulties, in particular finance and the need to persuade workers to accept the change. Therefore,
much depends on the availability of funds to invest in machinery and the ability of HRM to put the
case for change to workers.
4 ERP will enable Haisho to plan the purchase and use of resources to improve efficiency using a single
software program. ERP will reduce inventory holding costs by electronically tracking materials and
products at all stages. JIT production should make Haisho more responsive to customer demands.
Cost savings will reduce prices, making Haisho more price competitive. Communication between
departments will improve and closer coordination reduces waste.
However, ERP software is expensive and employees need to be trained to use it. Full implementation
can be time-consuming and software can quickly become outdated. Haisho will still have the key
problem of old, inflexible machinery. For ERP to provide maximum benefit, Haisho will have to invest
in new machinery.
Evaluation should include an overall judgement about whether Haisho will benefit overall from
adopting ERP.
Activity 28.3
1 Customers:
• Cost savings will benefit customers as Ambi-Rad will be able to offer more competitive prices.
Suggestions from workers have helped save $1m a year in costs.
• Gradual improvements will avoid the disruption caused to production of Ambi-Rad radically
changing production methods every few years.
• Kaizen groups will potentially lead to improvements in quality at no extra cost to the customer.
• If suggestions such as the idea from an assembly worker to punch holes in a piece of metal in a
different place shorten the production process, kaizen could help reduce lead times for customers.
Suppliers:
• Kaizen groups should enable the firm to continue its growth due to making Ambi-Rad more
competitive. This will generate increasing sales for suppliers.
• Although suggestions may lead to more efficient use of resources, suppliers may still find demand
increases for their raw materials.
• Kaizen groups have contributed to maintaining Ambi-Rad’s profits during difficult times.
This will protect orders to suppliers and ensure that Ambi-Rad remains a good customer.
2 Relevant conditions include:
• More democratic management approach. Groups will be more successful if there is genuine
empowerment. This requires company directors to relinquish some of their control. This can be
difficult as it requires a cultural shift in attitudes.
• Time. Kaizen groups need to meet regularly to discuss production issues, so management must
be prepared to provide the time for discussion. Workers may not be prepared to give up their own
time for this initiative.
• Teamworking. Workers must be willing to work as a team. This may require a change in approach
as previously workers may have been isolated on the assembly line. It may also require training to
prepare workers for their new responsibilities.
• Evaluation should include an assessment of which is the most important condition in this case.
Activity 28.4
1 Resort benefits. Lean production will reduce inventory costs and release working capital. For example,
reductions in food inventory will decrease waste, making the business more sustainable and improving
corporate social responsibility. Lower operating costs can be passed on to consumers and this makes
the hotel more competitive.
Employee benefits. Employees are multi-skilled and can perform a variety of tasks. This should make
work more interesting. Employees will have greater responsibility, which will help meet esteem needs.
Kaizen circles increase interaction between employees and fulfil social needs but also make employees
feel more valued. Empowerment and increased responsibility benefit career development and
prospects. A more competitive hotel improves job security.
Activity 28.5
1 Failure of the project will prevent or delay the company being competitive in the market. The company
will find it more difficult to compete on price and flexibility to meet customer demands. If the project
fails, the $10 million investment will have been wasted but, if financed by debt, the finance must still
be repaid.
2 The critical path is the sequence of activities that determines the minimum time for completing
a project.
3 If a critical activity is delayed, it delays completion of the project. By carefully monitoring the critical
path activities, Josh can ensure that the project is proceeding on time. The increased focus on critical
activities helps keep the project on track. If delays are identified, Josh can re-organise resources to try
to get the project back on schedule.
Activity 28.6
Node 1 2 3 4 5 6 7 8
EST 0 0+8 0 + 8 + 14 0 + 8 + 0 + 8 + 14 0 + 8 + 14 + 0 + 8 + 14 + 10 0 + 8 + 14 + 10 +
=8 = 22 12 = 20 + 10 = 32 10 + 3 = 35 + 3 + 3 = 38 3 + 3 + 4 = 42
Activity 28.7
Node 8 7 6 5 4 3 2 1
LFT 42 42 − 4 42 − 4 − 3 42 − 4 − 3 42 − 4 − 3 42 − 4 − 3 − 42 − 4 − 3 − 3 42 − 4 − 3 − 3 −
= 38 = 35 − 3 = 32 − 14 = 21 3 − 10 = 22 − 10 − 14 = 8 10 − 14 − 8 = 0
Activity 28.8
1 Network diagram for Project X:
G
16
0 A 4 B 10 D 22 F 25 H 28
1 2 3 5 3 7
0 4 4 6 10 12 22 3 25 3 28
C 11 E
4
7 13 9

2 Activity A B C D E F G H
EST 0 4 4 10 11 22 4 25
LFT 4 10 13 22 22 25 25 28
3 ABDFH
• The critical path identifies the minimum time for completing the project.
• Critical activities must finish on time for the project to be completed on time.
• The critical activities have no total float. They cannot be delayed without delaying the completion
of the project.
• The operations manager will know that they need to carefully monitor the progress of critical
activities to ensure that the project is not delayed.
• If any critical activity is delayed, the operations manager will seek to divert resources from non-
critical activities to try to get critical activities back on track.
Activity 28.9
1 Node 1 2 3 4 5 6 7
EST 0 3 2 5 10 14 16
LFT 0 3 6 10 10 14 16
2 ADGH
3 Total float = LFT – duration – EST
Free float = EST (next activity) – duration – EST
Non-critical activities are BCEF:
Activity Total float Free float

B 6−2−0=4 2−2−0=0
C 10 − 2 − 3 = 5 5−2−3=0
E 14 − 8 − 2 = 4 14 − 8 − 2 = 4
F 14 − 4 − 5 = 5 14 − 4 − 5 = 5
4 D is a critical activity, so any delay in its completion will delay the launch unless the manager is able
to speed up activities G and H. If Activity D is delayed by a week, the launch will be delayed by a
week. The marketing manager will have to focus on the remaining critical activities G and H. They
would have to divert resources from the non-critical activities to try to speed up either the pre-launch
advertising or the distribution of goods to the shops. The success of this will depend on whether
resources can be diverted to a different use.
5 Critical path analysis would be useful to the marketing manager in a number of ways:
• It is a planning tool. Constructing the network shows dependencies between activities and can be
used to ensure a more efficient use of resources. For example, ordering production materials has
a total float of four weeks and can therefore be delayed. Delaying ordering materials will aid cash
flow. Stocks can be built up so they are available just-in-time to be distributed to the shops. This
will save storage costs for the business.
• The marketing manager will recognise the importance of focusing effort on ensuring that the
critical activities happen on time. Designing adverts, producing adverts, pre-launch advertising and
distributing goods to shops will be given particular attention.
• Knowledge of the LFT of each activity will enable the manager to see whether the project is on
schedule. It acts as a control tool.
• Calculating the project duration allows the business to give accurate delivery dates to shops for
delivery of the new product.
• Resources can be allocated more efficiently. The manager will be able to see which activities can
occur simultaneously and this will reduce the overall project time. For example, printing leaflets
and producing adverts can be done at the same time.
1 Jamaica Photos ( JP)
1 Critical path network diagram for Jamaica Photos Ltd:
B H
4 2
0 A 2 C 6 E 9 G 12 I 14
1 2 3 4 5 6
0 2 2 2 6 3 9 3 12 2 14
D
2
F
8
2 ABEGI
3 As critical activities have no total float, any delay in completing an activity will delay the
completion of the project. In this case, there would be a more prolonged adverse impact on
production and therefore customer delivery times.
4 Free float = EST (next activity) − duration − EST
Total float = LFT − duration − EST
Activity Free float Total float

C 2 2
D 2 2
F 4 4
H 1 1

• The technique aids the project team to calculate the minimum time for switching production
from one site to the other. Identifying the project time will help minimise disruption to
production and customers. The analysis provides a clear target for the project team and a basis
for awarding a bonus on completion of the closure.
• If delays occur to critical activities, the analysis will help the project manager identify if there
are resources that can be diverted to try to keep the project on time.
• Knowledge of the LFT provides a useful control tool for the project manager. It identifies
when processing at Kingston should be suspended so as to ensure the project is completed
in the minimum time. This indicates that, as long as processing is suspended by day four, the
project can be completed within 14 days.
6 There are a number of reasons why the analysis does not guarantee successful completion of the
project on time, including:
• The timings are only estimates. This is a unique project and therefore managers cannot be sure
exactly how long each element will take. For example, testing the new integrated processing
system may take longer than two days because of unexpected difficulties. Machinery could
easily be damaged during its dismantling, transport or rebuilding.
• The accuracy of the estimates depends on the ability and knowledge of the managers planning
the closure.
• External factors, over which the project team has no control, can affect the closure. For
example, contractors used for transporting the machinery may prove to be unreliable.
However, in evaluation, analysis will aid the completion of the project with a minimum of
disruption, as it will ensure that the project has been planned and consideration given to which
activities can be completed simultaneously. It will help identify when resources are needed and at
what point activities need to occur. Further, by identifying critical activities, it will help project
managers to focus on those activities that have no float to try to prevent any delays.
Evaluation should include an assessment of the value of CPA in this case together with a
recognition that no planning technique can guarantee project success.
2 Using a network diagram
1 Node 1 2 3 4 5 6 7 8 9 10
EST 0 10 20 20 34 22 59 42 74 82
LFT 0 52 48 20 62 64 59 70 74 82
2 Critical path = EHKL = 82 days

3 Activity A B C D F G I J
Total float 28 42 36 28 42 28 42 28
4 Day 25. The EST for Activity D is 20 days so, if goods arrive on day 25, the activity will be
delayed. However, this will not delay the completion of the project because Activity D has 28 days
of float. Therefore, receiving goods on day 25 is much earlier than necessary as the latest start time
for Activity D is 48 days. Goods could be organised to arrive then.
Day 15. The EST for Activity D is 20 days, so there is no benefit in ordering goods to arrive so
early as they cannot be used until day 20. This would mean that the business is paying for goods
long before it needs to.
be different.
Coursebook answers
Unit 4
Asia Resort Hotels (ARH)
1 Benefit. By identifying operational areas where ARH’s performance is below that of industry leaders,
action can be directed to making improvements. For example, through benchmarking ARH has
discovered that its food waste levels and energy consumption per guest are some of the highest in the
region. ARH can now devise changes to reduce food waste and energy consumption. This will reduce
costs and make more efficient use of inputs, resulting in increased profits.
Limitation. Although Chas has identified weaknesses of ARH, action depends on managers
implementing, and workers accepting, change. There is a natural tendency for managers to explain why
the circumstances of their department make it difficult to replicate the performance of the industry’s
best. For example, the HR director dismisses using quality improvement groups by arguing that ARH
employees do not like change and are not used to being asked their opinions.
2 a i 18 weeks
ii 9 weeks
b Benefits:
• Planning makes it more likely that the 18-week deadline will be met.
• CPA identifies critical activities ABCFGH. Managers can focus on these activities to prevent
delays to completion of the swimming pool renovation. Managers can ensure allocation of
sufficient resources at the right time as the earliest start times are identified.
• Activities can be monitored and corrective action taken if necessary.
• Knowledge of total and free floats can be used by managers to manage resources.
For example, if critical activities are delayed, it might be possible to move resources from
activity E to help get the project back on schedule.
Limitations:
• Durations are only estimates.
• A lot of the activities lie along the critical path. There are only two non-critical activities
with float.
• ARH’s operations director has constructed the network diagram, which may or may not
be accurate.
• The contract has gone to a small firm that may not have sufficient resources to meet all the
deadlines as laid down by ARH.
Evaluation: critical path analysis can be a useful planning technique to help ARH meet the
18-week deadline for the project. However, as the construction company was not responsible for
developing the network, it is unlikely to be accurate.

1 Relevant comments might include:
• Diversification spreads risk so that if there is a downturn in one part of the business, other parts
may still be generating revenue and profits.
• Takeover of the small chain of fast-food restaurants was risky because of the food poisoning
incident. There was a danger that there could be long-term damage to sales. However, ARH
could benefit by incorporating the fast-food brand into its hotels. ARH acquired the assets of the
restaurant chain at a low price so could sell those assets to recover its investment if the chain was
not profitable.
• The joint venture with the IT business was an important opportunity to take advantage of the
benefits of online booking. ARH currently faces low capacity utilisation, which is a critical
problem as it has high fixed costs. An online presence is essential to attracting customers. However,
the joint venture started in 2015 and ARH still has low capacity utilisation. This suggests that the
venture may not have been as successful as hoped.
• The business offering ride-hailing taxi services makes use of an employee suggestion. This shows
that ARH values the opinion of employees, which could improve motivation.
• Takeover of a failing chain of shoe shops was a significant risk despite the experience of the
ARH director. In many countries, sales are increasingly moving online and retailers with physical
premises have high fixed costs to pay.
• Takeover of three amusement parks in 2021 required investment to modernise two of them.
This investment could complement ARH’s hotel operations as accommodation could be offered
as part of a package to customers. There is evidence that one of the parks has been
successfully modernised.
• Non-hotel services account for 30% of revenue. However, ARH is having to take on extra debt to
develop this business division.
Evaluation could assess the following issues: Has the diversification strategy been well planned? Is
it based on evaluation of each opportunity? Should ARH have focused on markets with significant
growth potential or markets that would complement what it currently does? What indicators are there
that the strategy has been successful? Is the cash flow position an indicator of neglect of core business?
Make a clear and supported overall judgement.
be different.
Coursebook answers
Chapter 29
Business in context
Need for finance
• For investment to set up the business and to expand; for purchasing capital equipment, e.g. sewing
machine, building a factory.
• For day-to-day trading activities, e.g. paying for stock, materials, overheads and labour.
• When facing cash flow problems.
Commercial bank might be unwilling to lend because of:
• Security. It may have required security for lending to Aala and she may not have had assets such as a
house to provide security.
• The high risk of Interloop’s ‘ambitious’ expansion plans and aims to enter a new market.
Activities
Activity 29.1
Activity 29.2
1 Working capital = current assets – current liabilities
Inventories of phones = 0.1 × 200 000 = $20 000
Extended credit terms = $30 000
Cash reserves $5 000
Trade payables $15 000
Total increase in working capital = $55 000 – 15 000 = $40 000
2 MPR could keep smaller inventory levels, i.e. hold fewer mobile (cell) phones in each shop. However,
this could impact customer service and the ability to meet customer demand. JIT inventory ordering
risks loss of customers as customers will expect to be able to purchase a mobile phone immediately.
MPR could offer fewer customers extended credit terms. However, this also risks a loss of revenue as
customers will be attracted by longer credit terms.
MPR could only use suppliers that are willing to offer credit. However, this could limit the range
of mobile phones that MPR could offer as not all suppliers will be willing to give credit or they will
charge for credit.
Activity 29.3
1 a A venture capitalist is an organisation that specialises in lending money to, or purchasing shares
in, businesses that find it difficult to raise money from other sources. They specialise in high-risk
investments that have the potential for good profit.
b The day-to-day finance needs of a business, e.g. paying wages and buying inventory such as
ice cream.
2 a (80 000 – 20 000) ÷ 2 = $30 000
b 0.1 × 60 000 = $6 000
0.12 × 60 000 = $7 200
3 This will provide limited liability to Omah and Sara, and therefore reduce the risk of losing personal
assets if the business fails. If Sara and Omah form a partnership, there is no legal distinction between
the business and the owners, and this lack of legal personality means that it is the owners who are sued
if something goes wrong.
It would also give the option of inviting other investors to purchase shares in the business to raise the
start-up capital required. Omah and Sara could maintain control of the business as long as they retain
over 50% of the shares. However, there is a cost to forming a limited company and annual accounts
must be submitted.
• Venture capital may be more expensive because it is typically taken because banks are unwilling to
lend money.
• Sara and Omah will retain control of the business if they secure a bank loan.
• The venture capitalist wants a 40% stake in the business, leaving 30% each to Sara and Omah.
This would mean that neither Sara nor Omah control the business by themselves, so the venture
capitalist may also exert some control over the direction of the business.
• Sara wants to be her own boss. If a venture capitalist supports the start-up, there is more likely to
be interference in the direction of the business.
• If an equity stake is given, the venture capitalist will take a dividend from the business indefinitely.
A bank loan has a fixed repayment date and interest payments stop once the loan is repaid.
• Evaluation could include a justification for one source of finance rather than the other with the
overriding factor being whether the two owners want to retain 100% control or not.
Activity 29.4
1 High risk; lack of experience; possibly a poor business plan or none at all.
2 It only requires a small sum; the scheme encourages entrepreneurship. However, interest rates may be
high; Nelson may take risks in a venture that is not a good idea.
3 It requires a larger amount of investment for a business start-up; crowd funding would allow lots of
investors to risk a small contribution, so they are more willing to invest. Serena’s idea is high risk but
could be high reward.
Activity 29.5
1 Source of finance Long-term Short-term Available to Available Available
finance finance unincorporated to private to public
businesses limited limited
companies companies
Sale of shares to the ✓ ✓
public
Sale of debentures ✓ ✓ ✓
Leasing ✓ ✓ ✓ ✓
Debt factoring ✓ ✓ ✓ ✓
Loans from family ✓ ✓ ✓
Take on partners ✓ ✓ ✓
Rights issue of shares ✓ ✓ ✓
Ten-year bank loan ✓ ✓ ✓ ✓
Bank overdraft ✓ ✓ ✓ ✓
Activity 29.6
1 Long-term finance is required because of ATC’s high level of debt and the interest payments arising
from that debt. There is weak demand for cars and this will affect its ability to pay the interest. ATC
is looking to restructure its finances. Share capital is preferable as it is permanent finance and, during
difficult trading conditions, ATC can decide not to pay dividends and therefore reduce cash outflows.
2 ATC is attempting to raise a very large sum of capital. Therefore, it will require a significant
proportion of shareholders to support the rights issue if it is to be successful. However, many
shareholders will be reluctant to support the share issue as they will question whether the board of
directors is managing the business effectively. The need for finance is a result of a decision to take
over car factories from a failing US car company. This decision now looks to have been a mistake as
it appears that ATC has too much debt finance. There is a danger that the money from the share issue
will not be spent effectively and that the share price will fall further. Therefore, shareholders may lose
money from further investment.
Evaluation could include a consideration of the following: there is no doubt the business needs
additional long-term finance and there is a danger that the business will face liquidity problems, which
could threaten its survival. Much will depend on shareholder assessment of whether the share offer
price of $34 provides a realistic chance of a capital gain.
Activity 29.7
Business ownership Reasons why source of finance selected is appropriate

and amount needed
Social enterprise Crowd funding comes from a wide range of individuals. The owner retains control
business trading as of the business. As it is a social enterprise, it is potentially attractive to individuals
sole trader: to invest in.
$50 000
Small private limited Developing IT software may be a high-risk investment and so less attractive to
company: $1m the commercial banking sector. Substantial investment is required and a small
business may lack assets to offer as security for a loan. Venture capital investment
may overcome these issues.
Large private limited Leasing requires a set monthly payment and spreads cost over time. The leasing
company: $6m company may also take responsibility for maintenance of the vehicles. Cost can
be competitive due to the buying power of the leasing company.
Public limited A substantial sum of finance is required, so share capital offers a low-cost source.
company: $300m Permanent capital is provided and does not have to be paid back. As a takeover
increases market power, shareholders may be attracted by the potential returns
on offer.
1 Learners’ answers will vary, e.g. expansion of business that requires more property, machinery etc.;
takeover of another business; extra inventory for a major festival or promotion.
2 Learners’ answers will vary, e.g. internal sources come from the resources of the business, including
sale of assets; retained profit.
3 Period of time in which it is to be repaid, e.g. a short-term overdraft may be paid back within one year,
a long-term loan over ten years.
4 Learners’ answers will vary, e.g. if it is high risk, especially if the entrepreneur has limited business
experience; if there are no assets as collateral, which the bank could sell to repay the loan if the business fails.
5 Learners’ answers will vary, e.g. it gives a potentially large number of investors; it may create interest
in the business.
6 a It is not guaranteed to raise the full amount required.
b There is a risk that they may lose money by investing in a start-up, which has no trading record
and might have been turned down by banks.
7 By delaying payments to suppliers (trade payables), it keeps cash in the business.
8 It injects immediate cash into the business in exchange for the loss of a percentage of the value of the
debts owed to the business.
9 Long-term loans raise the indebtedness of the business and interest charges to be paid for up to
ten years (or more), whereas the business only needs short-term working capital finance to pay for a
short-term increase in inventories.
10 Learners’ answers will vary, e.g. there is a lack of potential investors as income levels are low, on
average; owners are unlikely to have personal savings in a country where average incomes are low.
11 This increase in loans to overall capital (called an increase in gearing) is risky because the business will
still have to pay interest charges and loan repayments even if profits fall and if a loss is made.
12 Learners’ answers will vary, e.g. the gearing ratio will be an important factor as it influences the degree
of risk the manager could take, especially if future interest rates rise; equity (or share) capital will not
increase interest charges for the business but dividends will be expected by shareholders and business
control may change.
13 Learners’ answers will vary, e.g. purpose of loan; predicted future net cash flows; current liquidity;
current cash flow (likely to want to see previous years’ published financial records).
14 Learners’ answers will vary, e.g. availability of a wide range of small investors who may be willing to
take a risk on an invention that is not yet established; it reduces the need for loans, which have to be
repaid with interest, which a new start-up business might not be able to pay.
15 Learners’ answers will vary, e.g. the risk of loss of control if a high proportion of shares are sold; the
risk of hostile takeover; increased public scrutiny.
16 The industry is fast moving so machinery may soon become obsolete or out of date. By leasing,
the company can keep updating to newer models and have increased flexibility if the components
demanded change.
17 Learners’ answers will vary, e.g. a rights issue rewards shareholders with the exclusive opportunity
to buy more shares; it avoids interest repayments; the company can declare takeover intentions to
shareholders and not a bank.
18 Inventory is held in a supermarket for a limited period of time, e.g. perishable goods are purchased and
sold within days. Building a ship takes time and therefore there is significant work-in-progress at any
one time.
• Obtain a commercial mortgage. This is long-term finance so payments are lower per month.
Payments can be fixed so that there is less risk.
OR
• Form a limited company and invite investors to purchase shares. This permanent source of finance
lowers indebtedness but reduces the control of the original business owner.
20 Revenue expenditure is on regular day-to-day business expenses. Capital expenditure is on assets such
as property that the business will keep for more than one year.
Essay questions
1 a Learners’ answers will vary but should include two of:
• Owner’s capital. This is often from the entrepreneur’s savings, or from friends or family, which
can be a problem if the business fails.
• Debt finance. Loans from banks for which interest has to be paid. The entrepreneur may need
to provide an asset as security for borrowing.
• Bank overdrafts. This is a short-term form of finance with a relatively high rate of interest.
It is flexible as the amount of finance used can vary from day to day.
• Trade credit. To purchase inventory of raw materials. However, suppliers may be reluctant to
offer this until the business has been trading for some time.
• Equity capital. An entrepreneur might choose to form a limited company to increase the
finance available by inviting other individuals to invest in the business.
b Cost. Debt finance includes interest that must be paid whatever the trading conditions. Overdrafts
have high rates of interest; however, the cost can be low if finance is required temporarily.
Ownership and control of the business. Equity finance is available if the sole trader forms a limited
company. However, this reduces the control of the original owner of the business.
Risk. Incorporation provides owners with limited liability so reduces the risk of losing personal
possessions.
Size of existing borrowing. If the business has substantial debt already, taking out more loans may
result in liquidity problems as cash inflows take time to increase following expansion.
Evaluation could include whether the entrepreneur has savings (e.g. from redundancy payment
from their last employer); willingness of the entrepreneur to give up some control of the business
for venture capital or selling shares in a limited company.
2 a To finance expansion. Finance might be needed to purchase capital assets to expand the output of
the business and pay for the marketing and human resources required.
To support the business through a recession. In a recession, demand for products falls and this can
cause cash flow problems. Additional finance is therefore required to aid survival.
• Gearing. The structure of the business’s finances, i.e. the proportion of finance that is provided
by debt relative to equity. Analysing why high gearing is potentially risky.
• Current and future interest rates. These will determine the cost of further debt finance.
• Shareholder objectives. How much risk are shareholders willing to take? Successful expansion
financed by loans can result in high rewards for shareholders but there is increased risk too.
• Existing ownership and dilution of ownership.
• Level of retained profit to finance expansion. Profit is an internal source of finance and is
cheap, although there is an opportunity cost involved.
• Liquidity of the business. The working capital of the business will determine whether part of
the expansion cost can be met from existing cash in the business.
• Cost of leasing. Leasing can be an effective way of gaining use of capital equipment without
the cost of outright purchase.
Evaluation might include the cost of expansion plans compared to available internal finance;
willingness of existing directors or owners to risk potential loss of control from a public listing of
the company.

1 Sharma Taxis (ST)
a i Cash is not needed to purchase the asset.
ii The day-to-day finance needs of a business such as paying wages and buying inventory.
b i 0.8 × 10m = $800 000
ii Trade receivables result from offering regular business clients credit terms of up to two
months. This enables those clients to delay payment for the services of ST. This increases the
working capital required by ST. More effective management of trade receivables by offering
reduced credit terms or making sure that debtors pay on time will speed up cash inflows for
ST and reduce the working capital required.
c Disadvantage: it will dilute ownership of the business and will reduce the control of the
original owners.
Advantage: it avoids debt finance along with the associated risk of operational profits being
insufficient to cover interest payments.
d For:
• Interest is an expense to the business and therefore reduces taxable profits.
• It avoids further dilution of ownership of the business.
• It is usually quickly available but a sale of shares can take some time to arrange.
Against:
• Interest payments have to be paid whereas dividends do not.
• A loan will have to be repaid.
• Interest rates can change, leading to a potentially costly increase in interest payments.
Evaluation could include an assessment of the importance of the existing gearing ratio of the
business; the existing sources of internal finance might be considered first; Joe might want to
avoid diluting the ownership of the business as a priority.
2 StarJet (SJ)
a i High public demand for shares.
ii Long-term bonds issued by companies. They are a form of debt finance usually with a fixed
rate of interest.
b i $3.42 × 1.15 = $3.93
ii If the investment in purchasing new aircraft is successful in raising revenue and profit of SJ. This
will depend on continued growth in the low-cost airline market. The market may have confidence
in the leadership and decision-making of Stavros because of his success in building SJ.
c The public now own 25% of shares. Stavros and his siblings own 75% of shares. To issue a
further 63 million shares would raise public ownership of shares to 50% and dilute ownership
by the family.
As all shareholders have voting rights, with 50% of shares they can exert more control over the
direction of SJ. There is also an increased risk of hostile takeover.
d Discussion should be based on the advantages and disadvantages of debt versus equity. Internal
finance from retained earnings might be sufficient if the purchase of new aircraft leads to
substantial increase in passenger revenue.
Arguments may include dilution of ownership, gearing ratio, shareholder value and interest
payments. Learners should cover all the arguments above but apply them to this case.
Evaluation might include a justified conclusion based on an assessment of SJ’s share price at the
time; the level of interest rates at the time; the level of retained earnings from the purchase of
new aircraft.
be different.
Coursebook answers
Chapter 30
Business in context
• They have limited access to finance, e.g. they lack assets to use as security for loans.
• Many are new and lacked finance when formed, e.g. because it is more difficult to get trade credit, they
have to pay cash for supplies. Building a customer base takes time.
• Banks may think small businesses are higher risk.
• They depend on owners for capital.
Activities
Activity 30.1
1 All figures in $000 April Revised April
CASH INFLOWS
Owner’s capital injection 0 0
Cash sales 6 7
Payments by trade receivables 3 3
Total cash in 9 10
CASH OUTFLOWS
Lease 0 0
Rent 1 1
Payments to trade payables 2 2.5
Labour 3 3
Other costs 1.5 2.5
Total cash out 7.5 9
NET CASH FLOW 1.5 1
Opening balance (0.5) (0.5)
Closing balance 1 0.5
Activity 30.2
1 x = (1.5), y = 10.5 and z = 1.5
2 It helps to identify areas of potential cash flow problems so that the business can plan for them
and take action to help survive. Cash flow forecasts can be used to support applications for finance
from lenders.
3
All figures in $000 July Revised July
CASH INFLOWS
Owner’s capital injection 0 0
Cash sales 9 7.2
Payments by debtors 3 3
Total cash in 12 10.2
CASH OUTFLOWS
Lease 0 0
Rent 2 2
Payments to trade payables
(clothes purchases) 4 3.2
Labour 3 3
Other costs 1.5 1.5
Total cash out 10.5 9.7
NET CASH FLOW 1.5 0.5
Opening balance 0 (2)
Closing balance 1.5 (1.5)
4 Cash flow forecasting is a form of financial planning and is an integral part of creating a business plan.
Although a cash flow forecast is only ever an estimate of future cash inflows and outflows, if it is based
on sound market research, it may contribute significantly to the success of this fashion retailer in the
following ways:
• Many new businesses fail due to a lack of working capital. A cash flow forecast will help Sayuri
and Korede identify periods of negative cash flow so that additional finance can be sought.
• The cash flow forecast will help Sayuri and Korede secure financial backing from banks. The
forecast will indicate that Sayuri and Korede have carefully planned their business venture (of
course, the bank will be interested in the underlying assumptions made in drawing up the forecast).
• If a cash flow forecast identifies a significant shortfall of cash, Sayuri and Korede can investigate
whether it is possible to reduce cash outflows, by:
• reviewing expenditure on fixtures and fittings for the new shop
• identifying an alternative shop with lower rent
• reducing their own salaries
• employing hourly paid staff rather than salaried staff.
Evaluation could include: even though a cash flow forecast may prove to be inaccurate, due to the
difficulty of estimating demand and possible changes in the external environment affecting sales and
costs, it will help Sayuri and Korede prepare for the future. A cash flow forecast will not eliminate risk
but will enhance the chances of Sayuri and Korede being successful.
Activity 30.3
1 a Increase in oil prices would lead to a fuel price increase for taxis and increase cash outflows.
b Increased unemployment would lead to reduced demand for taxi services. This will reduce cash
inflows and some cash outflows, e.g. fuel purchases.
c Lower train fares would lead to increased demand for taxis. Train passengers use taxis to complete
journeys. This will increase cash inflows and outflows.
Activity 30.4
1 Pressures placed on Rishi’s cash inflows and outflows include the following:
• The global recession has caused a drop in demand. Falling demand means a lack of cash inflows.
• Customers demand credit terms for purchases, thus delaying cash inflows.
• Customers expect discounts, thus reducing cash inflows relative to cash outflows.
• The business paid cash for raw materials but the recession has delayed the sale of equipment to
customers, therefore delaying cash inflows.
2 Reduce stock, which is difficult to achieve in the short term due to reduced sales. In the longer term,
the firm should consider just-in-time (JIT) stock control. It should negotiate better credit terms with
suppliers – placing pressure on suppliers to extend credit terms will give more time to receive customer
income. It should control costs, reducing administrative and production costs by reducing work hours
and employee pay. It would be possible to replace labour with machinery.
Evaluation should include justified advice to Rishi on which method is most appropriate in this case.
1 Learners’ answers will vary, e.g. showing periods of negative cash flow, plans can be put in place to
provide additional finance; it helps raise finance from banks or investors, especially for new business
start-ups with no trading record.
2 Learners’ answers will vary, e.g. market research, so cash from sales is lower than expected; unexpected
events leading to price changes, which impact on demand and cash from sales.
3 Cash inflows minus cash outflows for the month.
4 The amount of cash left at the end of a month = opening balance + net monthly cash flow.
5 The sale of assets provides an immediate cash injection of money, although the leasing cost is usually
monthly and causes a regular cash outflow in the following months.
6 They are forecasts with many variables that may turn out to be different from forecast so, although
they provide a useful guide (e.g. for planning finance needs), they cannot be fully relied upon.
7 Learners’ answers will vary, e.g. reduce the credit period offered to customers on sales; monitor debtors
carefully and contact them when payment is due to encourage prompt payment.
8 Learners’ answers will vary, e.g. helps identify and plan for periods of negative closing balance; if a
cash flow problem is identified, managers can take corrective action to reduce cash outflows or increase
cash inflows.
9 Learners’ answers will vary, e.g. to identify the entrepreneur’s ability to pay back the loan from future
trading activities; to assess the risk of lending the finance required; it shows that the entrepreneur has
thought through the issues.
10 Learners’ answers will vary, e.g. lack of experience in drawing up cash flow forecasts; no past data on
which to base forecasts; limited finance to undertake detailed market research.
11 Learners’ answers will vary as many factors will influence the accuracy of cash flow forecasts during
periods of change, e.g. external changes (e.g. new competition); changing prices by suppliers; consumer
incomes changing (e.g. during a recession, affecting demand).
12 If the business tries to reduce the time given to customers (e.g. supermarkets) to pay, it may lose
custom to competitors who offer better credit terms.
Essay questions
1 a Learners’ answers will vary, e.g. a business is profitable if its revenues exceed its costs. However,
profit is not the same as cash flow. Cash inflows from sales will be delayed where goods are sold on
credit and cash outflows may result from capital expenditures which are not recorded in the profit
or loss account. Analyse a business example of why cash flow is not necessarily the same as profit.
Businesses may run out of cash for a number of reasons, including:
• Overtrading.
• Holding too much inventory.
• Giving too much credit.
• Seasonal fluctuations.
b This question centres on the possibility of overtrading – expanding too rapidly. A business needs
to manage its working capital carefully as it expands, to avoid cash flow problems. If there is
insufficient finance in place to fund expansion, insolvency is possible.
Cash flow forecasting, as part of the planning process, will help a business identify, in advance,
likely cash flow problems. The business can then take action to find the necessary finance to
fund growth.
Evaluation: although cash flow forecasting is important, it is only as good as the accuracy of the
assumptions on which it is based. Further, when a business is experiencing rapid expansion, it will
be more difficult to predict cash flows accurately.
2 a Define cash flow forecast. Businesses cannot continue to trade if they are unable to pay their
workers and suppliers due to lack of cash. This is particularly a problem for new businesses as, in
the first months of trading, there is often a significant pressure on cash flow. A new business will
typically face set-up costs and running
costs which drain cash from the business and it may be some time before sales start to generate
cash inflows.
Consequently, it is very important for a new business to prepare a cash flow forecast. Learners’
answers will vary, but should include an analysis of two of the following:
• It will help to predict when there may be a shortage of cash.
• A forecast can be used as a means of control.
• A new business will need to attract investors and bankers.
b A difficulty faced by building firms is that there is a significant time delay between cash outflows
for purchasing land, materials and paying labourers, and receiving cash inflows from the sale
of property.
Learners’ answers will vary, but should contain an evaluation and analysis of at least two of
the following:
• Improving inventory control. As inventories are a significant factor for building firms, this would
appear to be an area to consider carefully. The building company should delay purchase of
and payment for supplies until the last possible moment. The downside to this approach is that
opportunities for bulk-buying discounts may be lost. If that is the case, it may affect their ability
to set competitive prices when tendering for contracts. Further, any delay in the arrival of vital
stock could result in workers being left with nothing to do but still requiring payment.
• Reducing credit periods. Payment from trade receivables (debtors) is another significant issue
to a builder, so when entering into contracts for work the builder might ensure that payments
are staggered. Thus, some of the money may be paid upfront, with the remainder at specified
points during and following the building work.
• Avoid overtrading. In considering new contracts for work, the firm should take care to avoid
overextending itself.
• Factoring. This involves selling debt to a specialist debt collection agency. The building
company receives part of the value of the debt immediately from the debt factor, who then
collects the full amount from the debtor.
• Leaseback. Fixed assets could be sold and leased back, such as machinery and the premises
from which it operates. Although this generates immediate cash inflow, it is at the price of
long-term rental expense, so profit will ultimately be reduced.
• Overdraft. Overdrafts have high interest rates and should therefore be used for short periods
wherever possible. As interest is an expense to the business, it reduces profitability.

1 Asif Iqbal
a i Reduction in net cash inflow.
ii The amount of cash left at the end of a given time period. Closing balance = opening balance
+ net cash flow.
b i Cash sales will be $100 lower. Overheads will now be $5 500. So, closing balance = ($1 600).
ii Asif is setting up a new building business, so he is offering credit to encourage customers to
use his services.
c Learners’ answers will vary but might include:
• Offer less credit on sales. Cash sales in March are particularly low, although debtor payments
in April indicate that substantial sales are anticipated in March.
• Negotiate phased payments on the capital expenditure of $10 000. This would move the cash
outflow in March into subsequent months.
d Constructing a cash flow forecast as part of a business plan will benefit Asif in the following ways:
• Help secure finance. Asif’s forecast indicates that his business will be short of finance in its
first six months of trading. However, it provides clear evidence that the cash position of
the business is improving by the end of the period, with July and August showing net cash
inflows of $2 000 and $4 000 respectively. Thus, if the bank is convinced by the assumptions
underlying the forecast, it may look favourably on Asif’s application for finance.
• Avoid cash flow problems. By identifying times during which his business has scarce cash
resources, Asif would be able to plan how to deal with that problem. For example, he will
ensure that he is able to meet the $23 000 shortage of cash in June.
Evaluation could include: many businesses fail due to being unable to meet their short-term
debts. By preparing a cash flow forecast and taking action in the light of any cash flow problems
identified, Asif is more likely to avoid insolvency. This may be particularly important in the
building trade as money is often tied up in inventory and work-in-progress. Therefore, there may
be a significant time gap between cash outflows for supplies and labour, and cash inflows for
completed work.
2 Gita Fashions
a i It helps financial planning.
ii The cash balance at the start of a set period of time, e.g. a month.
b i All figures in $000 July
CASH INFLOWS
Cash sales 6
Payments by debtors 8
Total cash in 14
CASH OUTFLOWS
Materials 8
Labour 3
Overheads 6
Total cash out 17
NET CASH FLOW (3)
Opening balance (15)
Closing balance (18)
ii Cash flow forecasts do not prevent negative cash flow from occurring. However, as in Gita’s
case when she was surprised by the call from the bank manager, they help in the planning of
cash inflows and cash outflows. Decisions can be taken to avoid going over the overdraft limit,
which is $15 000 in Gita’s case.
c Risk of business failing: Gita’s business has a major negative cash flow problem. The forecast
shows a deterioration in its cash position of $3 000 from the start to the end of July and this is
likely to worsen by the end of September. The bank would be exposing itself to greater potential
losses by extending the overdraft.
Relationship with suppliers: if the bank doesn’t extend the overdraft, it is possible that the supplier
which is owed money will seek to have Gita Fashions declared bankrupt so that the supplier is able
to recover some of its debt. If that happens, the bank may not recover all of the money it is owed.
Extending the overdraft would provide Gita a breathing space to sort out the cash flow problems
and put her business on a secure financial footing. This would enable the bank to recover all of its
debts in the longer term.
• Use cheaper material suppliers so that cash outflows are reduced. However, this might impact
the quality of the clothing produced and therefore the price that can be charged.
• No sales on credit. This would bring forward cash inflows but there is a risk that customers
would go elsewhere.
• Raise finance by selling shares in the company. However, would Gita be able to find investors
willing to put their money into the business, as the cash flow forecast shows significant
problems facing the business?
Evaluation: each method should be assessed in terms of its suitability for Gita. A final supported
conclusion or judgement is needed.
be different.
Coursebook answers
Chapter 31
Business in context
Importance of knowing costs
• For setting prices.
• To calculate if profit is made.
• To monitor performance and means of control.
• To help with decision-making, e.g. which resources to use.
Importance of breaking even
• To set a target.
• To determine if a service or product is viable.
• To identify the point at which profit is made.
Activities
Activity 31.1
1 Costs Direct Indirect Fixed Variable
Rent of factory ✓ ✓
Management salaries ✓ ✓
Electricity ✓ ✓
Piece-rate labour wages of production workers ✓ ✓
Depreciation of equipment ✓ ✓
Lease of company cars ✓ ✓
Wood and other materials used in production ✓ ✓
Maintenance cost of special machine used to ✓ ✓
make one type of wooden chair

• Fixed costs do not vary directly with the level of output in the short term. For example, rent will
not change as output changes – even if the output of chairs and tables is zero, rent still has to be
paid in the short term.
• Variable costs vary directly with the level of output. For example, as labour is paid on a piece-rate
system then, as more is produced, the cost will increase.
• Direct costs such as labour, wood and the maintenance cost of the special machine relate directly
to the production of specific chairs and tables.
• Indirect costs are the overheads involved in running a business and are not directly related to
production. For example, management salaries and the lease of company cars cannot be identified
with a unit of production.
• A cost such as electricity can be viewed in a number of different ways. As electricity is used to
run machinery, as production increases the cost will also increase. However, the cost of lighting is
largely independent of output and therefore fixed.
Activity 31.2
1 & 2 a Purchase of a digger: it will be used on many building jobs.
b Cleaning costs: these are not directly linked to the provision of banking services to customers.
c Tools: the cost is not related to any particular repair job.
d Cost of employees’ canteen: it is not possible to identify with one unit of production.
3 a wood b postage c fuel d cost of bank-clerk time e oil.
• Identification of direct costs may help set prices.
• Price can be set to at least cover the direct costs and contribute to indirect costs.
• Cost data can be used to help set budgets and these will act as targets for the business.
• Calculating the direct costs of different options will help make decisions about what to produce.
• Direct costs need to be identified if they are to be charged to a cost centre.
Activity 31.3
1 a Average direct cost = (direct labour cost + direct material cost) ÷ output
Pump = 300 000 ÷ 50 000 = $6
Fan = 200 000 ÷ 40 000 = $5
b Total direct costs = $500 000, of which pump = $300 000 and fan = $200 000
Pump: allocated overhead cost = 3/5 × 200 000 = $120 000
Fan: allocated overhead cost = 2/5 × 200 000 = $80 000
c Full cost for pump = 420 000 ÷ 50 000 = $8.40
Full cost for the fan = 280 000 ÷ 40 000 = $7.00
2 It will be used to set price and ensure that costs are covered.
Break-even can be calculated and therefore sales targets can be set.
3 Full costing allocates indirect and direct costs to the products of a business. It enables the cost of
producing a product to be calculated so that a price can be set. This can ensure that all costs are
covered and a profit is made. The business can then set targets for different products. This can be used
to motivate employees. Targets can be used to compare with actual performance and help identify
which products are performing well.
However, in evaluation, how indirect costs are apportioned can be arbitrary. Inappropriate methods
of overhead allocation can lead to inconsistencies between departments and products. Setting a price
based on full costs can result in missing opportunities for sales, e.g. contribution pricing may be more
effective for considering one-off orders.
Activity 31.4
1 Contribution per guest = price − variable cost = 50 − 15 = $35
2 100 × 35 = $3 500
3 Profit = total contribution − indirect costs
3 500 − 1 000 = $2 500
4 If the hotel refuses the offer, assuming that just 30 guests stay at a price of $50,
profit = 1 500 − (1 000 + 450) = $50.
Accepting the offer makes a contribution of $5 per guest and a total contribution of $250. Therefore,
profit = 250 + 50 = $300.
Evaluation could include clear advice such as: the hotel should accept the offer. However, this depends
on whether the hotel could sell more rooms at above $20 per night during the same week because, if it
can, it would earn a higher contribution from selling more room nights at a price above $20.
Activity 31.5
Activity 31.6
1 Unit contribution = price less unit variable cost
Y = 30 − 19 = $11
Z = 21 − 19 = $2
2 Total contribution = unit contribution × sales
Y = 11 × 1 000 = $11 000
Z = 2 × 400 = $800
3 Y: total contribution = $11 000. Allocated overheads = 50% of $10 000 = $5 000
Total profit on Y = 11 000 – 5 000 = $6 000
Z: total contribution = $800. Allocated overheads = 20% of $10 000 = $2 000
Total profit on Z = 800 – 2 000 = − $1 200
4 Total profit if Z is produced is 2 500 + 6 000 – 1 200 = $7 300
If Z is dropped, the total profit, assuming no change in sales of X and Y, is:
Total contribution of X and Y less total overheads = 5 500 + 11 000 – 10 000 = $6 500
Stopping production of Z causes a drop in profit of $800 as the contribution made by Product Z is lost
but in the short term there will be no change in overheads.
Activity 31.7
1 Unit contribution = selling price – direct costs = 70 − (25 + 30) = $15
Total contribution = unit contribution × sales = 15 × 1 000 = $15 000
Thus, the local authority order will make a total contribution of $15 000. This will add to the $15 000
of profit, assuming that there is no increase in overheads or knock-on effect on other sales.
2 Relevant points to include in a report include:
For accepting the order:
• There is a positive contribution of $15 000. This will increase profits by $15 000, other things
being equal.
• There is spare capacity on the production line.
• Accepting the order will increase capacity utilisation. This will help control average costs
of production.
• There will be more effective use of fixed assets.
• There may be subsequent orders from the local authority.
• Accepting the order will increase market share.

Against accepting the order:
• It may be possible to gain other, more profitable, orders. Once the local authority order is
accepted, the business may have to reject other orders from new and existing customers.
• If other customers find out that the local authority has secured a low price, they will try to
negotiate lower prices as well.
• Is there sufficient capacity to fulfil the order? If not, it may cause disruption to other customers.
This will depend on the time period given to fulfil the order.
• Does the order increase overheads?
Evaluation: it is important to recognise that an order that makes a positive contribution is worth
considering. However, it does not follow that the order should be accepted. That will depend on the
other factors outlined above. A suitable judgement might observe that, assuming there is no impact on
overheads, sufficient spare capacity exists and no other orders are anticipated, the firm should accept
the order.
Activity 31.8
1 Repairs Petrol Parts Total
Sales revenue ($) 27 000 300 000 68 000 395 000
Direct costs ($) 24 000 215 000 50 000 289 000
Contribution ($) 3 000 85 000 18 000 106 000
Overheads ($) 60 000
Profit ($) 46 000

• The repairs division makes a ‘loss’ of $15 000 using full costing. This provides a reason for closing
the repairs division.
• However, full costing involves an arbitrary methodology for apportioning the overheads between
the different profit centres. In this case, the overhead has been apportioned in relation to direct
labour costs. The figures would change substantially if overheads were apportioned according
to direct materials or sales revenue. For example, if apportioned relative to direct materials, the
overhead would only be $2 259 (9 000 ÷ 239 000 × 60 000).
• If a contribution costing approach is adopted, this highlights that the repairs division makes a
positive contribution of $3 000. In other words, the revenue generated covers the direct costs of
the division and contributes to fixed costs. The managing director is wrong to assume that profit
would be higher if the repairs division was closed.
• Other things being equal, if the repairs division was closed, profit would be $43 000.
• It is quite likely that customers having a car repaired may purchase petrol, and parts sales may be
directly linked to repairs. In other words, the other two divisions make sales because of repairs and
revenue could fall by more than $27 000 if the repairs division was closed.
• The repairs division may enhance the reputation of the garage, leading to an increase in sales of
other products.
• Employees would have to be made redundant unless other work could be found for them.
As skilled workers, they may not wish to change jobs.
• Evaluation should include an overall decision together with a consideration of the following points
that would influence that decision: is it possible to use the repairs workspace more profitably?
For example, could the garage increase its number of petrol pumps or could it start selling other
products (e.g. food) as well as petrol?
• If the repairs division closed, what would be the impact on the motivation of employees at the garage?
• Can revenues from the repairs division be increased? Is the price appropriate?
• Can costs within the repairs division be decreased? Are wages at an appropriate level?
Activity 31.9
1 & 2 Break-even chart, showing the break-even point and the break-even level of output of 20 000 units:
Break-even point
1 500 000
Variable costs
Costs and revenue ($)
1 000 000 Fixed costs

Total costs
Break-even output
Sales revenue
500 000
0
0 5 000 10 000 15 000 20 000 25 000 30 000 35 000
Output
3 Profit = revenue less costs = 1 350 000 – 1 250 000 = $100 000
4 25 000 – 20 000 = 5 000 units
Activity 31.10
1 Site Break-even: Safety margin: Maximum profit:
Fixed cost ÷ unit contribution Current output − break-even Total revenue − total cost
output
A 60 000 ÷ (6 − 3) 40 000 – 20 000 240 000 – 180 000
= 20 000 units = 20 000 = $60 000
B 80 000 ÷ (6 − 2.50) 50 000 – 22 858 300 000 − 205 000
= 22 858 units = 27 142 = $95 000

• Site A has a lower break-even output and it will therefore be easier to achieve a level of sales at
which a profit can be made.
• Site B’s break-even level of output is over 10% more than Site A’s.
• Site B has a much greater margin of safety, i.e. sales can be up to 27 142 units below expectation
and they will still break even.
• Site A has a much smaller capacity and therefore, if sales are strong, the firm will have to consider
expanding sooner than at Site B.
• The profit at Site B, assuming all output is sold, is $35 000 greater than at Site A.
• At capacity, the average cost of production at Site A is $4.50 whereas at Site B the average cost is
only $4.10.
• If sales are expected to be above 40 000, Site B will be more profitable. The level of sales at which
profits would be the same can be calculated as follows:
Profit Site A = profit Site B
Let Q = output and sales
6Q – 3Q – 60 000 = 6Q – 2.5Q – 80 000
3Q – 60 000 = 3.5Q – 80 000
0.5Q = 20 000
Q = 40 000
valuation: answers could focus on the issues of risk associated with reaching the break-even level of
E
sales. Much will depend on the expected level of sales in the market. If it is above 40 000, Site B offers a
more profitable outcome. A final justification should be given for the advice offered to the business.
3 The business should consider: capital required to start production at each site; the availability of
suitable labour; impact on existing employees; room for expansion; planning issues.
Activity 31.11
1 a Break-even chart showing Option 1 break-even point:
450 000
400 000 Revenue
350 000
300 000 Total costs

250 000
200 000
150 000 Break-even point
100 000
Fixed costs
50 000
0
0 2 000 4 000 6 000 8 000 10 000 12 000
Output
The break-even level of output = 4 500 units

Break-even chart showing Option 2 break-even point:
The break-even level of output = 3 000 units
b Option 1: $99 000 350 000
Option 2: $90 000
c Option 1: 2 500 300 000 Revenue
Option 2: 4 000
2 The owner should choose Option 2 250 000
because it has a significantly lower Total costs

break-even and higher margin 200 000
of safety. Profit at maximum
capacity is only $9 000 less than 150 000
Option 1. Investment in new
machinery might improve quality 100 000 Break-even point
control. The reduction in wasted
materials makes production more Fixed costs
50 000
sustainable. However, as output
has already reached 5 000 units,
0
Option 2 provides less opportunity 0 1 000 2 000 3 000 4 000 5 000 6 000 7 000 8 000
for growth. Output
3 Break-even chart showing new Option 1 break-even point:

300 000
Revenue
Break-even point
250 000 Total costs
200 000
150 000
100 000 Fixed costs
50 000
0
0 1 000 2 000 3 000 4 000 5 000 6 000 7 000 8 000
Output
The break-even level of output = 97 200 ÷ (40 − 22) = 5 400 units

4 a Direct costs might fall because the new machinery will reduce the amount of labour required for
each unit of output.
b 62 000 ÷ (40 − 19.50) = 3 180 units
1 Learners’ answers will vary, e.g. it enables wastage costs to be monitored; to compare budget costs of
production to actual costs of production and allow variance analysis to be conducted.
2 Learners’ answers will vary, e.g. to help make pricing decisions to ensure that price covers costs or
determine the decrease in price for a promotional offer; to help inform decisions regarding product
portfolio, e.g. whether to continue a product line if its costs are rising or revenue is falling.
3 Direct costs are attributable to a specific product or service (e.g. raw materials). Indirect costs are not
easily attributable to a specific good or service (e.g. rent on premises).
4 Fixed costs stay the same regardless of output (e.g. managers’ salaries). Variable costs change in
relation to output (e.g. raw material costs).
5 Full costing includes identifying direct costs of producing a product and allocating a share of
the indirect costs to calculate a full cost. Contribution costing focuses only on the direct costs
of production.
6 Learners’ answers will vary, e.g. allocation of indirect costs is arbitrary and may lead to inappropriate
decisions about pricing; the full unit cost will only be accurate if actual output is the same as that used
in the calculation.
7 Learners’ answers will vary, e.g. to make a decision about whether to accept a one-off order, which
might offer a price less than the full cost price; to make a decision about whether to continue
producing a product if its revenue does not cover the full cost.
8 Learners’ answers will vary, e.g. to inform decisions regarding resource allocation and the size of
production runs; to take corrective action, e.g. to reduce capacity to lower break-even level.
9 a Break-even point = 7 500; b safety margin = 7 500; c fixed costs = $15 000
10 Learners’ answers will vary:

Set sales targets based on already-agreed profit targets, e.g. a break-even graph might show that if the
profit target is $12 000, a sales target of 15 000 units could be set.
To discontinue a product. If, for example, sales were forecast to be 5 000 units, the graph would identify
a loss and the marketing department may decide, based on further analysis of the product portfolio, to
discontinue the product.
11 Learners’ answers will vary, e.g. it assumes straight lines for variable costs whereas economies of scale
may be achieved as output increases, which could reduce average cost per unit; it assumes price levels
stay the same, e.g. no promotions or discounts offered for bulk buying from customers, but sales
revenue may change if discounts are offered to achieve higher sales volumes.
12 Learners’ answers will vary, e.g. to calculate the break-even number of customers required in the café
each week based on an average spend; to help in setting the price charged for a large group to at least
cover the variable costs.
13 Learners’ answers will vary, e.g. lower fixed costs by moving to cheaper premises; increase price to
increase revenue, assuming demand is not very responsive to price.
14 The amount by which the current output level exceeds the break-even level of output.
15 Learners’ answers will vary, e.g. revenue is forecast based on little or no past data and prices may need
to be changed; variable costs may change if suppliers are changed or decide to change prices.
Essay questions
1 a Pricing decisions require knowledge of costs to know whether the price will enable profit to be
made. Making profit is the overall objective of most private-sector businesses.
Choosing between different options requires cost information for the business to know whether
financing is feasible. Comparing the cost of different options will also increase the chance of
profitable decisions being made.
b Arguments for: the selling price will be influenced by competitors, e.g. it may have to be lower
if a new competitor enters the economic environment, affecting consumers’ sensitivity to prices.
Therefore, the total revenue line can vary significantly from forecast. Variable costs per unit can
change, e.g. if a supplier lowers or raises prices.
Arguments against: it can produce best- and worst-case scenarios. It helps inform decision-making
and changes can be monitored against forecasts.
Evaluation: it depends on the relative severity of changes in market conditions. Break-even
analysis is useful as a guide, as a decision-making tool and as part of business planning.
2 a Define and give examples of direct and indirect costs. Distinguishing between these two types of
costs is very beneficial in business decision-making, e.g. when setting product prices; when deciding
whether to accept a new order at less than full cost; when deciding whether to stop producing or
selling a particular product which is not, at least in the short term, earning enough revenue to
cover full costs.
b Usefulness: break-even graphs are relatively easy to construct and interpret for a new entrepreneur;
analysis provides useful guidelines on break-even points, safety margins and profit-and-loss levels
at different rates of output.
Limitations: not all variable costs change directly or ‘smoothly’ with output; the revenue line could
be influenced by price reductions made necessary to sell all units produced at high output levels.
It may be difficult for a new business to predict this information accurately. It is unlikely that fixed
costs will remain unchanged.
Evaluation: it depends on the knowledge of the entrepreneur, relative accuracy of market research
findings and market conditions.
3 a Learners’ answers will vary:

Full costing. When using full costing, a firm allocates all direct and indirect costs between its
products. Direct costs can be relatively easy to allocate (e.g. material costs and direct labour costs).
Indirect costs are more difficult to allocate as they do not arise from the production of a specific
product. Therefore, indirect costs have to be apportioned on the basis of one or more methods of
allocation, e.g. in proportion to a product’s share of total direct costs.
Contribution costing. Contribution costing focuses on the direct costs of production. Indirect
costs are not included. Contribution costing is often used as a basis for decision-making such as
setting prices by multi-product firms; when considering additional orders for a product; when
deciding whether to stop making a product.
b Usefulness of contribution costing:
• It informs decisions regarding special orders, e.g. whether to supply products to a customer at
a lower-than-normal cost.
• It can help make decisions on the product portfolio, e.g. whether to discontinue a line.
• It eliminates the random apportionment of overheads such as head-office costs.
Limitations of contribution costing:
• It ignores the importance of covering overheads to the business as a whole.
• Some products may result in much higher indirect costs than others.
• It is not appropriate when making decisions about expansion or R&D decisions about
new products.
• It may result in decisions which are not in the long-term interests of the business, e.g. to
continue producing a product because it has a positive contribution when a better decision
might be to introduce a new product.
Evaluation: it depends on the ease with which overheads can be apportioned and the type of
decision that a business is making. Qualitative factors are also important, such as the impact of a
decision on employees.

1 Midtown Imperial Hotel
a i Materials.
ii Apportioning indirect costs to the products, services or divisions of a business.
b i Full cost = variable cost + additional cost of audio-visual equipment + allocated overhead
= 15 × 100 + 200 + 1 000 = $2 700
$2 700 + 50% = 2 700 × 1.5 = $4 050
ii Contribution = revenue − additional cost of providing the conference
= 2 200 – 1 700 = $500
iii It helps the hotel’s managers set prices (e.g. for conferences), so that at least the price covers
the direct costs.
c Learners’ answers will vary, e.g. purchase audio-visual equipment if this costs less than regularly
hiring it at $200 per day; cut the direct costs, e.g. self-service instead of delegates being served food
at meal times, or cheaper food ingredients; ask delegates to pay for all drinks.
• A positive contribution of $500 will be made. Therefore, accepting the booking would increase
profits, other things being equal, by $500. If the booking is refused, overheads will not change.
• The booking is at the end of February, a slack time for the hotel. Therefore, it is less likely that
the hotel will be able to book out its facilities at the normal rate.
• Accepting the booking will help ensure that staff are kept busy.
• It will provide work for waiting staff and may help retain their services for other functions.
• The organisation will go to other hotels if the Imperial refuses the booking.
• The Friends are influential. If the hotel provides a good service, it may lead to further
conference bookings.
• The delegates at the AGM may spend money in other parts of the hotel, e.g. drinks from the bar.
• Is it likely that other groups will find out about the preferential price and therefore be reluctant
to pay the hotel’s normal booking fee in the future?
Evaluation of the advice given should be based on a balanced assessment of both qualitative and
quantitative factors. In this case, perhaps the two major factors are the positive contribution,
which helps pay for indirect costs, and the chance of gaining further conference contracts.
2 Cosmic Cases
a i They would fall.
ii Costs that are not attributable to the production of a specific product or service, e.g. rent of
premises.
b i Profit = revenue − total costs: vanity case = 75 000 − 45 000 = $30 000; small suitcase =
72 000 – 47 500 = $24 500; medium suitcase = 20 000 – 22 000 = ($2 000); large suitcase =
37 500 − 30 000 = $7 500
ii The contribution of each case helps to pay for the total indirect costs of the business and, if
the total contribution exceeds total indirect costs, a profit will be made.
c Learners should define contribution and profit. Basing decisions on the profit made by each
product can lead to decisions that, in the long term, reduce the overall profit made by a business.
If a positive contribution can be made (despite a loss being recorded once indirect costs have been
allocated), this is preferable, as at least the product is contributing to the payment of indirect costs,
which have to be paid anyway.
• Profit with the medium case = $60 000
• Profit without the medium case (assuming no change in sales of other cases or overhead
costs) = $52 000. The reduction in profit is equal to the lost contribution made by the
medium suitcases.
• As some cases are sold as part of a set, withdrawing the medium case may lead to a loss of
sales of other sizes of case. Customers may wish to buy a matching set, so may switch to a
competitor’s product.
• If the medium case is withdrawn, will that impact on material costs due to smaller
order quantities?
• It is possible that withdrawing the medium case could lead to an increase in sales of the
other cases.
Evaluation might include clear advice to Jill and a consideration of: the impact on employees if
production is stopped; whether the equipment can be used to make a product which makes an even
higher contribution; the final decision might depend on the recent trend in sales and revenue as the
data might have been from a non-typical period.
3 Gowri’s Pottery
a i Rent.
ii Variable costs change in relation to output.
b i Break-even graph showing break-even level of output:

25 000
Revenue
Costs and revenue ($) 20 000
15 000 Total costs
10 000
5 0000
Fixed costs
0
0 1 000 2 000 3 000 4 000 5 000 6 000 7 000 8 000
Output
Break-even level of output is 2 667 units.

Margin of safety = 5 000 – 2 667 = 2 333 units.
ii It assumes that variable costs per unit do not change as output varies when, in fact, buying
clay in bulk to make pots might lead to lower average costs per unit.
c One advantage is that the margin of safety increases to 2 666, which means that Option 2 is less
risky, in terms of avoiding making a loss, than either the current situation or Option 2.
One disadvantage is that the expected profit will be lower than either the current situation or
Option 1. Only a profit of $3 200 is forecast compared to $4 000 with a new kiln.
• Although cutting price (Option 2) may increase demand significantly, there is a drop in profits
as the price cut applies to all units sold and consequently the unit contribution is reduced to
only $1.20. This does not achieve the manager’s objective.
• If the estimate of demand is correct, the price cut will increase the margin of safety.
• The price cut does increase sales and will increase market share.
• Purchasing the kiln (Option 1) reduces the direct cost of production to the extent that profit is
higher if sales are as estimated.
• The margin of safety is reduced if the kiln is purchased, due to the higher break-even level
of output.
Evaluation: as the objective is to increase profit, the manager will prefer purchasing the kiln.
However, the success of the investment is dependent on estimated sales being accurate. If the sales
are actually above 3 333 units, the investment will generate more profit than making no change.
4 Abbey Restaurant
a i Increase in fixed costs.
ii The forecast or actual sales above the break-even level of output.
b i Profit = total revenue − total cost
Current menu: sales turnover = $12 000; variable cost = 5 × 600 = $3 000; overheads = $7 000;
profit = 12 000 − 10 000 = $2 000
New menu: sales turnover = 14 × 600 × 1.2 = $10 080; variable cost = 4 × 720 = $2 880;
overheads = $6 000; profit = 10 080 – 8 880 = $1 200
ii It allows the business to identify the range of output and/or number of customers at which a
profit is made and helps in decision-making if output is less than this range.
c The price is lower (by $6), but the variable cost is only reduced by $1. Therefore, with a lower
contribution per meal, the break-even number of customers will increase by 133 per week.
At the expected level of sales (output), the margin of safety will fall even though there will be more
customers paying $14 than $20. The margin of safety falls to 120 customers per week from 133.

• Profit from the new menu is $800 less than the current situation.
• Break-even output for the new menu is 133 customers per month more than the current
situation.
• This suggests that the new menu is not a good idea, as profits will fall as the target number of
customers to break even will increase.
• The problem for Phil is that the unit contribution from the new menu is much lower than from
the existing menu: $10 compared to $15. There is a significant reduction in the price charged
and a proportionately smaller reduction in unit variable costs.
• The increase in customers is insufficient to make the new menu more profitable; customer
numbers would have to rise to 800 per month to make the same profit as for the current menu.
• The margin of safety for the current menu is 133 customers compared to 120 customers for
the new menu.
• Evaluation should include clear and justified advice such as: if customer numbers for the
current menu continue to fall, there is a case for changing to the new, lower-priced menu.
be different.
Coursebook answers
Chapter 32
Business in context
Increase in costs could be because:
• Complexity of the projects makes it difficult to estimate costs, e.g. the scale of the Three Gorges Dam,
which was the world’s largest hydroelectric power project and involved flooding a huge area of land
and relocating hundreds of thousands of people.
• Time taken to complete the projects means that costs can change due to changes in the external
environment, e.g. construction of the Channel Tunnel took six years.
• Unforeseen problems can add to the cost of a project.
• Unique nature of many projects makes it difficult to predict costs, e.g. the International Space Station.
Despite the additional costs that occur within projects, budgeting is useful because:
• Targets provide a goal for business and enable resources to be allocated more effectively. This also
enables the coordination of activities to be improved.
• Progress can be measured against budgets and differences can be investigated to identify how resources
can be used more effectively.
• It can be used to aid motivation of employees.
Activities
Activity 32.1
Activity 32.2
1 No budgets were communicated to the shop manager. Therefore, the manager did not know what level
of sales to aim for. Consequently, the shop is facing closure due to low sales.
A large company with many outlets owns the shop and there has been a lack of consultation about
expectations of sales. The shop manager has appropriate local knowledge that would have helped to set
a realistic target for the shop.
The shop manager is dissatisfied because of the situation. This will impact the motivation of all
employees in the shop.
2 Delegated incremental budgeting could be beneficial as this gives the shop manager some authority for
setting and achieving the budget. This would ensure that local factors, such as the new supermarket
opening, would be accounted for when setting the budget for sales and costs. A key feature of effective
budgeting is participation to give a sense of ownership of the targets. By using incremental budgeting,
the shop manager would not have to justify every budget value – just the change from the previous
budegting period.
Delegated budgeting would potentially provide motivational benefits. This fits in with Herzberg’s
approach to motivation. Incremental budgeting, using the manager’s participation, would allow for
discussion about what changes to sales and costs budgets should be made from the previous time
period, which for a retail shop might not change very much.
In evaluation, the success of delegated budgeting depends on the skills and knowledge of the budget
holder. Does the shop manager have the experience to set effective budgets that are challenging but
realistic? Although the manager has four years of experience, he has not been proactive in considering
whether the food and drink shop was successful. Evaluation could also include a justification, in this
case, for using incremental budgeting and not zero budgeting.
Activity 32.3
1 a The difference between the budgeted figure and the actual outcome.
b Budgets are set to zero each year and budget holders have to justify any money that they
should receive.
2
$000 Budgeted figures Actual figures Variance Adverse or
favourable?
Revenue 165 150 15 Adverse
Cost of materials 80 70 10 Favourable
Labour costs 22 23 1 Adverse
Gross profit 63 57 6 Adverse
Overheads 40 43 3 Adverse
Operating profit 23 14 9 Adverse
3 a Variance in revenue could be due to:

• Lower sales due to the downturn in the economy. With no economic growth, unemployment
will increase and consumer spending will fall.
• Reduced selling price in order to stay competitive in the difficult trading conditions and the
appreciation of the currency, which has led to a decrease in the price of foreign imports.
b Variance in labour cost could be due to:
• Higher wages paid to employees. This could be a result of inflation in the economy, with
workers demanding higher wages to maintain their standard of living.
• Productivity of labour lower than expected. Therefore, each unit of work will take more time
and cost more.
4 Benefits include:
• Budgets help plan for the future. A budget provides a target for departmental managers to achieve.
• Setting targets can help motivate staff, particularly if they have had some input into the budgetary
process. Employees may feel a sense of achievement when targets are met.
• Budgets help control costs and improve efficiency. This is important to Oasis Cookers as the
external economic environment is not favourable and being price competitive will be important.
• Budgets aid assessment of the organisation. If actual outcomes diverge from those budgeted,
managers can investigate what has happened and try to resolve problems.
• The budgeting process can ensure that all parts of the business are working towards the same
objectives and that those objectives will be met.
Evaluation: budgets and budgetary control will only be effective if budgets are realistic, agreed by
those with responsibility for meeting the budget, coordinated with objectives, challenging to ensure
efficiency and flexible.
1 A budget is a set target or limit, normally set annually. A forecast is a prediction of performance based
on performance to date, maybe at a mid-year point.
2 Using the previous year’s budget with an adjustment made in order to set this year’s budget.
3 Cost budgets for each expense are allowed to vary to take into account changes in sales from
budgeted levels.
4 Learners’ answers will vary, e.g. to provide a target to achieve, which can aid motivation of employees;
it helps coordinate departments if they are able to discuss the allocation of resources between them.
• Budgets can result in unnecessary spending, as departments have an incentive to spend
unspent budget before the end of the budgetary period in order to protect their future allocation
of resources.
• Budgets tend to be focused on the short term, typically the next 12 months. Therefore, longer-term
needs of the business can become secondary as managers take short-term decisions to enable them
to remain within budget.
6 Learners’ answers will vary, e.g. calculate and analyse the reasons for differences between budgeted
outcomes and actual outcomes; as a means of controlling spending within a business to ensure that it
does not exceed its resources.
7 Budgets are set to zero each year and budget holders have to justify any money that they
should receive.
8 Adverse variances will reduce profit above the budgeted figure, whereas favourable variances increase
profit. For example, an adverse variance is where costs are higher than budgeted, whilst a favourable
variance is where revenue is higher than budgeted.
9 It could be due to lower demand caused by an increase in competition in the market.
10 It could be due to a fall in the price of inputs such as raw materials.
11 Sales budget should be set first. This might be based on the expected number of customers and average
spend. Demand has to be estimated and then cost budgets are set in relation to the sales budget.
12 Many external factors could influence sales, such as the exchange rate, the state of the economy and
competition. Therefore, cost budgets need to be flexible to respond to these changes.
13 Subject departments can be asked to justify how much money they need to spend to meet targets.
These discussions can then be used to allocate funds between the departments.
14 Amending budgets each year to allow for changes is more likely to be accurate as this is an established
business with experience of setting budgets. There is plenty of past data on which to base targets for
the year ahead.
Essay questions
1 a Zero budgeting requires all budget holders to justify all of their budget each year. This requires full
consideration of the work and the importance of each budget-holding section each year. It provides an
incentive for managers to defend the work of their own section. Also, changing situations, such as the
external environment, can be reflected in setting different budget levels each year.
Incremental budgeting makes changes for this year based on last year’s budget. Cost budgets are
typically adjusted for forecasted inflation and expected changes in output. Using last year’s figure
as a basis means that each department does not have to justify its whole budget for the coming
year – only the change or increment. There is no fundamental appraisal of each department’s
targets or need for resources.
b Budget setting should involve participation. Decisions regarding budgets should be made with the
managers who will be responsible for meeting the targets. Those who are responsible for fulfilling
a budget should be involved in setting it. This sense of ownership can help to motivate the
department concerned to achieve the targets – make references to Herzberg’s 2-factor theory.
Variance analysis is used to compare actual performance with the original budgets. This assesses
managers’ performance. It would not be possible to assess how well individual departments had
performed without a clear series of targets with which to compare actual performance. Setting
targets and monitoring their achievement can help motivate managers as long as targets are
realistic. This aligns with Vroom’s expectancy theory.
Budgets provide information for managers to evaluate the performance of departments and can be
used to reward good results. For example, budgets supply financial information for incentive-based
financial rewards. The profit budget can be used to award year-end bonuses according to whether
goals are achieved.
Evaluation might include an assessment of how the budgets are set and whether managers and
employees have any involvement in setting these targets.
2 a Learners should define variance analysis.
Actual outcomes can be compared with budgeted targets and variance analysis allows an
identification of why adverse variances have occurred. This analysis can then be used to avoid
mistakes in the future.
Analysis of favourable variances is also important in monitoring performance as the business can
learn from understanding why those favourable variances have arisen. Budgets may also be used
for determining bonuses for employees for the achievement of targets set.
b Benefits of setting budgets include:
• A hairdressing business may be split into different cost centres, including beauty treatments,
hair styling and sales of accessories. The process of setting budgets helps coordination
between individuals within the hairdressing business.
• If budgets are delegated, they can aid motivation of managers and employees. Departments
are more likely to control their costs if they have been involved in deciding the targets.
• Setting targets provides goals for departments to achieve. This can improve motivation as long
as the targets are realistic.
• Budgets provide a benchmark for assessing the performance of managers.
• A budgeting system allows for appropriate allocation of resources.
• Setting a sales budget provides the foundations for making decisions on the needs of the
business in terms of human resources and how much to spend in each area of the business.
• Variance analysis will review why budgets have not been met. This is a useful monitoring
process and will help identify efficiency problems.
However, budgets consume management time to set and it could be argued that this time is wasted
if change in the economic environment renders the budget meaningless.
Evaluation could include an assessment of the possible usefulness of a budgeting system to a small
business such as a hairdresser, weighing up benefits and possible limitations to such a business. A
clear overall conclusion is required.

1 Kinibali Timber Ltd (KT)
a i Actual performance can be compared.
ii Difference between budget and actual figures.
b i Profit = revenue – total costs
Budgeted profit = 66 000 − (15 000 + 12 000 + 6 000) = 66 000 – 33 000 = $33 000
ii Revenue – $4 000 (favourable); direct labour – $3 000 (adverse); direct materials – $5 000
(adverse); fixed costs – $1 000 (favourable); profit – $3 000 (adverse).
iii It allows the main differences between budget and actual data to be identified and the reasons
for the main adverse variances can be avoided in future.
c Flexible budgeting allows unavoidable changes during the budgetary period to be incorporated
into a revised budget so the variances (at the end of the period) become a more realistic indicator
of under- or overperformance.
It prevents managers and employees being demotivated by budgets that have been made unrealistic
by unavoidable events.
d Setting budgets is important because:
• The process of setting budgets helps coordination between departments.
• If budgets are delegated, they can aid motivation of managers and employees. Departments
are more likely to control their costs if they have been involved in deciding the targets.
• Setting targets provides goals for departments to achieve. This can improve motivation as long
as the targets are realistic.
• Budgets provide a benchmark for monitoring performance. In this case study, the adverse
variances for labour and materials need to be investigated and understood. Variance analysis
might help highlight the problems faced by the operations department, in particular the old
equipment that is continually breaking down.
• A budgeting system allows for appropriate allocation of resources.
Evaluation might include the fact that the budgetary process can be time-consuming, especially
if budget holders are involved in setting delegated budgets. The issue is whether the time taken
is justified by the benefits of an effective budgetary system. Learners should give their own
conclusion or judgement.
2 Karmali Carpets plc (KC)
a i Sales higher than budget.
ii Any difference between budgeted outcomes and actual outcomes which leads to higher profit.
b i Budget revenue = 1 000 × 550 = $550 000
Actual revenue = 825 × 530 = $437 250
Variance is $112 750 adverse.
ii A reduction in revenue will reduce profit for the year. Although lower sales result in lower
variable costs, this will not be sufficient to compensate for the loss of revenue.
c It provides a basis for investigating what, if anything, has gone wrong in the business. In this case
study, it can be used to highlight changes in the marketplace that have influenced sales.
It may enable the business to take action to improve efficiency in the business, e.g. by highlighting
the need to control costs in operations.
d The managing director’s approach to budgeting can be criticised on the following grounds:
• The budget was not discussed with the sales manager. It is beneficial to consult the sales
manager so that the resulting budget is considered to be fair.
• The budget was unrealistic. As a result of the lack of communication with the sales manager,
the budget set was too ambitious. A budget should be achievable if it is to motivate staff.
• An incremental budgeting approach was used that did not fully allow for changes in the
market. A zero budgeting method might have been more effective. This could have enabled the
sales manager to argue the case for increasing advertising expenditure in order to respond to
the increasing level of competition in the market.
Evaluation might include a justified assessment of the most important change that could be made
to KC’s budgetary system which would improve effectiveness.
be different.
Coursebook answers
Chapter 33
Business in context
Why public limited companies have to publish their accounting statements:
• To provide transparency for investors who might wish to purchase shares.
• To protect investors.
• To provide information to banks and suppliers to help them judge whether it is risky to supply funds
and/or goods to the business.
Should Nimir’s shareholders be satisfied with the trends?
• The business is growing.
• Revenue and profit have increased year on year. Profit has increased by 900m rupees between 2014
and 2019.
• Earnings per share have increased from 1.8 to 7.3 rupees over the same period.
Activities
Activity 33.1
1 Revenue = 5 × 1 500 = $7 500
Cost of sales = opening inventories + purchases − closing inventories = 500 + 3 000 − 1 000 = $2 500
Gross profit = 7 500 – 2 500 = $5 000
2 Profit is the reward to an entrepreneur for investment. Without making a profit, owners would
withdraw their investment and close the business.
Profit is important to finance growth. Profits can finance the purchase of fixed assets to help the
business grow.
3 Gross profit = revenue − cost of sales
Revenue = 4 × 3 500 = $14 000
Closing inventories = opening inventories + purchases − sales (all figures in units) = 200 + 4 000 – 3 500
= 700 units
Value of closing inventories = 2 × 700 = $1 400
Cost of sales = 2 × 3 500 = $7 000
Gross profit = 14 000 − 7 000 = $7 000
Activity 33.2
1 Gross profit (U) = revenue − cost of sales = 200 000 – 60 000 = $140 000
Profit from operations (operating profit) (V) = gross profit − overheads = 140 000 – 30 000 = $110 000
Profit before tax (X) = operating profit – interest = 110 000 − 10 000 = $100 000
Profit for the year (Y) = profit before tax – tax = 100 000 – 20 000 = $80 000
Retained earnings (Z) = profit after tax – dividends = 80 000 – 12 000 = $68 000
2 Shareholders (Rodrigues and friends):
• Profits affect the dividends available for distribution to shareholders.
• They affect the value of the business.
• They are a source of finance for future growth.
Employees:
• Profits give job security.
• They can affect wage negotiations.
Activity 33.3
1 Year ending 31/12/21 $ Notes
Revenue (5 000 units @ $4) 20 000 4 × 5 000
Cost of sales (@ $1.60 per unit) 8 000 1.60 × 5 000
Gross profit 12 000 Gross profit = revenue − cost of sales
Overhead expenses 5 000 1.25 × 4 000
Profit from operations 7 000 Profit from operations = gross profit − overheads
Interest 1 000 50% of 2 000
Profit before tax 6 000 Profit before tax = profit from operations – interest
Corporation tax @ 25% 1 500 0.25 × 6 000
Profit for the year 4 500 Profit for the year = profit before tax − tax
Dividends paid 1 200
Retained earnings 3 300 Retained earnings = profit after tax − dividends
2 Year ending 31/12/22 $ Notes

Revenue (6 000 units @ $4) 24 000 4 × 6 000
Cost of sales (@ $0.90 per unit) 5 400 0.9 × 6 000
Overhead expenses 5 500 5 000 + 500
Interest 1 000
Profit before tax 12 100 Profit before tax = profit from operations – interest
Corporation tax @ 25% 3 025 0.25 × 12 100
Retained earnings 7 875 Retained earnings = profit after tax – dividends
3 Satisfied:
• Operating profit has increased significantly. This is often the most important objective for business.
• Despite the higher tax rate, the profit for the year is greater than was estimated.
• Revenue has increased due to an increase in unit sales.

• There is a substantial decrease in direct costs in 2022.
Not satisfied:
• Overheads were higher than estimated and increased the following year.
Evaluation: management is likely to be pleased due to the overall improvement in profit and
profitability between 2021 and 2022. However, other information would be necessary such as whether
Karachi Traders Ltd achieved its targets and how similar businesses are performing.
Activity 33.4
1 Company car: non-current tangible assets
Work in progress: current assets
Four-year bank loan: non-current liabilities
Trade payables: current liabilities
Issued share capital: shareholders’ equity
Dividends owed to shareholders: current liabilities
Value of patents: non-current intangible assets
Trade receivables: current assets
Retained earnings: shareholders’ equity
Cash in bank: current assets
Activity 33.5
1 Changes include:
• Increase in non-current assets, partially financed by an increase in non-current liabilities such as
loans.
• Value of current assets has decreased but value of current liabilities has increased.
Therefore, Mauritius Telecom (MT) has experienced a reduction in working capital and its
liquidity position has worsened.
• Shareholders’ equity has increased but it is not shown whether the increase was due to an increase
in retained earnings or the sale of shares.
2 A statement of financial position is just a snapshot and can therefore be misleading. With two years of
data, it is possible to identify whether the financial position of the firm is improving or deteriorating.
This is important to stakeholders, such as suppliers, financiers, shareholders and managers.
Suppliers may be interested in MT’s working capital to help assess whether it is safe to supply goods
and services. They may be concerned about the liquidity of MT.
Shareholders:
• The statement helps evaluate whether investment is worthwhile. It shows that MT’s net assets
increased between 2017 and 2018. Therefore, the value of the business is greater.
• Indication of risk. The balance of long-term financing is weighted towards equity rather than debt
finance. This can indicate a lower level of risk. However, MT has substantial debts when current
liabilities are included.
Banks:
• The statement is useful in evaluating the risk of providing any further finance to MT.
MT is financed primarily through shareholder funds rather than debt finance.
• Gearing and liquidity are important to banks.
Evaluation: the information is useful to stakeholders but other quantitative and qualitative information
would also be required (e.g. the statement of profit or loss is also important as it records sales and
profit performance).
3 Learners’ answers will vary, e.g. chairman’s statement gives a general overview of the achievements of
the company and its future prospects, taking into account significant external influences. The report of
directors outlines the duties of directors, including safeguarding the company’s assets. The report gives
background information on the business and outlines key results from the year.
Activity 33.6
1 Shivani Beauty Ltd, Statement of financial position, year ending 31 March 2021 ($000)
ASSETS
Non-current assets:
Equipment 25
Current assets:
Inventories 15
Trade receivables 3
Cash 1
TOTAL ASSETS 44
EQUITY and LIABILITIES
Current liabilities:
Trade payables 5
Overdraft 3
Non-current liabilities:
Loan 20
Shareholders’ equity:
Share capital 10
Retained earnings 6
TOTAL EQUITY and LIABILITIES 44
2 Shareholders can measure the gearing of the business, which gives an idea of how risky further
investment would be. Shareholders might also be interested in the liquidity of the business to judge
the risk of insolvency. When combined with the statement of profit or loss, the statement enables
shareholders to calculate the return on capital employed and judge the returns from their investment.
Suppliers would be interested in the liquidity of the business, as they would want to ensure that
supplies will be paid for. Combined with the statement of profit or loss, the statement enables suppliers
to identify how long, on average, Shivani takes to pay creditors.
Banks would be interested in the security of any loans that might be made to Shivani. Therefore,
gearing is important to a bank.
Employees would be interested in job security. The statement of financial position would provide
employees with an insight into any liabilities of the business that could threaten its operations.
Activity 33.7
$m $m Notes (all figures in millions)
ASSETS
Non-current assets: Property increased by 800.
Property 2 800
Equipment 500
3 300
Current assets: Inventories reduced by 20%.
Inventories 96 Debtors reduced by 50 as bad debts

but increased by 50 as increase in trade
Trade receivables 650 receivables.
Cash 70 Cash increased by 50 due to retained
816 profit.
TOTAL ASSETS 4 116
Current liabilities: Trade payables increased by 30.
Trade payables 480
Overdraft 30
510
Non-current liabilities: Loans increased by 400.
Long term loans 650

650
TOTAL LIABILITIES 1 160
Shareholders’ equity: Share capital increased by 400.
Share capital 2 400 Retained earnings adjusted:
Retained earnings 556 • − 24 due to inventories.

2 956 • − 50 due to bad debts.
TOTAL EQUITY and LIABILITIES 4 116
• − 30 due to trade payables.
• + 100 retained profit.
Activity 33.8
1 It is worth repairing the coats because, for an extra cost of $10 per jacket, the company will receive $30
more than if the coats were simply sold as scrap. Therefore, the business will be $200 better off.
Sold as scrap = $50
Repaired and sold = $350 − 100 = $250
2 The net realisable value is the amount for which an asset, such as stock, can be sold, less the cost
of selling it. As the coats need repairing, this cost should be taken into account. Therefore, the net
realisable value is the amount for which inventory can be sold minus the cost of selling it = 35 − 10
= $25 per coat. This value will be used as it is below the historical cost of the coats.
Activity 33.9
1 a Depreciation = (original cost of asset − expected residual value) ÷ expected useful life = (20 000 –
2 000) ÷ 6 = 18 000 ÷ 6 = $3 000
b Year 1 2 3 4 5
Net book value ($) 17 000 14 000 11 000 8 000 5 000
c At the end of year 3, the machine would have an expected value of $11 000. If it is sold for $13 000,
that represents a profit of $2 000.
2 a Depreciation over the four years is expected to be 4 × 2 500 = $10 000. Therefore, the expected
residual value is 12 000 − 10 000 = $2 000.
b Depreciation = 10 000 ÷ 3 = $3 333 (to the nearest $).
c Depreciation is an expense and is recorded in the profit or loss account of the income statement.
A higher level of depreciation reduces annual profit in the years for which the depreciation
is charged.
Activity 33.10
1 Year ending 31 March 2021 $ $ Notes
Revenue (5 000 units @ $11) 55 000 11 × 5 000
Opening inventories 3 000
Plus purchases 40 000
Minus closing inventories 8 000

Cost of sales 35 000
Overhead expenses 12 000
Interest 1 000
Profit before tax 7 000 Profit before tax = profit from operations − interest
Corporation tax @ 20% 1 400 0.20 × 7 000
Retained earnings 1 600 Retained earnings = profit after tax − dividends
2 $m $m
ASSETS
Non-current assets:
Property 2
Vehicles 10
Equipment 1
13
Current assets:
Inventories 1
Trade receivables 3
Cash 0.2
4.2
TOTAL ASSETS 17.2

Trade payables 1
Overdraft 2.5
3.5
Long-term loans 5
5
TOTAL LIABILITIES 8.5
Share capital 6
Retained earnings 2.7

8.7
TOTAL EQUITY and LIABILITIES 17.2
1 Midas Toys Ltd
Year ending 30 September 2021 $m
Revenue 6
Cost of sales 2.55
Gross profit 3.45
Overhead expenses 0.75
Profit from operations 2.7
Tax 0.54
Profit for the year 2.16
Dividends 0.5
Retained earnings 1.66
cost − residual value 1 000 000 − 100 000

2 Annual depreciation charge = =
expected useful life 3
= $300 000
3 $1m − (0.3m × 2) = $0.4m
4 $000 $000
ASSETS
Non-current assets:
Property 10 700
Equipment 3 000
Intangible assets 350

14 050
Current assets:
Inventories 210
Trade receivables 640
Cash 80
930
TOTAL ASSETS 14 980
Trade payables 525
Overdraft 320
845
Long-term loans 4 500

TOTAL LIABILITIES 5 345
Share capital 6 000
Retained earnings 3 635
Other reserves 0
9 635
TOTAL EQUITY and LIABILITIES 14 980
be different.
Coursebook answers
Chapter 34
Business in context
Problems in comparing performance
• There is insufficient data to identify trends. Data on growth of revenue, profit etc. is needed
for comparison.
• It is also important to know targets, and whether profits match the objectives set for the year.
• Other information is also required, e.g. capital investment being made. A high level of investment
might reduce current profits but boost future profits and growth.
Usefulness of comparing profit with capital invested into a business
• This provides the return on investment, a key measure for evaluating the success of investment.
• It gives an indication of how effectively each dollar of investment has been used to generate profit.
• This can be compared to other investment opportunities to identify which is best.
Activities
Activity 34.1
1 Current ratio = current assets ÷ current liabilities
2018 = (18 134 + 81 513 + 36 795) ÷ 232 951 = 136 442 ÷ 232 951 = 0.59:1
2019 = (20 737 + 125 700 + 26 103) ÷ 232 847 = 172 540 ÷ 232 847 = 0.74:1
2 Acid test ratio = liquid assets ÷ current liabilities
2018 = (81 513 + 36 795) ÷ 232 951 = 118 308 ÷ 232 951 = 0.5:1
2019 = (125 700 + 26 103) ÷ 232 847 = 151 803 ÷ 232 847 = 0.65:1
3 Air Mauritius’s (AM) liquidity, as measured by the current ratio, has improved from 0.59:1 to 0.74:1.
However, AM still has insufficient current assets to cover its short-term debt. This means AM may
struggle to meet its debt obligations. Although the current ratio has improved, the amount of trade
receivables has increased by 50%. This could indicate that the business is giving too much credit
to customers.
4 Sell off fixed assets for cash. AM could sell planes or property to raise cash. However, it can only sell
assets that are no longer required to generate revenue. Planes are likely to be needed for generating
sales. Selling assets quickly can result in the assets not realising their true value.
Increase loans. Borrowing from financial institutions would inject cash into the business and improve
liquidity. However, it would also increase gearing, the ratio of debt to equity finance. This would
increase the risk of being unable to meet the interest payments associated with borrowing. Interest
payments are an expense and therefore reduce profit margins.
Judgement is needed about the most appropriate way to improve liquidity in this case.
Activity 34.2
1 2018 2016 2014
Gross profit 39 636 ÷ 1 063 744 × 100 22 525 ÷ 677 940 × 100 36 824 ÷ 1 187 639 × 100 =
margin (GPM) = 3.7% = 3.3% 3.1%
RoCE 31 870 ÷ 115 617 × 100 = 22 826 ÷ 99 902 × 100 41 972 ÷ 83 805 × 100 =
27.6% = 22.8% 50.1%
2 Over the time period as a whole, PSO’s profitability has decreased. Although there has been a small
increase in the GPM from 3.1% to 3.7%, the RoCE has decreased by nearly 23 percentage points. In
2014 and 2016, the profit from operations was greater than the gross profit, which indicates that PSO
must have other sources of income. Gross profit and profit from operations vary significantly between
2014 and 2018 because of changes in revenue. Revenue in 2016 is much lower than in 2014 or 2018, and
this leads to much lower profit and a lower GPM and RoCE.
• A price increase will increase the profit on each item sold and therefore increase the GPM.
However, this is a dynamic market and it is likely that PSO has competition from other sellers
of oil. As the product is difficult to differentiate, it is likely that demand is relatively price elastic.
Therefore, any increase in price will lead to a more than proportionate decrease in quantity
demanded. This will reduce revenue and, although the GPM will increase, total profit could fall.
• Reducing marketing expenses will reduce overheads and could therefore increase the operating
profitability of PSO. However, reduced marketing could result in reduced sales and therefore lower
total profits for PSO. This will depend on the promotional elasticity of demand.
• Judgement is needed about the most appropriate way to improve profitability in this case.
Activity 34.3
1 Gross profit margin = gross profit ÷ revenue × 100
Operating profit margin = profit from operations ÷ revenue × 100
Gross profit margin Operating profit margin

Ahmed 100 000 ÷ 350 000 × 100 = 28.6% 20 000 ÷ 350 000 × 100 = 5.7%
Flash Builders (FB) 150 000 ÷ 600 000 × 100 = 25% 60 000 ÷ 600 000 × 100 = 10%
2 Relevant points include:

• Ahmed generates $0.286 of gross profit compared to FB’s $0.25 for every $1 of sales.
• Ahmed generates $0.057 of profit from operations compared to FB’s $0.10 for every $1 of sales.
• Ahmed’s business has a higher gross profit margin (GPM), suggesting that his business has been
effective in controlling the cost of sales. This indicates either that he is charging a high price for his
work and/or that he has bought materials at a relatively low price compared to FB. It may also be
a result of better control of direct labour costs.
• However, the profit margin for Ahmed Builders is much lower than for FB. This indicates that
Ahmed’s business has relatively high overheads. There has been a failure to control those costs
effectively. Consequently, Ahmed is less effective in turning sales into profit from operations.
• These figures are only for one year. To judge his success more fully, Ahmed would need to consider
trends in profitability to assess whether his performance is improving or worsening.
3 Increase prices. Increasing the differential between price and unit cost will increase the operating profit
margin. However, Ahmed faces competition from other builders such as FB and, therefore, there may
be a loss of sales, leading to a fall in total profit. This will depend on the price elasticity of demand. As
Ahmed specialises in quality fitting out of shops and has to work to tight deadlines, the price elasticity
of demand may be quite low.
Reduce costs. This may be done in several different ways:
• Cut stock levels. Ahmed keeps stocks of important materials but this will increase his costs as
stock requires storage space. However, reducing stock levels may adversely affect Ahmed’s ability
to meet the tight deadlines imposed by his customers. If customers are lost because of that,
revenue will fall.
• Use cheaper materials and fittings. As Ahmed provides a service for internationally famous
retailers, this may not be a suitable option. His customers will expect a high-quality finish and
therefore good-quality materials are needed. However, it may be possible to find cheaper suppliers
of these materials.
• Reduce overhead costs. As the GPM for Ahmed is higher than for FB, this appears to be an
area that needs attention. Ahmed should analyse where overhead costs are incurred and look to
make savings. For example, it may be possible to move the location of his head office and thus
reduce the rent paid. Ahmed should review the structure of the business to see if it has too many
administrative and managerial positions. If so, delayering could be used to reduce management
costs without affecting the quality of service offered to customers.
Evaluation should include a judgement about the most appropriate way to improve operating profit
margin in this case.
4 Current ratio = current assets ÷ current liabilities
Acid test ratio = liquid assets ÷ current liabilities. Note: liquid assets = current assets − inventory
Current ratio Acid test ratio

Ahmed 100 000 ÷ 45 000 = 2.22 (100 000 – 50 000 ) ÷ 45 000 = 1.11
Flash Builders 150 000 ÷ 120 000 = 1.25 (150 000 – 60 000) ÷ 120 000 = 0.75

• Ahmed’s business has no apparent problem with liquidity. The current ratio indicates that there is
$2.22 of current assets for every $1 of short-term debt. The acid test ratio shows that there is $1.11 of
liquid assets for every $1 of short-term debt. Therefore, the business should have no problem paying
creditors and other short-term debt holders. It might be argued that Ahmed’s business holds a little
too much stock, shown in the big difference between the current ratio and the acid test ratio.
• FB has less liquidity. Both the current ratio and the acid test ratio are slightly below the textbook
ideal. Thus, the firm may have difficulty paying short-term debt.
6 Sell fixed assets for cash. If FB has unutilised land and property, it could be sold to release working
capital. However, if the business needs all of its fixed assets, it would have to lease the assets back and
in the long term this would increase costs and reduce profit margins. To realise a healthy price for fixed
assets, FB would need to take time over their sale.
Sell off inventories. Selling stock for cash will improve the acid test ratio for FB but have no effect
on the current ratio. The problem of selling stock is that, like Ahmed, FB may have to work to tight
deadlines for customers and therefore need to hold stock. FB already holds relatively low stock levels
compared to Ahmed. If FB adopts a just-in-time stock control policy, this would improve the acid test
ratio by reducing cash outflows.
Evaluation should include a judgement about the most appropriate way to improve liquidity in
this case.
Activity 34.4
1 Ratio Calculation Company A Company B
Return on capital employed Profit from operations ÷ capital employed × 100 25% 12.5%
Gross profit margin Gross profit ÷ revenue × 100 27.5% 25%
Rate of inventory turnover Cost of sales ÷ average inventory 7.25 6.43
Cost of sales = revenue − gross profit

Current ratio Current assets ÷ current liabilities 0.86:1 1:1
Acid test ratio Liquid assets ÷ current liabilities 0.57:1 0.5:1
Liquid assets = current assets − inventory
2 Profitability. Both companies have similar GPM. However, Company A has a return on capital
employed which is double that of Company B. It returns $0.25 in profit for every $1 invested compared
to only $0.125 for Company B. This suggests that Company A’s profitability is superior to that of B.
Financial efficiency. Inventory turnover is higher at Company A. This means that inventory is held
for a shorter period of time, around 50 days at Company A compared to 57 days at Company B. The
results are similar and may reflect the particular nature of the industry in which they compete.
Liquidity. Company A has a very low current ratio, having only $0.86 of current assets for every $1
of short-term debt. This may indicate that Company A will have difficulty paying its debts. Although
Company B has a stronger current ratio, due to its higher relative level of inventory (the least liquid
current asset) it has a weaker acid test ratio. This shows that Company B also has a precarious
liquidity situation.
Evaluation should include a brief assessment of which company has the more favourable profitability,
financial efficiency and liquidity.
Activity 34.5
1 PPP has borrowed more than 50% of its capital. Therefore, PPP has a relatively high level of debt to
service (i.e. to pay interest on). This increases risk to the business as, if trading conditions are difficult,
PPP may struggle to cover interest payments. The cancellation of two major sporting events has
reduced PPP’s demand and revenue. However, the borrowing costs from expanding facilities still have
to be covered. With lower profits now expected and reduced cash inflows, PPP is in trouble because of
the increased borrowing.
2 Issue share capital. This will increase total capital and inject cash into the business. Gearing will be
reduced and the increased financing will enable PPP to restructure its debt. However, PPP may find it
difficult to attract investors due to the problems it currently faces and investors may lack confidence in
the management of the company.
Sell assets to raise finance. PPP could sell land to raise finance to pay off the loans. PPP is likely to
have valuable land and this could be sold for housing development. However, this would depend on
whether planning permission is possible for building housing, and on the location of the land. Selling
land might mean a fall in the number of visitors attracted to the park each year, which would affect
revenue. An alternative would be to use sale and leaseback of land or facilities. However, this would
increase long-term costs and reduce the assets owned by the business.
Evaluation should include a judgement about the most appropriate way to reduce gearing in this case.
Activity 34.6
Activity 34.7
1 PepsiCo 55.1%, Coca-Cola 60.8%
2 PepsiCo 15.3%, Coca-Cola 27.1%
3 Coca-Cola is more profitable than PespiCo. Coca-Cola is much more effective at generating profit
from each dollar of sales. However, the RoCE is similar for both companies: PepsiCo 17.4% and
Coca-Cola 17%.
4 PepsiCo 0.85:1, Coca-Cola 0.76:1
5 PepsiCo 0.7:1 Coca-Cola 0.64:1
6 PepsiCo has better liquidity. However, liquidity for both companies is low. This is unlikely to be a
concern as both companies are likely to have strong cash inflows from sales and debtors.
7 Rate of inventory turnover: PepsiCo 9.3, Coca-Cola 4.5
Trade receivables turnover: PepsiCo 42.5 days, Coca-Cola 39 days
8 Coca-Cola has a much lower rate of inventory turnover. It keeps inventory for an average of 81 days
compared to PepsiCo’s 39 days. This suggests greater financial efficiency at PepsiCo as it has less
finance tied up in inventories.
1 Bhopal Paper Products plc (BPP)
1
2021 2020
Current ratio 0.89:1 1:1
Acid test ratio 0.48:1 0.7:1
Trade receivables turnover 81 days 86 days
P/E ratio 10.7 9.9
Gearing ratio 50% 46%
Gross profit margin 70% 70%
Operating profit margin 8.75% 10%
RoCE 11.7% 12.7%
Dividend yield 6.25% 5.2%
2 There has been a slight decrease in profitability. Although revenue has risen, expenses have
increased more quickly, leading to a decrease in the profit margin. Profit from operations has
increased by 6.1%, but total capital has increased by 15.4%. This has decreased the RoCE.
Evaluation could include an assessment of whether the profitability is improving or not.
3 Reduce the time given to customers to pay. This would reduce the trade receivables turnover
in days. However, there is a risk that it might reduce revenue, as credit terms are an important
attraction for customers.
Maintain a debtor collection list. This ensures BPP will chase up debtors who are late paying debts.
Delay payment to suppliers. If this is done without the agreement of suppliers, there is a risk that
suppliers will withhold supplies in the future.
Evaluation could include an assessment of the best way to improve financial efficiency.
4 Sell assets that are no longer required. This will raise finance to pay back loans. As BPP has
grown rapidly in recent years, it might not have any unused assets. However, if it has bought new
machinery, there may be fixed assets to dispose of.
Issue more share capital. The expansion of the business could make it attractive to investors.
Expansion has been achieved despite a competitive market and the Indian economy is growing so
the prospects for BPP may be positive. However, a share issue would dilute ownership and control,
so might be opposed by shareholders.
Evaluation should include a final judgement about the most suitable way to reduce gearing in
this context.
5 For investment:
• Share price has risen in the last 12 months. Capital gains are possible for shareholders.
• Dividends paid to shareholders have increased by $5m. Dividend per share is now $0.25.
• P/E ratio has increased to 10.7 from 9.9. Although this means that it takes over ten years to
recover investment, it shows market confidence in the future profitability of BPP.
• Revenue has increased by 21% in the last 12 months despite a competitive market.
• The Indian economy is growing so BPP should also be able to continue to increase sales.
• Dividend yield has increased to 6.25%.
Against investment:
• Declining profit margin. The RoCE and operating profit margin have decreased in the last
year. Despite a large increase in sales, profit has increased by only 6.1%.
• Increase in gearing increases the risk of investment. BPP is highly geared, with 50% of capital
from borrowing.
Evaluation: investors would need further information before making a decision, e.g. the RoCE in
other similar businesses. The attitude of the investor to risk is important. A company that is highly
geared gives the opportunity for shareholders to benefit more if the business is able to increase
profit, as there are fewer shareholders with whom to share the profits.
2 Habib Manufacturing Ltd (HM)
• The gross profit margin (GPM) has increased as a result of the firm reducing the cost of sales
by using cheaper raw materials and buying in bulk to benefit from purchasing economies.
• Although the GPM has increased, the operating profit margin has decreased. This could be
the result of ineffective advertising and promotional expenditure, which has doubled. This
would increase HM’s expenses but may have had a limited impact on sales, and therefore the
profit margin would decrease.
2 Declining liquidity. HM may have problems paying short-term debts (e.g. trade creditors).
This could lead to suppliers refusing to give further credit and insisting on cash payments for
components and raw materials. Liquidity problems can, ultimately, lead to bankruptcy.
Declining rate of inventory turnover. This can have a negative impact on profit as HM will have
to pay for the cost of stock holding, thus increasing expenses. There is also the possibility of
obsolescence becoming an issue, although this should be less of a problem in the ovens market.
3 Increase prices. Higher prices will increase the GPM. However, if demand is price elastic, there will
be a more than proportionate fall in sales and therefore revenue will fall. Profit margins could still
be higher but the business may make less profit in total.
As Asif would have to target the oven at higher-income groups, he may need to increase promotional
activity to raise customer awareness. Quality may also have to be improved to support the higher price.
Asif has previously moved to using cheaper materials and might have to reverse that decision.
Reduce other overheads. Asif’s plan to relocate the factory will lead to a reduction in overheads,
as business rents will be lower outside the city centre. This may also benefit distribution of the
finished product and delivery of raw materials. As the new location is 20 km away, this may have a
negative impact on employees.
Evaluation could include a judgement about which method Asif should use in this case.
3 Financial efficiency and gearing ratios

1 Trade receivables turnover = trade receivables ÷ credit sales × 365
Company X = 112m ÷ 1 008m × 365 = 41 days
Company Y = 319m ÷ 1 314m × 365 = 89 days
Trade payables turnover = trade payables ÷ credit purchases × 365
Company X = 106m ÷ 580m × 365 = 67 days
Company Y = 270m ÷ 750m × 365 = 131 days
Rate of inventory turnover = cost of sales ÷ average inventory
Company X = 560 ÷ 73 = 7.67
Company Y = 730 ÷ 150 = 4.87
Gearing ratio = non-current liabilities ÷ capital employed × 100
Company X = 500m ÷ 1 575m × 100 = 31.7%
Company Y = 1 025m ÷ 2 050m × 100 = 50%
2 Both companies have trade payables turnover (days) that is greater than trade receivables turnover
(days), i.e. customers repay debt more quickly than the companies pay creditors. This will help
both companies with cash flow. However, Company Y takes 131 days to pay its suppliers (i.e. over
four months). This could result in suppliers being unwilling to offer further credit to Company Y.
Company X has a higher rate of inventory turnover compared to Company Y. Therefore, its
inventory holding costs are relatively lower than those of Company Y. This suggests that Company
X has better financial efficiency.
3 a Company Y has $150m of inventory, so it could finance the expansion by reducing inventories.
Company Y has a lower rate of inventory turnover than Company X, which might indicate
that Company Y could reduce inventory holding and still meet customer needs. However,
as the business expands it may need greater levels of inventory to meet customer demand.
Reducing inventory and using the cash to finance the expansion would also reduce the
liquidity of the business and consequently it may struggle to pay its short-term debts.
b Capital employed will increase to 2 050m + 75m = $2 125m
Long-term loans = 1 025m + 75m = $1 100m
Gearing = 1 100m ÷ 2 125m × 100 = 51.8%
Relevant points include:
• A bank loan is suitable as it is an appropriate source of finance for expansion.
• Company Y is highly geared. It has a high ratio of debt finance to equity finance.
• High gearing means a high level of interest payments. Servicing debt may be difficult if
trading conditions are difficult.
• The strain of paying back high debts could leave the firm with a lack of liquidity.
• Banks may be reluctant to lend more money, due to the interest burden.
• Knowledge of the firm’s current ability to cover interest payments from operational profits
would be useful.
• Current levels of interest will be important. The availability of retained profits is also
a consideration.
• Evaluation should include a final justified recommendation/advice on the best source of
finance to use in this context.
be different.
Coursebook answers
Chapter 35
Business in context
• Profit is usually the most important objective for business.
• The primary duty of a business is to its shareholders.
• Directors have more to gain from increasing profit than from reducing environmental impact, as their
bonuses are often linked to company performance and share price.
Activities
Activity 35.1
1 a Sales will depend on the state of the economy, as the cars are luxury products.
b It is difficult to predict uptake of services as they are new.
c The sample size is small and could be unrepresentative, so estimates of usage of the sports centre
may prove inaccurate.
d Costs for major infrastructure often go above budget, as unexpected construction problems can
be encountered.
e The price of oil is subject to large fluctuations over time and these changes are difficult to predict.
The price of oil will impact cash outflows.
Activity 35.2
1 30 000 ÷ 5 000 = 6 years
2 $3 million returned after 2 years. 1m ÷ 1.5m × 12 months = 8 months. So 2 years 8 months.
3 $240 000 returned after 3 years. 10 000 ÷ 80 000 × 12 months = 1.5 months. So 3 years 1.5 months.
Activity 35.3
1 Payback for Project X = 2 years and 3 months (number of months into the third year = 5 000 ÷
20 000 × 12)
Payback for Project Y = 2 years
2 Project Y has a quicker payback and should be selected. A quicker payback reduces risk and is
important to businesses that have limited finance available.
3 ARR = average annual profit ÷ average investment × 100
For Project X: profit = $40 000. Therefore, average profit = 40 000 ÷ 5 = $8 000
Average investment = $27 500

ARR = 8 000 ÷ 27 500 × 100 = 29.1%
For Project Y: profit = $32 000. Therefore, average profit = 32 000 ÷ 5 = $6 400
ARR = 6 400 ÷ 41 000 × 100 = 15.6%
4 Both projects are acceptable. Project X is 14.1% points and Project Y is 0.6% points above the
minimum acceptable ARR.
5 Project Y has a marginal advantage over Project X based on payback period. However, there is a
significant difference in the ARR for the two projects. At 29.1%, Project X provides a much higher rate
of return than Project Y. For every $1 invested, Project X returns an annual profit of $0.291 compared
to just $0.156 for Project Y.
ARR focuses on profitability, which is the central objective of business investment decisions. Project X
requires less initial capital than Project Y. Project X may therefore be easier to finance and cause less
strain on liquidity. Taking all these factors into consideration, Project X is more suitable based on the
quantitative data.
• Projected inflation rates. Cash flows received in the future have less real value than cash
flows today.
• Impact on employees and other stakeholders of the investments. Will workers need retraining?
Will the investment lead to redundancies?
• Amount of disruption caused as the machinery is installed.
• The new machinery’s impact on the quality of textiles produced.
Activity 35.4
1 Present-day value = cash flow × discount factor:
a 10 000 × 0.68 = $6 800
b 2 000 × 0.41 = $820
c 6 000 × 0.83 = $4 980
2 a Payback is in the second year after 7 000 ÷ 10 000 × 12 = 8.4 months. Payback is 1 year and
8.4 months.
b Year Net cash flows ($) Discounted cash flow @ 10% Cumulative discounted cash flow
0 −15 000 −15 000 −15 000
1 8 000 7 280 −7 720
2 10 000 8 300 580
3 5 000 3 750 4 330
4 5 000 3 400 7 730
c NPV = $7 730
Activity 35.5
1 a NPV = −$1 600
b The NPV is negative because the future cash flows have been discounted so heavily that the
cumulative discounted net cash flows are less than the initial investment.
c If the business had to borrow finance at 20%, future cash flows are not sufficient to cover the cost
of the investment. The project has a negative NPV.
d If the discount rate for new investments is 10%, the NPV is $5 400. Therefore, it is worth
considering this investment.
Activity 35.6
1 Payback for Location A is three years. Payback for Location B is two years and four months. Location
B would be an advantage to the business as a quicker payback reduces risk and reduces the pressure
on cash flow.
Location A: average profit = 11 000 ÷ 5 = $2 200
ARR = 2 200 ÷ 6 000 × 100 = 36.7%
Location B: average profit = 9 000 ÷ 5 = $1 800
ARR = 1 800 ÷ 6 000 × 100 = 30%
3 The investment appraisal techniques provide contrasting recommendations. Using payback, the
directors would favour Project B. Using ARR, the directors would favour Project A. Further, there
is little difference between the payback for both options and the ARR for each location is similar.
Therefore, it is difficult to make a decision based only on these calculations.
4 Net cash flow Discounted Discounted Net cash flow Discounted Discounted
Location A cash flow 10% cash flow 20% Location B cash flow 10% cash flow 20%
−12 000 −12 000 −12 000 −12 000 −12 000 −12 000
3 000 2 730 2 490 6 000 5 460 4 980
4 000 3 320 2 760 5 000 4 150 3 450
5 000 3 750 2 900 3 000 2 250 1 740
6 000 4 080 2 880 2 000 1 360 960
5 000 3 100 2 000 5 000 3 100 2 000
4 980 1 030 4 320 1 130
Location A: NPV @ 10% discount = $4 980; NPV @ 20% discount = $1 030

Location B: NPV @ 10% discount = $4 320; NPV @ 20% discount = $1 130
5 The two locations offer similar net present values (NPVs). Although the net cash flow from Location
A is higher than for Location B, when the time value of money is taken into account, the difference
is reduced and, at a sufficiently high rate of discount, the NPV of Location B becomes greater than
Location A. This reflects differences in the timing of cash flows; Location A has higher net cash flows
in the later years of the investment whereas Location B’s net cash flows occur earlier in the investment.
6 Employees are affected by the relocation, as they may have to travel further to work or move home.
Location A is closer, so may be preferred by employees as they may be able to travel to work without
moving. If employees have to move home then Location A has the advantage of a nearby school and
housing estate.
Location A has a port, which might be beneficial for the business if it uses imported metal or needs to
export goods.
Location B has high unemployment nearby, so it might be cheaper to recruit workers. However, it is a
specialist workshop, which suggests that workers are skilled. Therefore, the business is likely to want to
keep existing workers if possible.
Location B is on the edge of a nature reserve. If the workshop causes pollution, this could be a
disadvantage as there might be regulations to consider.
7 There is no clear preference for location based solely on quantitative factors. However, some of the
following points may be made:
• The cost of borrowing needs to be considered. Both investments have a positive NPV even at a 20%
discount rate. If rates of interest are around 10%, Location A would be favoured. Although Location
A has a longer payback and is therefore more uncertain, the difference is only eight months.
• Shortage of finance. If this is an issue, the owner may prefer a speedier payback.
• The ARR for Location A is higher and it is therefore more profitable. The return is over 6% points
higher. As profit is a key consideration, this is an important difference.
• As the business offers a specialist service, it may be important to retain employees after the move to
avoid disruption and increased training costs. Therefore, Location A will be the preferred choice.
1 King and Green Ltd
1 a Payback: Option 1 = 3 years and 1 month. (In year 4: 5 000 ÷ 70 000 × 12 = 0.85 months)
Option 2 = 2 years and 8 months. (In year 3: 48 000 ÷ 72 000 × 12 = 8 months)
b ARR: Option 1: annual profit = 135 000 ÷ 5 = $27 000
Average investment = (355 000 + 20 000) ÷ 2 = $187 500
ARR = 27 000 ÷ 187 500 × 100 = 14.4%
Option 2: annual profit = 128 000 ÷ 5 = $25 600
Average investment = (240 000 + 10 000) ÷ 2 = $125 000
ARR = 25 600 ÷ 125 000 × 100 = 20.5%
c NPV: Option 1 = $31 300; Option 2 = $49 960
Table of discounted cash flows for calculating NPV:
Discount Option 1 net Discounted Option 2 net Discounted

Year
rate @ 10% cash flow ($) cash flow ($) cash flow ($) cash flow ($)
0 1 −355 000 −355 000 −240 000 −240 000
1 0.91 150 000 136 500 120 000 109 200
2 0.83 110 000 91 300 72 000 59 760
3 0.75 90 000 67 500 72 000 54 000
4 0.68 70 000 47 600 42 000 28 560
5 0.62 70 000 43 400 62 000 38 440
2 Quantitatively, Option 2 is preferable because it has a quicker payback and, therefore, is less risky.
It also has a higher ARR so, for each $1 invested, it has a higher rate of return. It also has a higher
NPV. However, other considerations include:
• Corporate social responsibility. Option 1 will minimise water pollution.
Option 2 might face opposition from the local community because of concerns about pollution.
• Impact on workforce. Option 2 requires more workers. Option 1 would lead to a loss of jobs,
so might be resisted by employees. However, with the higher labour costs for Option 2, there is
a danger that any increase in wages would significantly affect profitability.
• Option 2 has an established record for reliability. This is important in meeting customer
expectations. Further, if the fully automated machinery breaks down, it may be expensive to
fix due to its technical complexity.
Evaluation: King and Green has relatively low profitability, so may prefer the higher profitability
of Option 2.
2 Asia Print (AP) – investing to stay competitive
1 Unit contribution for each unit sold is 1.25 − 0.5 = $0.75
Additional operating costs are $1m for Project Y and 0.5m for Project Z.
Project Y: net cash flow = 8m × 0.75 − 1m = $5m in years 1, 2, 3 and 4. In year 5, there will be an
additional $1m inflow from the residual value of the machine.
Project Z: net cash flow is 6m × 0.75 − 0.5m = $4m in years 1, 2 and 3. In year 4, the residual value
of the machine is $0.5m. This will be an additional cash inflow in year 4.
2 Project Y payback is four years. Project Z payback is three years.

Project Y makes an annual profit of $1.2m.
Average investment = $10.5m
ARR = 1.2m ÷ 10.5m × 100 = 11.4%
Project Z makes an annual profit of $1.125m.
Average investment = $6.25m
ARR = 1.125m ÷ 6.25m × 100 = 18%
4
Project Y Project Z
Year Discounted cash flow @ 12% ($) Discounted cash flow @ 12% ($)
0 −20 000 000 −12 000 000
1 4 450 000 3 560 000
2 3 950 000 3 160 000
3 3 550 000 2 840 000
4 3 200 000 2 880 000
5 3 420 000
−1 430 000 440 000
Project Y: NPV @12% discount = −$1 430 000

Project Z: NPV @12% discount = $440 000
5 Relevant issues include:
• Project Y makes a higher annual profit but the purchase price is $8m more. Its annual rate of
return is only 11.4% compared to 18% for Project Z. Profitability is a fundamental goal of the
business and Project Z is forecast to be more profitable.
• The payback for Project Z is three years, compared to four years for Project Y. A quick
payback reduces risk as the predicted cash flows are sooner. Payback is particularly important
if a business is short of finance.
• The NPV for Project Z is $440 000 at a discount rate of 12% and is therefore worth
consideration. However, the NPV for Project Y is negative, i.e. taking into account the time
value of money, the project does not generate sufficient net cash flows to justify the initial
capital cost.
The quantitative evidence is clear. Option Z is the favoured investment as it has a higher rate of
return, quicker payback and a positive NPV. Project Z is also significantly cheaper and therefore
the business does not require such a healthy cash position to proceed with the investment.
Managers should always consider qualitative factors alongside the quantitative investment
appraisal techniques. In some cases, qualitative factors will prove decisive. The qualitative factors
relevant to this decision include:
• Impact on the current workforce. Project Y would lead to six redundancies whereas Project
Z would only require three redundancies. Opposition from the workforce is likely to be
greater with regard to Project Z. The trade union has expressed concern about job cuts, so
management should consider consulting the union to avoid industrial relations problems.
• Training for workers. For Project Y, workers need training. AP would have to select workers
carefully and there could be discontent from workers about who is chosen.
• Impact on the environment. Project Z machinery is noisy and there could be opposition from
the local community. AP may be concerned about corporate social responsibility.
• Impact on customers. Project Y is highly automated and allows links with customers that will
speed up the production of materials. This could help AP’s reputation and help maintain
market share.
• Reliability of machinery. Project Z uses a proven technology whereas Project Y uses new
technology which may prove to be unreliable. There is an increased risk with Project Y.
Evaluation: qualitative factors are important and should influence decisions such as this because
businesses have a responsibility not just to shareholders but also to other stakeholders such
as employees and the local community. However, there may be conflict between the wishes of
different stakeholder groups and difficulty in weighting the relative importance of those factors.
be different.
Coursebook answers
Chapter 36
Business in context
Importance of analysing accounts before developing a new business strategy
• Analysis will identify what the business can afford to invest in.
• Analysis of accounts is required to consider sources of finance. Gearing and liquidity will be
particularly important influences on whether to borrow capital.
• Accounts will show whether the business is sufficiently profitable to support an application for finance.
Impact of expansion on profitability
• In the short term, profitability might decrease due to an increase in interest costs from borrowing and
the high level of depreciation. Both of these are expenses, so reduce profit.
• Increase in profits by improving efficiency and productivity. Higher productivity could lower unit costs
and result in high profits per unit or more competitive pricing which leads to higher sales. Greater
efficiency (e.g. reducing levels of inventory) will also reduce costs.
• Manufacturing the new range of products should increase sales and profit, depending on costs.
Activities
Activity 36.1
1 Delayering to reduce overhead expenses. This will not directly impact gross profit margins, as the
delayering will not reduce the cost of sales. With fewer middle managers, expenses are reduced and
therefore the profit margin should increase. However, delayering will increase the span of control
and the workload of the remaining managers and supervisors, which could affect productivity and
delay decision-making or reduce the quality of decisions. This could affect sales and therefore profit.
With fewer levels of management, vertical communication could be improved and there would be
less bureaucracy, which could improve the flexibility of the business to respond to market changes. If
profits increase, the RoCE will increase.
Increasing promotional spending. This will increase expenses but, if it is successful in improving the
brand identity, demand will be less price elastic and higher prices could be charged. Therefore, the
gross profit margin will increase. Higher expenses will be deducted from gross profit and therefore
profit from operations could either be higher or lower depending on the change in revenue compared
to direct and indirect costs. The effectiveness of the promotion will be critical to the overall impact
on profitability.
A final justified conclusion about which is the best strategy to use in this case is needed.
Activity 36.2
1 Reduce dividend payments. The dividend per share increased by $0.15 between 2019 and 2021.
Shareholders will have benefited from this increase. If dividends are reduced, there will be more
retained profit to use to pay back debt. However, shareholders may be unhappy about the reduction
and it could result in a decrease in the share price of Company B. This is not necessarily a problem,
as it does not directly affect the finances of the company. It might become important if the business
wanted to raise more money from shareholders or if the decrease in share price encourages a takeover
bid from another company. Shareholders might accept a reduced dividend as risk is reduced if gearing
is lower.
Delay payment to some suppliers. Trade payables turnover of only eight days is quite low. Often
businesses will have credit terms of a month or more to settle debts. Delaying payments will release
some finance to repay debt but can only be done if suppliers are willing to offer a longer credit period.
If Company B takes the decision without the agreement of suppliers, there is a danger that future
supplies will be affected, which will affect operations and sales.
A final justified conclusion about which strategy could be preferable in this context is needed.
Activity 36.3
1 Introduce a just-in-time system. Just-in-time inventory control will decrease inventory holding and
therefore increase the rate of inventory turnover. With less inventory, holding costs will decrease,
helping to increase profitability. However, Company C must be certain that suppliers can reliably
supply materials on time to avoid the costs of running short of inventory. Small shipments of supplies
reduce purchasing economies and are therefore likely to increase the unit cost of materials.
Only sell products online. This is a major change from using retailers. Costs of distribution will
increase. However, trade receivables will be reduced to zero as all furniture is paid for before
distribution. Selling directly to consumers will enable Company C to absorb some of the profit margin
of the retailer. This will increase profitability. However, as consumers can no longer see and touch the
furniture, there is a risk of sales being lower.
A final justified assessment of which is the best strategy to use in this context is needed.
Activity 36.4
1 Borrow finance. Using debt finance increases gearing, which is already high. This is a riskier strategy
due to the additional interest costs that Company D has to pay. With inflation being high, interest
rates are likely to be high as well. Therefore, the interest costs could be significant. However, with high
inflation, the real value of debt decreases quickly and, with strong economic growth and demand for
energy increasing, Company D should be able to service the debt. Shareholders will potentially gain
from a debt strategy as profits increase.
Raise finance from shares. Using shareholder capital is less risky but the reward to shareholders is
likely to be lower as there are more shareholders to pay from profits. It can be expensive to issue new
share capital due to legal, marketing and banking costs. However, it provides permanent capital that
does not have to be repaid.
Evaluation could include a consideration of whether banks are willing to lend and whether there
is sufficient demand for shares from shareholders. In the long term, shareholders are more likely to
benefit from Company D using debt finance. Risk does not appear that great, given the nature of the
product and the likely future demand for it. A final, justified conclusion about the most suitable source
of finance is needed.
Activity 36.5
1 If earnings per share are predicted to halve next year, profits after tax and interest are expected to
decrease by 50%. Falling profit is likely to reduce the demand for shares and this will cause a fall in
share price. Shareholders may decide to sell their shares as well if they think the price is set to decrease.
Secondly, as the dividend per share is to be reduced by $0.15, it is less desirable to hold or purchase
shares in Company E. This is also likely to result in the market share price falling. The P/E ratio gives
an indication of the confidence of shareholders in the future profitability of the business. The evidence
does not give any reason for shareholder confidence to increase. Therefore, it is unlikely that the P/E
ratio would increase to 12. It is more likely to decrease as shareholders dispose of shares, and the
price falls.
2 The lower-dividend strategy reduces the return from investing in Company E. Therefore, shareholders
are less likely to invest in Company E. This could result in a decline in the share price and therefore
affect the capital gains for shareholders that come from a rising share price. However, a low-dividend
strategy may enable Company E to reduce debts or invest in expansion. Reducing debts reduces
interest payments and therefore increases profit for the year. Expansion can result in higher sales and
profits, therefore increasing dividends in the future and increasing demand for shares, leading to an
increase in market share price.
Evaluation could consider that the reaction of shareholders might depend on whether they are short-
term investors hoping for rapid increases in share price or long-term investors hoping for future
increases in dividends and, possibly, share price.
Activity 36.6
1 a Debt finance will increase gearing as gearing is fixed cost capital ÷ total capital × 100. Although
total capital will also increase due to the acquisition of assets, the ratio of debt to total capital
will rise.
b The sale of redundant factories will transform a fixed asset into cash. This will increase current
assets and therefore the liquidity of the business will be higher.
c The profit margin may increase due to economies of scale which reduce average variable costs.
The sale of factories will reduce the average fixed costs. Therefore, the profit margin
should increase.
d If Company F has doubled in size, and profits have more than doubled, the RoCE will increase.
The relative increase in profit is greater than the increase in capital employed.
1 ZenCO Construction (ZC)
1 The gross profit margin has decreased from 25% to 22.5%. Although revenue has increased by
18.3%, cost of sales has increased by 22.2%, so the GPM has fallen.
Profit from operations has decreased despite the increase in revenue. Overall costs have increased
by $24m and revenue has only increased by $22m. This has contributed to a decrease in the RoCE
from 22.5% to 18.4%. This is the primary profit ratio.
2 The data only covers a two-year period so it is not possible to identify trends. It is also necessary to
compare these ratios with other building companies to provide a benchmark to judge performance.
Ratios do not take into account qualitative factors affecting the business. For example, as the
economy has been growing rapidly in recent years, this should have been an opportunity for ZC to
not only increase revenue but also increase profitability. Therefore, the performance of ZC looks
even more disappointing. ZC’s objectives for the year are also a factor to consider. Perhaps one
objective was to increase sales rather than profit.
Evaluation could assess that these results are useful to an extent, but that a much fuller analysis of
past years and accounts from similar companies is needed before strategic decisions can be based
on the ratio analysis.
3 The gearing of ZC would increase due to the use of debt finance to purchase the site. It is likely
that the development would reduce the liquidity of the business as materials would need to be
financed and employees paid. These cash outflows could place the business in danger of insolvency
as cash inflows from the sale of apartments on the new site would take 12 months to start coming
into the business. However, ZC’s liquidity position would also depend on how many properties are
due to be sold from current work in progress. As this is a significant investment in property, it is
likely that the inventory turnover would further decrease, as for the next 12 months ZC would be
building the apartments and therefore holding large amounts of inventory. Profit from operations
would depend on when the apartments are finished and sold. Profit would be potentially high
as ZC is adding significant value to the site. However, if the government increases interest rates,
this could result in property prices falling, which could reduce ZC’s profit. Shareholders might be
concerned that ZC is at risk from overtrading and the amount of new debt. This could cause a
decrease in the market share price.
Evaluation could consider and make a judgement about the most likely impact on the accounts/ratios.
4 Gearing would decrease as the takeover would increase total capital and would be financed by
the issue of shares. As ACR has low liquidity, ZC may have to inject capital into its operations to
complete its work in progress. This would reduce the liquidity of ZC. The small starter homes sold
by ACR are likely to have a lower profit margin than the luxury apartments sold by ZC. Although
ZC’s profits might increase, this would reduce ZC’s operating profit margin. Inventory turnover
could increase as ACR sells small starter homes; therefore, they may be quicker to build, reducing
the relative amount of work in progress. Market share price could fall if the market is concerned
about the long-term prospects of ACR’s operations, given its financial difficulties. However, those
financial difficulties give ZC an opportunity for acquiring assets at a low price.
Evaluation could consider and make a judgement about the most likely impact on the accounts/ratios.
be different.
Coursebook answers
Unit 5
LeFranc Kitchen Machines (LKM)
1 The budgeting system involves managers setting budgets for each factory and product range. This gives
managers greater responsibility, which Herzberg identifies as a motivating factor. Budgets will also be
more realistic and it is more likely that the monthly financial targets will be achieved. This should help
LKM compete against its larger rivals.
LKM will benefit from the more effective monitoring of the budgets that the new system allows.
The finance director, in discussion with managers, will be able to take action on adverse variances
and therefore identify and correct problems. This is a key purpose of effective budgeting and will help
control costs and ensure that profit targets are achieved.
2 a i Market price per share ÷ earnings per share = $5 ÷ $0.275 = 18.2
ii Dividend per share ÷ market price per share × 100 = $0.20 ÷ $5 × 100 = 4%
b The proposed dividend is $20 million less than in the previous year. That would be a dramatic
decrease and result in a decrease in the dividend yield to 4%. A lower dividend yield, despite the
falling share price, might dissatisfy shareholders. That could result in shareholders selling shares
and further reduce the value of LKM on the stock exchange. However, it would allow for internal
financing of the expansion plans, helping to reduce the interest burden associated with debt.
As gearing is already over 50%, this would be beneficial.
The price/earnings ratio has risen to 18.2. This means that it would take over 18 years for earnings
per share to cover the current market price of LKM shares. This may indicate that the market has
confidence in the future profitability of LKM. However, an increasing price/earnings ratio with a
lower market share price reflects a significant decrease in LKM’s profits.
Evaluation: a decrease in dividends risks a further fall in the share price. However, shareholders
might be persuaded that the long-term benefit of the investment makes accepting a lower dividend
today worthwhile. Directors would also have to take into account that LKM does not have
sufficient profits to pay the same dividend as last year. Final decision and justification required.

1 Relevant comments might include:
• Option B only requires a net investment of $7 million, which is $21 million less than Option A.
• Option A has a higher estimated ARR and expected monetary value than Option B. This could
justify the much higher level of borrowing that would be required.
• Option A is lower risk as it is market penetration. With a 32% market share following the takeover,
LKM would be as big as its two rivals.
• Option A would give LKM the scale to be cost competitive with the other two remaining firms in
the market.
• Option B could cause significant disruption to production and only 40% of employees would be
retained. Industrial action is possible. Training new workers would add costs to the option and
take time.
• Option B spreads risk as LKM would be developing kitchen furniture units for its electrical
equipment. LKM could use these skills to further develop its product range in the future.
• Force-field analysis marginally supports Option A.
• Takeovers often fail to achieve expected benefits because of the difficulty of integrating the
businesses. In this case, there is likely to be a culture clash unless LKM intends to operate the
acquired business as a separate entity.
Evaluation: A fully justified conclusion is required such as: although there is significant risk in Option A
due to the increase in gearing required, as LKM’s objective is rapid growth, Option A is better. Higher
potential profits and market share which builds on LKM’s core competence make this the more
attractive option, subject to sufficient finance being available.
be different.
Coursebook answers
Chapter 37
Activity 37.1

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CAMBRIDGE INTERNATIONAL AS & A LEVEL BUSINESS: TEACHER’S RESOURCE

Data response questions

Data response questions

2 Capital Waste Disposal Ltd (CWD)

Data response questions

Data response questions

2 South American Forest Corporation (SAFC )

Data response questions

2 Persuasive advertising aimed at children is acceptable

5 South Africa accelerates its car production

3 Coaching Inns (CI)

World car industry

Forces for change Forces against change

Cutting costs due to

$530 000 0.8 High

2 Node 2: EV = 500 000 × 0.8 + 400 000 × 0.2 = $480 000

2 Country A: EV = 5m × 0.4 + 8m × 0.6 = $6.8m

Business strategy question

Data response questions

2 Cameron Sweets Ltd (CS)

c Learners’ answers should include development of any two of:

4 Loss of job security (e.g. a firm reducing the size of workforce).

Data response questions

c Learners’ answers will vary, e.g. any two of:

d Focus on non-financial incentives is supported by motivational theorists such as Herzberg, Mayo

Evaluation may include:

Data response questions

Finance Marketing Administration Vehicle

Accounting Sales Office Night Day

Junior sales assistants Office staff Mechanics Mechanics

• Increased motivation of hotel managers due to greater responsibility.

2 A meeting with all workers present.

Evaluation: as SC is expanding operations to Country X, it is beneficial to encourage localised

Business strategy question

2 The initial equilibrium price is P and the quantity is

1 Being product-orientated means product development D

Data response questions

2 Adidas and Rapha

2 Learners’ own answers.

Data response questions

b Learners’ answers might include:

• However, marketing decisions will also depend on:

Data response questions

Evaluation might include:

Data response questions

Disadvantages of Apple owning its own stores:

2 Year/quarter Sales ($000) Four-quarter Eight-quarter Quarterly Seasonal

3 Graph showing sales forecast to 2022:

Business strategy question

Data response questions

• Reliable suppliers to deliver inventory on time.

Efficient inventory management will help ensure that:

Data response questions

Output 1 100 200

2 Capacity utilisation = actual output ÷ maximum output × 100

3 It means that only 75% of available capacity is currently being used.

b These may be considered non-core activities.

Data response questions

d Learners’ answers might include:

Activity Total float Free float

Activity Free float Total float

5 Learners’ answers might include:

2 Critical path = EHKL = 82 days