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THE BUSINESS ENVIRONMENT
QCF Level 5 Unit

Contents
Chapter Title Introduction to the Study Manual Unit Specification (Syllabus) Coverage of the Syllabus by the Manual 1 The Nature of Business Introduction The Nature and Purpose of Business The Business as a Legal Entity The Economic View of the Firm Introduction to the Business Environment Introduction The Internal Environment Change and The Business Environment Managing the Change Process Strategic Choices Introduction The Life Cycle Concept The Nature of Strategic Management Analysis of the Business Environment Organisational Growth Market Structure and Business Introduction Perfect Competition Monopoly Monopolistic Competition Oligopoly A Macro-economic Perspective on Business Economic Systems Introduction Macro-Economic Systems The Government and Economic Activity Regulating the Market Government Interventions to Achieve Economic Objectives Page iii v ix 1 2 2 8 16 27 28 28 42 45 57 58 58 59 64 80 91 92 92 94 98 99 107 108 108 115 127 131

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Chapter Title 6 Governments and Business Introduction Pressure Groups Reasons for Government Intervention in Business Forms of Government Intervention Equality and Diversity Fair Treatment of Employees Business in the Global Context Introduction The Characteristics of Global Business Free Trade and Globalisation Technology as a Driver of Globalisation Theories of Globalisation Going Global Introduction Growth Options in a Global Perspective The Global Financial Environment Globalisation and Culture Limitations to Globalisation Introduction to the Socio-Cultural Business Environment Introduction Demographic Trends and Business Business Ethics Corporate Social Responsibility Whistle-blowing and Corporate Responsibility

Page 139 141 141 143 146 151 154 163 164 164 168 175 179 189 190 190 193 198 205 213 214 214 225 237 245

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Introduction to the Study Manual
Welcome to this study manual for The Business Environment. The manual has been specially written to assist you in your studies for this QCF Level 5 Unit and is designed to meet the learning outcomes listed in the unit specification. As such, it provides thorough coverage of each subject area and guides you through the various topics which you will need to understand. However, it is not intended to "stand alone" as the only source of information in studying the unit, and we set out below some guidance on additional resources which you should use to help in preparing for the examination. The syllabus from the unit specification is set out on the following pages. This has been approved at level 4 within the UK's Qualifications and Credit Framework. You should read this syllabus carefully so that you are aware of the key elements of the unit – the learning outcomes and the assessment criteria. The indicative content provides more detail to define the scope of the unit. Following the unit specification is a breakdown of how the manual covers each of the learning outcomes and assessment criteria. The main study material then follows in the form of a number of chapters as shown in the contents. Each of these chapters is concerned with one topic area and takes you through all the key elements of that area, step by step. You should work carefully through each chapter in turn, tackling any questions or activities as they occur, and ensuring that you fully understand everything that has been covered before moving on to the next chapter. You will also find it very helpful to use the additional resources (see below) to develop your understanding of each topic area when you have completed the chapter. Additional resources  ABE website – www.abeuk.com. You should ensure that you refer to the Members Area of the website from time to time for advice and guidance on studying and on preparing for the examination. We shall be publishing articles which provide general guidance to all students and, where appropriate, also give specific information about particular units, including recommended reading and updates to the chapters themselves. Additional reading – It is important you do not rely solely on this manual to gain the information needed for the examination in this unit. You should, therefore, study some other books to help develop your understanding of the topics under consideration. The main books recommended to support this manual are listed on the ABE website and details of other additional reading may also be published there from time to time. Newspapers – You should get into the habit of reading the business section of a good quality newspaper on a regular basis to ensure that you keep up to date with any developments which may be relevant to the subjects in this unit. Your college tutor – If you are studying through a college, you should use your tutors to help with any areas of the syllabus with which you are having difficulty. That is what they are there for! Do not be afraid to approach your tutor for this unit to seek clarification on any issue as they will want you to succeed! Your own personal experience – The ABE examinations are not just about learning lots of facts, concepts and ideas from the study manual and other books. They are also about how these are applied in the real world and you should always think how the topics under consideration relate to your own work and to the situation at your own workplace and others with which you are familiar. Using your own experience in this way should help to develop your understanding by appreciating the practical application and significance of what you read, and make your studies relevant to your

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personal development at work. It should also provide you with examples which can be used in your examination answers. And finally … We hope you enjoy your studies and find them useful not just for preparing for the examination, but also in understanding the modern world of business and in developing in your own job. We wish you every success in your studies and in the examination for this unit.

Published by: The Association of Business Executives 5th Floor, CI Tower St Georges Square New Malden Surrey KT3 4TE United Kingdom

All our rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the Association of Business Executives (ABE). © The Association of Business Executives (ABE) 2011

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Unit Specification (Syllabus)
The following syllabus – learning objectives, assessment criteria and indicative content – for this Level 5 unit has been approved by the Qualifications and Credit Framework.

Unit Title: The Business Environment
Guided Learning Hours: 160 Level: Level 5 Number of Credits: 18

Learning Outcome 1
The learner will: Understand the significance of the environment on business activity. Assessment Criteria The learner can: 1.1 Explain the features of business activity. Indicative Content 1.1.1 Explain the business organisation as a transformation process. 1.1.2 Describe the different ways in which a business may structure its activities. 1.2.1 Discuss the complexity, volatility and uniqueness of an organisation's environment. 1.2.2 Explain the influence of shareholders on the internal environment of an organisation. 1.2.3 Outline the nature of the external environment (PEST). 1.3.1 Discuss the need to monitor changes in the external environment. 1.3.2 Discuss the implications of environmental change for a business, its stakeholders and society. 1.3.3 Explain reasons for resistance to change by firms, managers and employees. 1.3.4 Describe ways in which resistance to change may be overcome

1.2 Discuss the complex interactions that operate between a business and its environment.

1.3 Explain the need for change and its management within an individual business.

Learning Outcome 2
The learner will: Understand the structure and organisation of business. Assessment Criteria The learner can: Indicative Content

2.1 Discuss the impact of industrial 2.1.1 Classify businesses by sector – primary, and legal structure and size on secondary and tertiary – and discuss reasons for organisational behaviour. changes in industrial structure, including concentration. 2.1.2 Apply life cycle theory to an organisation to explain the strategic choices it faces. 2.1.3 Discuss the advantages and disadvantages of different legal forms of organisation. 2.1.4 Discuss the use of franchises, licensing and joint

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ventures as means of doing business in both national and international spheres. 2.1.5 Distinguish between public sector and private sector organisations and their objectives. 2.1.6 Explain the advantages and disadvantages of large and small firms. 2.1.7 Discuss the reasons and methods by which businesses grow.

Learning Outcome 3
The learner will: Understand the competitive and political environment facing businesses. Assessment Criteria The learner can: 3.1 Discuss differing ways of analysing the environment of a business. Indicative Content 3.1.1 Discuss the need to monitor the competitive environment of businesses. 3.1.2 Analyse a business organisation, using SWOT analysis. 3.1.3 Apply Porter’s Five Forces analysis of the competitive environment to a business organisation. 3.1.4 Evaluate the benefits of benchmarking as a form of environmental analysis.

3.2 Explain the impact of market 3.2.1 Describe the characteristics of perfect competition, structure on the behaviour of firms. monopolistic competition, oligopoly and monopoly. 3.2.2 Describe forms of anti-competitive behaviour and their impact upon other organisations and consumers. 3.3 Describe the complex 3.3.1 Describe the different ways that a government interactions between business and may affect business. government. 3.3.2 Assess the role of pressure groups and lobbyists on business and government. 3.4 Discuss the need for government intervention and the forms it might take 3.4.1 Describe government intervention to control the competitive activities of business organisations. 3.4.2 Outline government legislation to protect the environment and the rights of consumers and workers

Learning Outcome 4
The learner will: Understand the impact of the macro-economic environment on business. Assessment Criteria The learner can: 4.1 Compare and contrast alternative economic systems. Indicative Content 4.1.1 Assess the advantages and disadvantages of centrally planned and market economies. 4.1.2 Discuss the need for the provision of public goods and merit goods in a mixed economy. 4.2.1 Describe the four main macro-economic objectives of government: low inflation, economic growth, low unemployment and balance of payments stability. 4.2.2 Explain the nature and characteristics of the

4.2 Analyse the role of government in controlling the level and pattern of economic activity.

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business cycle. 4.2.3 Discuss the impact of the stages of the business cycle on business and the economy.4.2.4 Discuss the role of fiscal policy in the control of the economy. 4.2.5 Discuss the role of monetary policy in the control of the economy. 4.2.6 Explain the limitations of government economic measures in controlling the economy.

Learning Outcome 5
The learner will: Understand the influence of the global economy on business. Assessment Criteria The learner can: 5.1 Discuss the importance of international free trade and its operation. Indicative Content 5.1.1 Explain the reasons for international trade and barriers to free trade. 5.1.2 Describe the importance of regional trading blocs such as ASEAN, NAFTA, SADC, CARICOM and the EU. 5.1.3 Explain the impact of exchange rate fluctuations on international business. 5.2.1 Discuss the main causes of globalisation. 5.2.2 Describe the advantages and disadvantages of globalisation. 5.2.3 Examine the different perspectives relating to multi-national corporations, franchises and joint international ventures. 5.2.4 Assess the relationship between globalisation and culture change. 5.2.5 Discuss the limitations to globalisation

5.2 Assess the main causes and implications of globalisation.

Learning Outcome 6
The learner will: Understand the impact of socio-cultural influences and technology on business decisions. Assessment Criteria The learner can: Indicative Content

6.1 Describe key demographic and 6.1.1 Discuss the implications of demographic changes social trends that affect business. for business activity (e.g. the age profile of the country’s population). 6.1.2 Assess the impact of social changes on business activity (e.g. women in the workforce). 6.1.3 Explain the impact of national culture on the conduct of business and business activity. 6.2 Discuss Corporate Social Responsibility (CSR) and its implications for business. 6.2.1 Define the meaning of CSR and explain the different views on it. 6.2.2 Discuss the role of business in promoting ethical practices.

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6.2.3 Discuss the costs and benefits to businesses of implementing environmentally friendly policies. 6.2.4 Discuss the role and importance of environmental pressure groups in influencing business activity. 6.3 Discuss the impact of technology on business and business systems. 6.3.1 Identify and describe the different forms of technological change, including the introduction of ecommerce and different applications of technology. 6.3.2 Assess the costs and benefits of changing technology on business activity.

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Coverage of the Syllabus by the Manual
Learning Outcomes The learner will: 1. Understand the significance of the environment on business activity. Assessment Criteria The learner can: 1.1 Explain the features of business activity 1.2 Discuss the complex interactions that operate between a business and its environment 1.3 Explain the need for change and its management within an individual business 2.1 Discuss the impact of industrial and legal structure and size on organisational behaviour 3.1 Discuss differing ways of analysing the environment of a business 3.2 Explain the impact of market structure on the behaviour of firms 3.3 Describe the complex interactions between business and government 3.4 Discuss the need for government intervention and the forms it might take 4.1 Compare and contrast alternative economic systems 4.2 Analyse the role of government in controlling the level and pattern of economic activity 5.1 Discuss the importance of international free trade and its operation 5.2 Assess the main causes and implications of globalisation 6.1 Describe key demographic and social trends that affect business 6.2 Discuss Corporate Social Responsibility (CSR) and its implications for business 6.3 Discuss the impact of technology on business and business systems Manual Chapter Chaps 1 & 2 Chaps 2 & 3

Chap 2

2. Understand the structure and organisation of business. 3. Understand the competitive and political environment facing businesses.

Chaps 1 – 3

Chap 3 Chap 4 Chaps 5 & 6 Chaps 5 & 6

4. Understand the impact of the macro-economic environment on business.

Chap 5 Chap 5

5. Understand the influence of the global economy on business.

Chaps 7 & 8 Chaps 7 & 8

6. Understand the impact of socio-cultural influences and technology on business decisions.

Chap 9 Chap 9 Chaps 7 & 9

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Chapter 1 The Nature of Business
Contents
Introduction

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A.

The Nature and Purpose of Business Two Basic Categories of Business For Profit Business Not-For-Profit-Business

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B.

The Business as a Legal Entity Non-corporate Organisations Corporate Organisations – Limited Companies Charitable Status Overview of Accounting Rules for Each Legal Business Entity

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C.

The Economic View of the Firm Factors of Production Business Organisation as a Transformation Process Classifying Production Classifying Firms into Industry Sectors

16 16 18 18 20

Summary

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Answers to Activities

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The Nature of Business

INTRODUCTION
This chapter is intended to provide you with the basic framework of business: the reasons for starting a business, the categories, ownership and legal status, basis of accounting rules and a discussion of the business as a transformation process. As you work through the chapter, you will find some activities to help you to reflect on each part in order to develop your understanding of the issues involved.

A. THE NATURE AND PURPOSE OF BUSINESS
What a business does depends on the purpose for which it was established and we shall start our examination of this by considering a fundamental difference in the types of businesses which exist.

Two Basic Categories of Business
There are a number of ways of categorising businesses, but we shall start with a very basic distinction in the types of purpose for which they may be established – those that operate for profit and those which don't.  For Profit Businesses The fundamental characteristic of most businesses is to make profit. Whatever the size of the company, the primary objective of the owners or shareholders is to make as much profit as possible. Examples of "for profit" businesses range from multinational companies such as Coca Cola, BP and Xerox to small, local firms such as your local restaurant, hairdresser or dentist. This is not to say that profit is the only objective – many businesses have other important purposes, as we consider below. However, profit making is generally the main goal of Anglo-American business enterprises. By contrast, many Asian businesses provide an example of those for which making profit may be a secondary purpose.  Not for Profit Business Usually businesses that are set up as "not for profit" are charities or organisations seeking to provide a service to the community or to improve circumstances for the "social good". The goal of the business is to spend all of the proceeds on its selected mission and therefore, not to make a profit. These organisations may generate a profit, but in the UK, a not-for-profit organisation does not distribute profits to the owners or shareholders but passes them on to selected recipients or members of the organisation. Examples of not-for-profit organisations are clubs, societies and charities. These may have widely differing objectives and undertake many different activities, as the following examples show.  Trade associations – These exist to provide services to their member firms, such as undertaking public relations and advertising for the trade as a whole, publishing trade magazines, providing information services and arranging exhibitions. They may also offer other services themselves or through a third party – for example, an arbitration service or employment services could be run as a direct service, whereas the trade association might negotiate special terms

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with a third party for members to buy insurance products, holidays or publications at a discounted rate.  Professional bodies – which provide qualifications and education, information services, employment advice, meetings and conferences for their members with the aim of developing and maintaining their knowledge and skills in a particular area of employment. Learned societies – which exist to further understanding, studies and education in their specialist field. An example is the Royal Horticultural Society. Clubs – which provide a variety of activities catering for the specific interests of their members, such as sports facilities (for example, rugby, football or tennis), dinner clubs for members to meet new people, young farmers clubs for those working in agriculture, etc. Charities – which can be formed for many reasons, but always for the benefit of a defined group of people. For example, the National Trust owns and preserves properties and open spaces for the general benefit of UK citizens, the friends of a local hospital provide resources to help care for the very ill, and various children's' charities exist to assist disabled or disadvantaged children.

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Think point
What is the key purpose of the businesses in your country and of the organisations that you have worked for? Make a list of five "for profit" and five "not-for-profit" businesses that you have regular dealings with.

Each of these categories has a distinct set of characteristics which define their nature and purpose.

For Profit Business
We noted above that the primary purpose of these types of business is to make profit. That may be a bit of an oversimplification, but it is generally true. However, an organisation's objectives can vary a great deal and often change with time as the internal and/or external environment alters. For example, many Japanese car companies originally focused on gaining a share of the car market and often made minimal or no profit on each item sold. As time progressed and they became recognised for quality and value, then maximising profit became more important. In general, a business will not normally pursue one objective to the exclusion of all others. However, if there are too many goals there is often no clear focus and owners or other stakeholders can be easily distracted by following several aims, so that the business may not prosper. The major objectives of business usually include one of the following: Survival This is the prime objective of a business since, unless a business can generate sufficient sales to cover its running costs, its start up capital will soon be exhausted and it will fail. Once a firm has reached this stage, which often takes a year or longer, it may then change its prime objective to one of the other common business objectives.

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Profit maximisation Making profit is normally essential for a business to survive in the long term. There are unusual exceptions, such as where the owners have sufficient funds to ignore profit levels and run the business as if it is a hobby, but these are rare. In most cases, the level of profit is crucial to most stakeholders who depend on the organisation for an income. At the most basic level, the profit generated must be sufficient to make it worthwhile to continue to operate of business. However, profit goals can vary in the way they are set, measured and applied to different types of business – for example, as time progresses, larger companies, in particular, seek to achieve some accounting measure such as a specified level of return on capital employed (ROCE) or income per share. Economic theory states that businesses should have the over-riding goal of profit maximisation. In economic terms, profit is defined in two ways:  Normal profit – which is the minimum return that owners must make on the capital sum they invest to prevent them from closing that business and moving their capital to an alternative source, which returns more income from that same capital sum. This could be another business or an interest bearing investment. This approach is a practical application of the economic term "opportunity cost". This concept describes the situation in which as an individual investor uses his/her money to support a particular firm, s/he loses the opportunity of investing it another way where a better return might be received.

Activity 1
What is the opportunity cost of you studying for this qualification? See the suggested answer at the end of this chapter.

Using opportunity cost, normal profit can be seen as the return available on a risk free investment, plus an additional return for the risk involved in different type of investment: Normal profit = rate of riskless interest + risk premium The risk premium will depend on the amount of business risk of a particular enterprise. A retail business would usually have fairly low value of risk premium compared to new high technology or mineral exploration business. In summary, the normal profit is the level of profit that will just satisfy the owner and encourage him/her to remain in business.  Supernormal profit – This is the excess of profit above normal profit. If firms earn supernormal profit they will definitely prefer to stay in business. This type of profit potential will attract new firms into the industry sector and create competition for the existing businesses. In the short term, this may be unlikely as there will not be time for new firms to identify this characteristic of the business sector, but in the longer term, their entry is likely to reduce the level of supernormal profit and possibly force some firms to close their businesses. An example is firms selling computer equipment. When few people wanted to buy computers, prices and profit levels were high, but as demand increased, more firms entered the market and prices dropped. Now that most businesses have computers,

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higher profit levels are to be found in associated areas, such as information security where intellectual capital must be protected for the firms to retain their competitive edge. Market share Gaining a share of the market for a particular product is essential for a business to survive. If is not possible to achieve a viable level of sales, the firm will fail. In the short term, most new entrants to a market aim to gain market share through market penetration. However, market share is often linked to competitive advantage, particularly in the longer-term, whereby a firm attempts to achieve and maintain its position in the market by offering a better "deal" to its customers than that offered by its competitors in the same market. This can be in terms of price, quality, service, etc. The importance of this can be seen in a firm such as Coca Cola, which has the biggest share of the non-alcoholic drinks market but is always seeking to improve this, partly in order to reduce the possibility of its closest rivals such as Pepsico gaining further share. Growth – increasing market share Often firms are forced to grow to survive in their market sector. If they fail to grow their competitors, may take a more aggressive approach and force them out of business. Expansion can be accomplished by internal and/or external growth that results in a growth in their share of the market in that industrial sector:   Internal expansion can be achieved by increasing manufacturing capacity, expanding the premises, purchasing more equipment or adding a new building, for example. External expansion is achieved when the business joins with another firm through a joint venture (strategic alliance), merger (mutual agreement) or acquisition (takeover).

Sales revenue maximisation According to Baumol (1959), sales levels alone are not an adequate business goal – rather, sales maximisation is the ultimate objective of the firm. Hence, business management should direct its energies to promoting and maximising its sales revenue instead of profit. This approach does not ignore the cost of production and the need for a margin of profit. Baumol encourages the adoption of a price that will cover costs and also yield a minimum rate of profits. Thus, while the firm is maximising its revenue from sales, it should generate enough profit to keep its owners/ shareholders satisfied. The objective is usually linked to the desire to retain competitive advantage. It is also closely linked with measuring management success, especially for sales managers whose performance is linked to increases in sales and, thus, revenue. The magnitude of sales is a major indicator of a firm's achievement and a manager's reputation, level of power, speed of career progression and salary may all depend on the level of sales generated. If the sales department is perceived as having a major role in the organisation's success, then sales revenue maximisation is more likely to be the primary objective. Sometimes this results in managers pursuing their own objectives to the detriment of the shareholders, but this is tolerated so long as there is enough profit to keep shareholders content. Satisficing Large organisations are often complex, consisting of many different divisions and or subsidiaries each with different objectives – which sometimes may conflict with each other. Hence, it is impossible for the firm to have a single primary objective. In such cases a minimum level of achievement will be set for the organisation as a whole, and the firm is said to "satisfice" instead of maximise.

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Simon (1957) proposed that decisions were taken in conditions of uncertainty and ignorance. He believed that decision-makers could rarely obtain and evaluate all the information which might be relevant to the making of the best decision. Instead, they work with limited and simplified knowledge in order to reach acceptable choices (satisficing), rather than pursue the best choice where one particular objective is fully achieved. The reason for this could be    Time pressure The influence of powerful stakeholders Lack of knowledge about future external or internal factors.

The adoption of satisficing models of behaviour, instead of maximising, has been found useful in the theory of the firm and corporate behaviour. Cyert and March (1963) perceived the firm as a coalition between shareholders, managers and customers. In their publication "A Behavioural Theory of the Firm" (1963), they reasoned that organisational goals and the outcomes of decision making were a compromise between those of these various stakeholder groups. They also recognised that the compromise reached would depend on the relative power of the different stakeholder groups. A satisficing strategy minimises conflict between different parts of the organisation. In practice, this usually results in setting targets for production, sales, profit, research and development, stock levels and so on. Each period's targets is usually set with reference to the target or the outcomes from the previous period, the logic being that there is certainty about the previous year's achievements. Using past performance to predict the outcomes of an uncertain, unknowable year ahead is seen as better than a 'wild' guess (reflecting Simon's approach to decision making). The targets set are also likely to take supply and demand into account, be influenced by competition in the market and the economy in general. If there is conflict between parts of the organisation about the level of targets, this may be resolved by bargaining on the agreed target outcomes with the result depending on the departments or managers that wield most power in that firm. (This aligns with Cyert and March's approach.) If the targets are not achieved there will be an investigation as to why this situation has occurred and how to rectify it. If it is not possible to meet the targets, they may be reduced or, if they appear too easy to achieve, increased. Coalition governments are a practical example of satisficing. The UK's Coalition Government elected in 2010 was formed by an agreement between the Conservative and Liberal Democrat political parties. The Conservatives pledged to abolish rises in National Insurance for employers and employees planned by the former Labour government, while the Liberal Democrats promised to give "substantial increase" in personal tax allowances to benefit low and middle-income workers from April 2011. The compromise was to keep part of the planned National Insurance rise, the employee element, and to increase capital gains tax on non-business assets to pay for a rise in personal tax allowances, but one which was lower than the Liberal Democrats had planned. Technical excellence This is a frequent objective of research organisations and engineering firms. Innovation and technological advances may be considered as more important than sales or profit maximisation. The pursuit of excellence may bring the kind of reputation which builds sales and profit in the longer term. For example, Rolls Royce is renowned for its excellence in engine technology.

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Corporate social responsibility Although in many cases it will not be the primary objective, corporate social responsibility is growing in importance. CSR covers a wide range of goals relating to the environment and support for social communities associated with the business – for example, demonstrating careful use of scarce resources, avoiding use of child labour and funding projects to help disadvantaged members of the local community. Often, a reason for setting such goals is to attract consumers to buy products based on the perception of the firm as acting for the social good, rather than for the social good in itself. For many firms, there may be a tension between these goals and business goals – for example, Coca Cola's 'Rain' project to assist African people to obtain drinkable water and its confrontation with Indian farmers over its use of water in beverage production when there is too little for locals to grow crops.

Think point
Which companies do you recognise as having a good reputation for Corporate Social Responsibility? Do you see any of these as having conflicting social and business goals? Do you have doubts about the authenticity of any company’s stated commitment to the good of society as a whole?

Not-For-Profit-Business
The primary purpose of not-for-profit businesses will be to fulfil a social need of some kind. Thus, the objective of a healthcare organisation might be to meet the healthcare needs of its community whereas a community play group's might be to make basic social and learning skills accessible to all pre-school children. However, revenue maximisation remains a key objective of these types of business in order that they have the resources to achieve that purpose. They will aim to generate a high level of income while keeping costs to a minimum in order to maximise the use of that income for the primary purpose. Associated with this, many not-for-profit-businesses have high level of service as an objective – aiming to provide the highest possible level of service or the best service achievable for a given cost. The UK National Health Service aims to do this. Not-for-profit businesses may also seek to generate the maximum income in order to extend the services and benefits they provide. There are many organisations which are supported by government bodies to run certain services such as education, travel and so on. This support, often in the form of a subsidy, may cover the cost of providing the service for a certain level of users, but any additional revenue can be used to provide all sorts of special offers to get more people to travel or attend basic skills courses and so on. It can also be applied to other objectives including staff development, management excellence or outstanding customer service. Note, though, that whatever objectives they try to achieve, singly or together, the ultimate aim of not-for-profit-businesses is, as with profit-making organisations, to survive.

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Activity 2
Choose two for-profit and two not-for-profit companies in your country. (a) (b) (c) Find out the purpose of their businesses what their main objectives are. Examine those business objectives and compare the rationale behind any differences Try to find out how their main business objectives have changed over times and for what reasons.

B. THE BUSINESS AS A LEGAL ENTITY
The basic legal distinction between types of business enterprise is their status as corporate or non-corporate organisations:  Non-corporate organisations are those which do not have a separate legal identity from their owners. The main forms of non-corporate organisations are sole traders and partnerships. Corporate organisations are those where the legal status of the organisation is separate from that of the owner. The main categories of corporate organisations are private limited companies and public limited companies (plc).

Very often an individual will start a business working on his/her own as a sole trader. Alternatively two or more individuals may work together in a partnership. In both cases, sole trader and partnership, the business may grow larger and the owners will decide (or not) to change the type of legal business status to a private limited company or a public limited company. (There are some types of organisation in the UK, such as solicitors, that are not allowed by law to form either type of limited company.) Before we go on to examine particular aspects of the legal status of these different types of organisation, there is a further important distinction to consider – that between limited and unlimited liability.  Unlimited liability means that the individual owner or owners of an organisation have unlimited liability for all debts or actions taken by the business. If, say, the organisation fails, the owner(s) would be liable for the full extent of any debts of the organisation and would have to use all their personal resources to meet those debts. Limited liability means that the responsibility of the owners of a business for its debts or actions is limited in some way. In practical terms, this means that the shareholders who are its legal owners are not liable for any debts of the organisation beyond the amount they have paid or agreed to pay for their shares. They may lose all the money they have invested in the company, but cannot be called upon to pay any more. (Thus, the term "limited" in public or private limited companies means that the organisations – or more properly, the owners/shareholders – enjoy limited liability.)

Non-corporate Organisations
As noted above, the main forms of non-corporate organisations are sole traders and partnerships. Sole trader This type of business is owned and managed by one person who provides the financial resources and makes all the business decisions. Since the owner makes all the business decisions, s/he is responsible for the success or failure of the business.

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The sole trader is the most common form of business ownership in many countries. Typical examples of sole traders are small shops, builders, window cleaners, electricians, caterers and plumbers. In the UK, approximately 20 percent of sole traders operate in the construction industry, 20 percent in retailing and 10 percent in catering. In most cases in the UK, there are no restrictions on the ability of a person to set up and run a business as a sole trader. S/he can start up a business at any time and does not need complete any specific documentation – s/he merely advises the Her Majesty's Revenue and Customs (HMRC) of the date the business commenced. (There are a few exceptions where special licences need to be granted, for example, opening a retail wine and spirits shop or starting a taxi firm.) In other countries the rules can be very different especially those countries where trade is highly regulated – a good example being Italy where all businesses must be approved by the local council and are very restricted in their operation. The key legal principle of sole trader status is that the proprietor of the business is liable for all the debts of the business – that is, has unlimited personal liability. An important consequence of this is that if s/he takes out a loan to support the business or its growth, s/he will normally have to provide some form of personal security – such as his/her house – against any failure of the business to repay it. If the business is unable to make the repayments, the bank will seize the property that was taken as security for the loan. This can make investment capital difficult to obtain, and lack of investment capital often severely restricts growth of the sole trader firm. Partnerships The legal definition of a partnership was put forward in the Partnership Act 1890 as: "The relation which subsists between persons carrying on a business in common with a view of profit". Partnerships offer a business the opportunity to share skills and workload, and importantly, to raise more capital than would be available to a sole trader. Common examples of partnerships include the practices of doctors, solicitors, accountants, estate agents, architects and auctioneers. There are two main types of partnership – ordinary and limited partnerships.  Ordinary partnerships There are two types of such partnerships (a) Partnership without a legal contract This is the simplest type of partnership where the partners informally set up a business with no legal contract. It is often applies to married couples or members of a family who open a business together. The partners are jointly and severally liable for all the debts of the business. This means that each of them have unlimited liability in the same way as sole traders. Each partner can be sued for the whole debt and could lose all of his/her assets or be forced into bankruptcy. If one partner leaves the business, the other(s) is responsible for settling all of the debts. (b) Partnership with legal contract This is where there is a formal partnership agreement or deed of partnership between the owners. The existence of a formal deed avoids disputes on how work and profits are to be divided. The agreement will also record the date the partnership commenced and, if it is to exist for a fixed period, the date on which it is to end. If it is not for a fixed period, there should be agreement on what will happen on the retirement or death of a partner.

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If there are no procedures for operating and dissolving the partnership, the individual members can suddenly be faced by all the financial difficulties caused by unlimited liability for all the debts of the partnership.  Limited partnerships The Partnership Act 1907 states that a limited partnership shall consist of no more than twenty limited partners and include one or more persons who are termed general partners. General partners have unlimited liability whereas limited partners have limited liability. From 20 December 2002, the restriction on the number of partners was lifted. Limited partnerships must be registered with Companies House which will issue a newly registered limited partnership with a certificate. This will be conclusive evidence of the partnership's formation. In addition, such partnerships are required to register in that part of the United Kingdom where their principal place of business is situated or is proposed to be situated. As noted above, one or more persons in a limited partnership are general partners who are liable for all debts and obligations of the partnership – i.e. they have unlimited liability. In addition, there will be one or more persons called limited partners, who contribute a sum of money as capital, or property valued at a stated amount, to the partnership. Limited partners are not liable for the debts and obligations of the firm beyond the amount contributed, but are unable to receive back any part of their contribution to the partnership during its lifetime. They also cannot take part in the management of the business and do not have power to oblige the firm to any action; if they do, they become liable for all the debts and obligations of the firm up to the amount drawn out, received back or incurred while taking part in the management of the company. The same person cannot be both a general and a limited partner at the same time. An individual or a legal body such as a company may be a partner in a limited partnership, either as a general or as a limited partner. The limited liability of limited partnerships means that they are able to raise any capital needed more easily, and more finance can be raised in this kind of business organisation than by a sole trader. Partnerships are usually set up by writing out a deed of partnership which is witnessed by a solicitor and sets out the important details such as how the profits and losses will be shared. In a limited partnership arrangement, income can be distributed to partners in a way that minimises the tax liability. This means the partners can pay the taxes on their individual shares of the profits, rather than pay taxes on the partnership itself. Limited partnerships are much less common as it is easier to form a limited company to achieve the same purpose

Activity 3
Take a walk around your local area and see what proportion of businesses are sole traders or partnerships, and in what business specialisations. Find out how easy is it to become a sole trader or to establish a partnership in your country. Are there any restrictions on setting up such a business?

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Corporate Organisations – Limited Companies
In legal terms, a limited company is an organisation that has a separate legal status from those who own it. This means that all assets belong to the organisation and not to the owners. The owners have limited liability. The owners of a limited company are the shareholders – those who have invested their money in the firm by buying (ordinary) shares in the company. The proportion of the company that they own is known as the equity and, hence, ordinary shares are often called equities. If the company fails, the owners are generally not responsible for settling its debts. The shareholders' liability is limited to the amount of equity they own and would lose only the amount they originally paid for their shares. The exception is where owners have secured loans from financial institutions using their own property; this would be seized by the financial institution if the business failed. Shareholders often take no part in managing the firm. Forming a limited company Companies normally have two or more individuals wishing to start a business together. They are required to file a number of documents to establish the company, including:  Articles of Association – this is the document which sets out the rules by which shareholders and the company will be administered, for example voting rights, powers of directors. Memorandum of Association – this document sets out the company name, status, address of the registered office, objectives of the company, statement of limited liability and amount of guarantee. Statement of Capital – this gives details of the types of share (ordinary, preference, etc.), the amount paid up and unpaid on each share, the number of shares issued, the nominal value of shares issued, voters rights and the shareholder's details. Public limited companies must also issue a prospectus which describes the history of the firm, its future prospects and the terms on which it offers its shares.

If the Registrar of Companies approves the application, a Certificate of Incorporation is issued. Directors Directors in limited companies are chosen by the owners to manage the affairs of the company. The powers of directors are written down in the company's Articles of Association which serve as the internal rules of the company. They are also governed by statute, including the Companies Act 2006 which added duties in such areas as:   A duty to promote the success of the company To take reasonable care, skill and diligence and to give consideration to matters that go beyond the Balance Sheet and impact of the business operation on the environment and community.

The Companies Act (2006) also introduced some significant changes to the way companies were registered and included a reduction in the time allowed to file the company accounts as well as making it mandatory to submit the Statement of Capital when applying for incorporation. They now must also complete a Statement of Capital when filing annual tax returns and notify Companies House if the amount of capital changes.

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Types of limited company There are three main types of limited company – private, public and limited by guarantee.  A private limited company is one in which the owners hold a percentage share of the value of the company. Often this is dictated by the amount of the capital sum or the value of the property that each person contributed to the company. There must be at least two directors Owners of private limited companies have limited liability for the debts of the company up to the amount they originally invested. Private companies do not trade their shares to the public, but can offer shares to business contacts. This constraint often restricts raising capital for growth so that most private limited companies remain relatively small.  A public limited company (plc) is a company that trades shares nationally and or internationally. It can sell shares directly to the public or through an investing institution. A plc is owned by the shareholders who have bought an interest in the company. Their liability is limited to the value of their original purchase of shares. In the UK, a public limited company must satisfy the following conditions: – – – – – –  A minimum of paid up share capital of £50,000 There must be at least two shareholders There must be at least two directors The right to offer its shares (and debentures) to the general public A certificate from the Register of Companies that states these requirements have been met A memorandum that states it is a public limited company

A Company Limited by Guarantee is an alternative type of company usually used primarily for non-profit organisations that require corporate status. It does not have share capital and has members who are guarantors instead of shareholders. Guarantee companies include clubs, membership organisations, sports associations and some charities. The guarantors give an undertaking to contribute a nominal amount towards the winding up of the company in the event of a shortfall of funds upon cessation of business. A guarantee company cannot distribute its profits to its members, and is therefore eligible to apply for charitable status if necessary.

Charitable Status
In the UK, applications for charitable status are usually made to Charity Commission. An organisation may apply for charitable status if its aims are exclusively for the "public benefit". There are currently four categories under which an organisation may qualify:     Educational advancement Poverty relief The advancement of religion Purposes beneficial to the community

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Charities with an annual income of less than £1,000 do not need to register. (There is also a category of "exempt charities" in England and Wales who do not need to register, including Industrial and Provident Societies whose objectives are exclusively charitable. However they must still register with the HMRC.) Charities do not have owners in the same sense as non-charitable organisations. Rather, they have "trustees" who have responsibility for the running of the charity and for its property, finances and the employment of any staff or volunteers. There are significant advantages for organisations dedicated to the public benefit to be registered as charities, including:      Charities do not normally have to pay income tax or corporation tax and most other taxes Charities are perceived and regarded in a way that can make it slightly easier to raise funds than it would be as a non-charitable body. Some funding is only available to charities. Donors can receive tax relief on their donation. Obtaining charitable status can take a long time and the organisation is subject to considerable controls, as the Charity Commission imposes complex trading and financial rules to ensure that all money raised, and any surpluses, can only be distributed in accordance with the charitable objectives of the organisation. The trustees can be paid only reasonable expenses, which could restrict the type and complexity of professional assistance from those in senior positions that the organisation can call on. Charity law also restricts what charitable organisations can do and how they are run, including that trustees avoid any situation where charitable and personal interests might conflict, that employees of a charity cannot usually serve on its governing body, and that charities are not allowed to undertake political campaigning. Being a charity restricts the type of trading activities allowed.

On the other hand, the disadvantages of charitable status include:

Overview of Accounting Rules for Each Legal Business Entity
The basic accounting rules vary according to the legal status of the organisation. The rules are very simple for small businesses such as sole traders, but become increasingly complex as size and legal status changes. Here, we are only concerned with a brief overview of what can be a highly complex area of study – you should, though, be aware of most of these rules from your studies of other, specialist units in your course. Sole trader Sole traders are required to submit their accounts to the HMRC annually. They can choose not to prepare formal accounts if their turnover is below a fixed threshold which is dictated by HMRC, but they still need to keep records of income and expenditure over a set accounting period. The sole trader is taxed as an individual and is liable to pay tax on any profit. Partnership If the partnership receives income only from its sales and taxed interest on its bank or building society investments, the accounts the partnership must submit to the tax authorities is very simple. However, if the business income is more complex, a more detailed return will be required.

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Partners may be an individual or a company and different rules apply in relation to their position. In simple terms, these are as follows:  Where the partner is an individual, he/she will be self employed for tax purposes and must pay income tax on his/her share of the partnership profits. S/he must complete documents relating to the partnership as well as his/her own self employed tax return. Where the partner is a company, its partnership profits must be included in the accounts of the company itself and, as such, will be liable to corporation tax.

Private limited companies and public limited companies These companies must draw up Annual Accounts which report its performance and activities during the year. The accounts must include the following main specific financial statements:    Balance Sheet (now known as the Statement of Financial Position) Profit and Loss Account (now known as the Statement of Comprehensive Income) Certain other information depending on the type of limited company.

The period reported on in the accounts is called the "Accounting Period" or "Financial Year". Among other uses, the accounts are used by HMRC to work out tax due.

Activity 4
Complete the following table on the advantages and disadvantages for businesses of the different legal entities. Type of Organisation Sole Trader Advantages Disadvantages

Partnership

Limited Partnership

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Type of Organisation Private Limited Company

Advantages

Disadvantages

Public Limited Company

Company Limited by Guarantee

Charitable Status

See the suggested answer at the end of this chapter.

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C. THE ECONOMIC VIEW OF THE FIRM
This concerns how a firm operates and acts as a transformation process. A firm needs to have certain factors of production in order to transform starting materials (inputs) into products and services (outputs). Since so many combinations of factors of production are possible, firms are classified into particular sectors and then further divided according to actual activities. This form of classification allows us to quickly find information and details about the types of firm and production activities within an economy, and to make comparisons between economies.

Factors of Production
Traditionally, there are three accepted factors of production – land, labour and capital. More recently, it has been proposed that a fourth should be added – entrepreneurship. This is considered a vital addition in a business world that is becoming increasingly competitive.  Land Land as a factor of production can be interpreted in two ways: – –  The space occupied to carry out any production process, such as the land needed for a factory or office, or to grow crops The basic resources within the land, sea or air which can be extracted for productive use, such as metal ores, coal and oil.

Labour Labour refers to any mental or physical effort used in a production process. Some economists see labour as the ultimate production factor since nothing happens without the intervention of labour. Even the most advanced computer can only provide outputs as a result of some human involvement.

Capital This term is also used in several senses. There are two main categories: – Real capital consists of the tools, equipment and the human skills employed in production, which can be either:   – physical capital, such as factory buildings, machines or equipment, or human capital – the accumulated skill, knowledge and experience which allows the physical capital to achieve its full productive potential.

Financial capital, which is the fund of money which is usually needed to acquire and develop real capital, physical or human.

All of the production factors are closely related with most production requiring some combination of all the factors. Only labour can function purely on its own, if the need for space is ignored – for example, an unaccompanied singer or singers. However, the addition of a musical instrument and some training usually provides a better product, and resources and labour are needed to make the instrument and financial capital to make it. The majority of economic history evolves from people's success in increasing the quantity and quality of production through the accumulation of human capital and the development of technically advanced physical capital. Modern firms depend for their survival and success on both their physical and their human resources. Human resources are scarce and talent is at least of equal value to the successful firm as the physical resources it needs to manufacture its products, even when it has adequate capital available.

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Scarcity of resources At any period of time, there will only be a limited quantity of the production factors available to businesses. For example: – – – The workforce will have a certain skill set There will be limited amount of capital assets available Land may be restricted in the location

Hence, an economy would only be able to produce a limited output with all resources it has available. In order to progress, it must find ways to increase its resources.  Increasing the supply of labour The supply of labour can be increased in three main ways: – By the population of the country increasing, through either an increase in the birth rate, which is a normal trend in some countries, but in others, such as UK, the birth rate has been falling over a number of decades, or by the immigration of people of working age from other countries. By decreasing the numbers of people currently not working, through such measures as lowering the threshold at which young people can begin working, extending the retirement age, or persuading retired workers or others such as mothers and fathers who stay at home to care for the children to return to the workforce By developing the skills available in the workforce to improve performance

– 

Increasing the supply of land/resources There is a finite quantity of land and resources such as minerals, water or wood, so this is effectively impossible. However, advances in technology can make previously unusable land and unreachable resources available for productive purposes. More efficient use of resources also makes greater output possible, and recycling and other conservation methods mean that productive resources can be extended.

Increasing the availability of capital Plant and machinery used in the production of goods and services wears out with time as well as becoming less effective as technological progress is made. Therefore it must be replaced by newer items. This requires financial capital investment (spending on capital assets).

Enterprise as a production factor Enterprise is often quoted as the fourth production factor, but there is considerable disagreement about what this term means. The concept of enterprise was developed by economists who wished to explain the creation and allocation of profit which these economists viewed as the reward earned by the initiator and organiser of the economic activity. This individual possessed the special factor of "enterprise" and was able to identify an unsatisfied economic want and to successfully combine the other production factors in order to supply the product that satisfies that want. Larry Page and Sergey Brin, the founders of Google, are an example. They began by exploring how to retrieve relevant data from the large sea of data floating on the internet and within a short period the public were using their website to quickly retrieve facts to satisfy their personal knowledge needs. Enterprise was the factor that started them along the route to Google's global success. The idea came first, then the labour, resources and capital. Many other modern firms have been formed in the recent past by initiators, innovators and risk takers of the kind that certainly fit the accepted definition of the business entrepreneur. It

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is often the case that innovating is easier for a smaller firm where there is less structure in the way operations are carried out and where it takes less time to influence others to invest in an idea – and an oft-cited example to support this is that some of the most important inventions have been declined by large companies (for example, Xerox declined the personal computer). Nevertheless, this identification of enterprise in terms of individual risk-taking raises a great many problems when we attempt to apply it in a general way to the modern business environment. Much contemporary business activity is controlled by very large international and multinational companies such as Microsoft, Toyota, Sony, Philips and Unilever who are constantly challenged to continue to recruit and foster enterprise. This can be seen effectively as developing the skill levels of the existing labour supply and, indeed, most universities now run MBA courses and modules in entrepreneurship in an effort to supply "ideas" people to existing organisations. The notion that large companies do not innovate is also contradicted by the fact that the personal computer was taken up and developed by IBM.

Business Organisation as a Transformation Process
All businesses undertake the conversion of an input into an output; in other words a transformation process. The inputs are the factors of production – land, labour, capital and entrepreneurial skills. The outputs produced can be tangible such as shoes, clothes, skateboards or magazines, etc. or intangible such as insurance, service in a shop. INPUTS Land Labour Capital Entrepreneurship OUTPUTS

Tangibles – products Intangibles – services

The output could be a combination of all four inputs above. For example, a fashion designer producing a new dress or suit, will need resources such as material, labour (to cut, sew, check and pack), real capital in the form of machinery (to sew and pack the item) plus financial capital (money) to buy the physical and human resources. The combination of the risk the designer takes in terms of innovating, using sales skills and being intuitive as to what will appeal to a potential customer are all a part of entrepreneurship. The outputs are the tangible dress or suit and the intangibles are aspects such as the quality of the product and the status or confidence the customer receives from the dress or suit. The nature of the transformation process will differ from one business to another and firms are constantly competing to add value to retain competitive advantage, improve profit level and/or combine the inputs in a way that will reduce costs. Cost reductions are achieved by producing more with the same level of scarce resources, or by producing the same amount (or more) with lower levels of inputs. This can involve changes in the way in which the factors of production are applied – for example, through new working practices, investing in new technology, motivating staff or modifying the way goods and services are produced.

Classifying Production
Production is usually classified into three types:  Primary – the extraction of natural raw materials from land, sea or air, including agriculture and fishing

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Secondary – the conversion of primary materials into more useful physical forms through construction and manufacturing, for example, taking copper extracted from the earth and making copper tubing, or refining oil into various useful liquids such petroleum and diesel. It also includes the production of further products from the outputs of other secondary production, such as the manufacture of cars from steel, plastics and rubber. Tertiary – the production of services in a wide range of categories such as finance, retail, transport, leisure and education. Services are often the last stage of the process of delivering products to the consumer – for example, iron ore is extracted from rock, converted into steel and then manufactured to produce steel tube, which is then transported by rail services to a customer. They can, though, be a product in their own right, such as insurance policies or education.

Note that an individual business may span all the different sectors. For example, a farmer could grow fruit, manufacture jam and then sell it in his/her farm shop and so be involved in primary, secondary and tertiary production. The proportion of employment in each of these sectors is often an indication of the stage of a country's development and/or available resources. Generally, advances in development are associated with a move from, firstly, predominantly primary production to secondary manufacturing, and then into tertiary service-based economies. For example, compare the following proportions for the UK and Ghana. Figure 1.1: Employment by sector (UK and Ghana) UK Ghana

Primary Secondary Tertiary

Activity 5
Find out the proportion of total employment in each of these sectors in your country.

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Classifying Firms into Industry Sectors
Industries, firms that produce similar goods or services, can be grouped together in categories such as engineering. A broad group of similar industries makes up an industry sector. Key industry sectors include manufacturing, finance, chemicals, engineering, leisure and recreation. The Standard Industry Classification The Standard Industry Classification (SIC) is a formal system used in the UK to classify business establishments and other productive units by the type of economic activity in which they are engaged. This provides a standard framework for the collection, tabulation, presentation and analysis of data which can then be used for comparing industrial production, employment, etc. both over time within particular categories and between different categories. The Standards Industrial Classification (2007) has 21 sections and 88 subdivisions. These main sections are then further divided. For example, Classification Section C is Manufacturing, which contains Divisions 10 – 23. Each of these divisions contains groups, which are broken down into classes and subclasses. So: Within Section C, Manufacturing: Division 10 is the Manufacture of Food Products Group 10.5 is the Manufacture of dairy products The classes and subclasses within Group 10.5 include 10.51 Operation of dairies and cheese making 10.51/1 10.51/2 10.51/9 10.52 Liquid milk and cream production Butter and cheese production Manufacture of other milk products (other than liquid milk and cream, butter, cheese, etc.)

Manufacture of ice cream

(Source: UK National Statistics Office) In this way, the SIC system covers every industrial activity within the 21 sections. Trends and reasons for changes in industry sectors The SIC structure changes over time to reflect new products and the emergence of new industries that produce these products. The UK Office for National Statistics states that the classification has been revised six times since 1948. There are also changes in the relative importance of existing industries. In the UK, for example, manufacturing has declined while services have increased very substantially, and this will be reflected in the changes since 1948. Rural development is a key factor in changes in the SIC. With economic growth, workers in the country (mostly in the primary sector) tend to move into the manufacturing (secondary) and service (tertiary) sectors. This involves movement of labour from rural to urban areas. The migration of labour to the secondary and tertiary sectors forces agricultural production to become more efficient and intensive in its use of physical and human capital, of knowledge and technology, in order to maintain and develop production levels with decreasing resources.

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Activity 6
You are thinking about setting up a business to provide web design, hosting and search engine optimisation. You have approached a number of friends who are interested in joining you in the business. As a group of five people, you have £20,000 that you could invest to start the business. (a) (b) (c) What types of legal business status should you consider and why? What factors should you consider when deciding on the main purposes of the business and why? How will the different factors of production impinge on your success?

See the suggested answer at the end of this chapter.

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SUMMARY
Businesses are set up for two main purposes – to make profit for their owners, or "not-forprofit" which aim instead to provide services for the benefit of (particular parts of) society. For-profit businesses can have a variety of key objectives such as sales maximisation or growth in market share, rather than being solely about profit maximisation. The legal status of the business defines particular operational rules applying to the business organisation, including those about the way in which it presents its accounts. There is a basic distinction between corporate and non-corporate forms of organisation, the former including private limited companies and public limited companies (plc), and the latter covering sole traders and partnerships. A further distinction between business organisations is that of the liability of the owners for the debts and commitments of the organisation. In limited liability businesses (which includes all corporate businesses and certain types of partnerships), the owners are considered to be separate entities from the business itself and are only usually only responsible for debts and commitments to the extent of the property they originally invested. Unlimited liability means that the owner does not have a separate legal status from the business and is responsible for all debts and commitments made. Businesses may be considered as transformation processes that convert resources into products and services. The resources required for this process are termed factors of production and there are generally considered to be three such factors – land, labour and capital. A fourth and more recent addition to factors of production is entrepreneurship; an ability to visualise the unconscious future need of a customer and to innovate a product or a modification to a product to satisfy that need and to find ways to sell it successfully. Production, and businesses, are divided into three economic categories – primary (extraction of natural resources and agriculture), secondary (manufacturing) and tertiary (services). Production, and businesses, may also be further classified into industry types or sectors under the standard industry classification (SIC). Such classification enables the development of comparative data to show trends in production and employment within and between different types of industry.

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ANSWERS TO ACTIVITIES
Activity 1 The opportunity cost of you studying for this qualification is any other activity you could be carrying out instead during the same time period – such as earning money on a part-time job, enjoying leisure activities with your friends and helping your family with some of the domestic tasks. You could also include the financial cost of your studies, in which case the opportunity cost would be what you may otherwise have spent the money on (or, perhaps the return possible from investing the same sum). Activity 4 For this task, you should have been able to think of several aspects not mentioned in the text. The following is a fairly complete list and many will be covered in later chapters. If you have identified any additional points, well done. Type of Organisation Sole Trader Advantages Disadvantages

Simpler tax Free to make own decisions No difficult legal contracts to start the business All profits are the owner's

Legal status is same as business – therefore, unlimited liability Limited resources Growth difficult Long working hours Legal status is unlimited liability – liable for all debts, jointly and solely If a partner leaves, the other(s) must pay all outstanding commitments Limited resources Growth difficult Limited partners have no decision making power Ordinary partner is liable for all debts and liabilities More complex tax matters Must register with Companies House

Partnership

Simple tax returns Profits shared between partners Easier to make decisions Can be a legal arrangement

Limited Partnership

Limited partners have limited liability for debt up to the value of property originally invested Legal agreement Tax advantages Able to share skills and responsibilities Able raise capital relatively easily

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Private Limited Company

Shareholders have limited liability Owner and company are separate entities Company owns the assets Profits are distributed between shareholders Usually the shareholders manage the business

Taxation is much more complicated Legal documents provide the working practices and other rules which must be adhered to Tax documentation must be lodged annually with Companies House Shares are not available for sale publicly, so raising funds for expansion can be limited Owners do not generally get involved in managing the business, so actions taken in running the business may not be in the interests of the owners The amount of profits distributed as dividends is at the discretion of the Board, but may also be partly retained in the business for growth Dividends not guaranteed Taxation can be very complicated Legal documents provide the working practices and other rules which must be adhered to Tax documentation must be lodged annually with Companies House Its owners are guarantors not shareholders The guarantors give an undertaking to contribute a nominal amount towards the winding up of the company in the event of a shortfall of funds upon cessation of business

Public Limited Company

Shareholders have limited liability Owner and company are separate entities Company owns the assets Profits are distributed between shareholders as dividends Shares can be sold to the public and substantial capital can be raised

Company Limited by Guarantee

Can be for non-profit organisations that require corporate status without the applying for charitable status It cannot distribute its profits to its members, and is therefore eligible to apply for charitable status if necessary Guarantee companies can be very varied giving considerable decision making flexibility

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Charitable Status

Do not normally have to pay most standard taxes Regarded by public in a way that can make it easier to raise funds than non-charitable bodies Donors can receive tax relief on their donation

Obtaining charitable status can take a long time and the organisation is subject to considerable controls Trustees can be paid only reasonable expenses which restricts the professional assistance available Charity law demands that trustees avoid any situation where charitable and personal interests might conflict Restricts the type of trading activities allowed

Activity 5 (a) It is likely that you would be a "for-profit" type business unless the group is intending to offer a "not-for-profit" service to some sector of the community. The options for legal status would be to form a partnership or a private limited company. A legally binding limited partnership agreement would be sensible as one of the original team might leave the organisation and the others will be left to pay all the commitments if the business should fail. In that case, though, one person would have to be a general partner and assume unlimited liability. You could also consider setting up a private limited company and allotting shares according to the capital you have invested. The documentation and legal formation can be relatively straightforward, and as the owners you will all have limited liability. However, there will more restrictions on the way you operate and a more complex tax regime to comply with. In summary there are advantages and disadvantages to each option. As a group you have to make the choice between being the owners of a company with more freedom but unlimited liability, or the more complicated operation (with less freedom to act) and more complicated tax affairs which comes with limited liability. (b) The business objective will probably be survival in the first instance, but you would also want to set some positive goals which will enable you move forward after establishing the viability of the business in the market. This may be to gain a particular market share and to maximise sales to start with. Profit maximisation is likely to be an objective when the business is on a sound footing. Having one or two main purposes allows you to set your goals or targets accordingly and work towards them. However, remember not to have too many objectives or you may lose focus and fail! (c) The possible ways that the factors of production may impinge on your business include:  Labour – You and your colleagues may not be sufficient, on your own, to make the business a success and you would, then, have to employ additional staff. More importantly, you and your colleagues may not have all the skills required to make the business a success. If the missing skills are scarce, then, if you can find individuals with them, you may have to pay more to acquire their services.

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Alternatively, you could develop those skills by training one the founders or taking on an untrained person and developing that person. If the skill is crucial to the initial success of the business, then it could be a big cost. However, this has to be balanced against failure without that skill.   Land – This should not be an issue as, usually, IT based firms require only small premises and you could even start operations out of your home or garage! Capital – This is, with labour, is often the most scarce resource. £20,000 may not go very far in covering start-up costs, so decisions will have to be made about how the capital you have is spent, keeping some for day-to-day running costs and unforeseen emergencies. You will have to create forecasts for spending and income and monitor these carefully so that you do not incur cashflow problems in the early stages. Technology also changes quickly and it may be that having the most up-to-date equipment is important and, then, you may need to budget for changing some of it regularly. Enterprise – Are you entrepreneurs? Who are the ‘ideas’ people? As a small organisation, you should be able to make fast decisions and thus get your service to market quickly. However, you need to consider what will make potential customers perceive your service as superior to that of your many competitors in this area.

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Chapter 2 Introduction to the Business Environment
Contents
Introduction

Page
28

A.

The Internal Environment Forms of Organisation Formal and Informal Structures Line Organisation Span of Control Functional Organisation Staff Relationships Matrix Structures Mintzberg's Model The Virtual Organisation

28 29 30 31 34 34 37 38 40 41

B.

Change and The Business Environment The External Environment – PEST Analysis How can the Firm Influence its Environment? The Internal Environment – Responsiveness to Change

42 42 43 43

C.

Managing the Change Process Planning and Communication Change Models The Role of Change Agents Stakeholders and Change

45 46 47 50 51

Summary

54

Answers to Activities

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INTRODUCTION
This chapter provides an overview of the manner in which organisations structure themselves so that they are able carry out their business effectively. We start by looking at ways the internal environment can be organised. While there are a number of classical ways of attempting this, we also reflect on less conventional structures that firms have adopted in an attempt to cope more adequately with the needs of modern business and/or globalisation. The external environment of the company can have an affect on the way in which the internal organisation is structured, but its most important influence is on business planning. Organisations need to continuously monitor and review the external environment for change, and assess how such change may impact on both the content and implementation of their business plans. Managing and responding appropriately to changes in the external environment is a crucial process for survival and prosperity, especially in the fast moving world of business today, and it is this which we examine in the second half of the chapter. Change is no longer a step process which must be handled on a periodic basis – it is a continuous process that impacts greatly on success, failure and mediocrity.

A. THE INTERNAL ENVIRONMENT
The internal environment is concerned with the way in which people interact with each other for the purpose of accomplishing the organisational goals. Most large businesses started either as one individual carrying out every function of the business or a group of entrepreneurs who got together to take a business idea or philosophy forward. These small firms will then have subsequently grown into much larger organisations and, in the process, will have had to consider how they can best be organised to use their skills and competences to grow the business successfully. For example, in 1824 John Cadbury opened a grocer‟s shop in Birmingham, selling cocoa and drinking chocolate that he prepared himself using a mortar and pestle. In 1831 he started to manufacture on a commercial basis. Many years later, the business was enormous and employed many thousands of people - and in 2010 Cadbury's was acquired by Kraft Foods Inc for $19.5 billion. A further example of this scale of expansion is Lenovo, the Chinese PC manufacturer that started business in 1984 with 11 people working in bungalow. By 2010, Lenovo had become the third largest PC manufacturer in the world.

Think Point
What issues do you imagine Mr Liu, the founder of Lenovo, encountered when organising his team to start the business?

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Mr Liu would have had several issues, but perhaps the key ones were:    What role each person would play in the new organisation to maximise their strengths How the business should be organised internally to ensure communication between them What skills did they not have and how would they acquire them.

Underlying this, and the first step in creating an organised structure, even in the initial expansion from one to two people, is the division of work. The first task, therefore, should be to list the tasks to be performed and decide who has the best skills and experience to complete each task. The next step is to decide how each person is going to relate to the others in carrying out their tasks – particularly in terms of decision-making and management authority. Thus, we can say that all organisations require a system for:    Planning and decision making Implementing decisions through a structure of authority and delegation Organising work into functions so that people can specialise and decisions are carried out efficiently.

Different structures provide these systems and are used to ensure that plans and decisions are made on the basis of informed knowledge and that decisions are understood and carried out effectively by all. In every case, good communication is essential.

Forms of Organisation
Many forms of business organisation exist, providing alternative structures for different purposes. In all cases, whatever the type or size of the organisation, general organisational, management and leadership will be the same; it is the way in which these principles are applied that varies. The kinds of questions that will be asked include:     Should the company organise according to its products or services? Would structuring the organisation according to the markets it serves be more appropriate? Should the firm‟s management be centralised or decentralised? Should all the business functions come under one line of control or should each be separate?

In time, the solutions to these questions will alter and it will be external factors as well as internal preferences that will influence the move to new formats. For example, in 2010 Kraft Foods, one of the largest firms in their sector, was organised into three geographical units:    Kraft Foods North America Kraft Foods Europe Kraft Foods Developing Markets.

However, the North American and European operations were then organised by product category, but the Developing Markets by location. Structures must allow for change and development, to enable the organisation to respond to technical innovations, social and environmental developments and, above all, competition. Thus, Kraft changed its organisational structure for Europe in 2009 to provide centralised category management:

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"In line with a revision in strategy, the European operations were reorganised to be based upon a pan-European centralised category management and value chain model. The European Biscuit, Chocolate, Coffee and Cheese categories were changed to become fully integrated business units, further strengthening the focus on these core categories and to ensure that decisions are made faster and closer to the customers and consumers. Each category is fully accountable for its own financial operations, including marketing, manufacturing and R & D. Category leadership based in Zurich, Switzerland, reports to the Kraft Foods Europe President. These business units now make up the Kraft Foods Europe segment." (Author’s emphases) In small organisations, there is not so much specialisation. In a partnership of three or four people, for example, one person may be responsible for all the accounts, purchasing and marketing. The accountant in a small to medium sized business will need to be credit manager, cost clerk, wages clerk and purchasing controller as well. Large businesses, though, need a high degree of specialisation to manage all the work. Communication between specialists then becomes a key issue and is the fundamental challenge when deciding on the organisational form. There can easily be a loss of cooperation and control in large organisations with highly structured specialist departments, which can adopt their own business plans and operational priorities. Any structure must reflect the priorities of the business and be capable of adapting to changes in the organisation's environment and objectives. We shall return to this later.

Formal and Informal Structures
All organisations have formal structures. However, it is important to realise that all organisations also have informal structures existing alongside them at the same time. These informal structures, if powerful, can have considerable influence on decision making and operations. In large companies the two structures are usually quite distinct and in some companies any tendency for overlap of the two is discouraged. In small, especially small family-controlled organisations, the two are very likely to be intertwined. Whilst the formal organisation structure of roles and relationships is determined by management and can be represented by an organisation chart, the informal organisation varies in structure and composition. It is based on relationships between groups and individuals and the power and influence that these have outside of the formal structures – for example, groups of friends, a particular group within a department or even a whole department within the organisation. Any of these may have their own particular agenda, such as a commitment to corporate responsibility or a commitment/inertia to any change in their job roles. The informal organisation has its advantages but also its dangers. For example: (a) Information can often flow freely without time-consuming and frustrating formal communication networks, but personalities can damage business effectiveness and personal arguments or divisions can literally ruin a business. A strong and effective informal structure can make it extremely difficult for a successful, family-managed or individual-entrepreneur-dominated company to transform itself into the kind of professionally managed corporate organisation that the financial institutions and operating capital markets expect in a large public company. When professional managers are brought into an organisation, they can quickly find themselves in conflict with the informal structure. The infrastructure, which is the way in which authority is allocated in an organisation.

(b)

(c)

The formal organisational structure is made up of two basic parts: 

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The superstructure, which is how employees are grouped into various departments or sections.

Line and function are the names given to the two different types of authority that exist in organisations.

Line Organisation
Traditionally, line relationships have been the most important in shaping the structure of the organisation. The key elements are: (a) (b) (c) There are direct lines of authority, linking superior and lower ranking employee/ subordinate directly. There is a chain of command, which means that each subordinate knows from whom he/she is to take orders. At its simplest, line organisation is a direct flow from the top to the bottom of the organisation.

The form of organisation is hierarchical as shown in Figure 2.1. Figure 2.1: The Hierarchical Line Organisation

Vision of future development

Board of Directors Senior Management Middle Management Junior Management Supervisors Operatives

Set objectives

Long term planning

Strategic decisions

Short term planning

Administrative decisions

Operational planning

Operating decisions

Carry out decisions

Communication flows up and down. Information about plans and decisions is communicated downwards through the levels of the hierarchy, while information required so that senior levels of management know how well targets are being met by those at a lower rank, flows upwards. This upward communication flow will include information on sales, output, stocks, orders and finance. Henri Fayol identified the features of the hierarchical line organisation in the early 20th century. According to Fayol, the two key "principles" of management are:   Unity of effort – everyone in the organisation should be working towards achieving the goals of the organisation. Unity of command – each member of the organisation should have one clear superior to whom he/she is responsible. The span of control should not be too wide; ideally no

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person should supervise more than five or six subordinates. (We shall consider this in more detail in the next section.) Line organisations fall into two categories which reflect key aspects of their structure: (a) (b) The number of levels in the hierarchy which then defines its height as either a tall or a flat structure The number of lower ranking employees that each manager or supervisor manages, making the structure either wide or narrow. This is also known as the span of control.

Tall structures Tall structures have many levels, as demonstrated by Figure 2.2. Figure 2.2: Tall Organisational Structure

Director

Assistant directors

Divisional managers

Section heads

Team leaders

Supervisors/foremen Junior staff/operatives

There are advantages and disadvantages to such a tall structure: Advantages Clear line of authority Clear division of work between the various levels Disadvantages Possible confusion of objectives between the numerous levels Possible communication problems both ways, top to bottom and vice versa Slow decision making and implementation Tendency to be bureaucratic, generating an increasing number of levels Career progression and promotion can seem very slow, and those at the bottom may be discouraged

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Flat Structures A flat structure has relatively few organisational levels, as shown in Figure 2.3. Figure 2.3: - Flat Organisational Structure

Director

Departmental managers

Team leaders

Operatives

The advantages and disadvantages of flat structures are essentially opposite to those of tall structures: Advantages Good communication Smaller risk of divergence between the objectives of one level and another More flexible and less bureaucratic Short ladder of promotion Disadvantages Some lack of clarity in authority and division of work Requires greater flexibility at all levels with people being prepared to undertake a wider range of activities. This calls for dedicated and well-trained employees.

In recent years, there has been a reaction against the hierarchical type of organisation shown in Figure 2.1. Instead of the "tall" structure shown there, with several layers of management and supervision, firms have been changing to "flat" organisation structures. In the 1990s, in many organisations, layers of middle management were cut as responsibility for decisions and functions was pushed down to the lowest practical level in the business. The main reasons for this included:    A better educated and trained workforce meant that employees could be given the opportunity to manage their own work New technology made it possible for shop floor workers to schedule, control and maintain their machinery and organise their workload Employee empowerment was considered to be the best route to better motivated staff as people took more responsibility for their own jobs.

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Activity 1
In what types of industry might you find either a tall structure or a wide structure? Make a note of your answer below: (a) (b) tall structure: wide structure

See the suggested answer at the end of this chapter. Can you think of two examples of organisations with each type of structure?

Span of Control
The span of a manager's or supervisor's control refers to the number of subordinates which he/she controls. When an organisation decides the span of control for each manager it will consider the following points: (a) A narrow span for situations is appropriate where much support is required:    (b)   Complex work New members of staff Recently promoted employees. Staff carry out relatively simple tasks Employees are very experienced and do not require much supervision.

A wider span of control is considered appropriate when

Naturally the experience and quality of the manager or supervisor must also be taken into account – the more able the manager, the wider the span of control s/he can operate. Therefore, the key variables in deciding on the width of the span of control are the nature of the work, the quality of the subordinates and the quality of the manager or supervisor. There is often a relationship between the height of the structure and the span of control. Narrow spans of control are most often associated with tall structures, while wide spans of control may be associated with flat structures – with fewer levels each manager has more people to control.

Functional Organisation
This is an organisational structure arranged into specialist groups or departments. Most organisations have at least a degree of functional organisation since it provides for the grouping of specialist work within one area. All organisations have similar specialised business functions but the importance of each of them varies, according to the size and objectives of the firm. Functions include sales and marketing, finance/accounting, human resource management or personnel, security and production. A sole trader will have to manage and complete all functions alone. In smaller firms some of the functions will be merged to form one role.

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The main functional departments of a business The main functional areas of business can be classified as follows: (a) Human Resource Management (or Personnel) This function covers all aspects of managing people:  Strategic human resource planning – numbers and types of employees required for future activities, and integration of staff that become part of the firm after an acquisition Job design Recruitment, retention and talent management Training and development Performance and reward management Redundancy systems, procedures and decisions Industrial and employee relations Health and Safety All legal aspects of complying with current employment law Record keeping.

         (b)

Security Security is essential to safeguard people, premises and materials. Knowledge management and personal data now forms an essential part of this function although the IT department is more likely to manage these aspects of security.

(c)

Marketing Marketing is concerned with ensuring that the products and or services of the business are purchased by consumers. It is involved in the whole process from research into new products through to sales. Responsibilities may include:        Producing a strategic marketing plan that aligns with the organisation‟s strategic plan Market research Product management Sales promotion, traditional and web based Public relations Selling and distribution Servicing and payment.

A large company will have a Marketing Director with managers for specified functions. (d) Production The objective of the production department is to provide an agreed quantity of products in line with the marketing plan. Products have to be of appropriate quality and made at the right cost. Quality control is an essential part of production. It is responsible for:   setting standards checking

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  

materials and components monitoring production following up sales.

Internationally recognised quality standards such as IS0 9001 series are adopted by many firms. Quality control is equally vital in service industries. Many retail stores, banks, hotels and transport firms employ specialist agencies that send out „mystery shopper‟ or inspectors posing as customers to check on the way customers are actually treated. (e) Purchasing Purchasing is the specification and sourcing of materials and components required for all the firm's operations. It may form part of the production department or may stand alone, with separate department sourcing the requirements of all the other departments. Purchasing can be a key element within a company, particularly in respect of costs and the supply of components as they are needed. As a result, many organisations have strict purchasing systems. For example, in American Express a 50 strong Global Real Estate & Procurement Services EMEA team is responsible for acquisition of all goods and services across the organisation and forms an integral part of the business structure.‟ Just-In-Time manufacturing is a relatively recent development, involving component parts being delivered to the factory only as they are required in the production process and reducing (sometimes to zero) the holding of stock. This reinforces the importance of purchasing and stock control. Holding too much stock is costly for the organisation as more effective use of the investment capital could be made in other parts of the business. If stock control is not well managed, production may be held up resulting in lost employee hours. The use of IT based purchasing and inventory as well as the ability to source materials globally has given purchasing a much more responsible role in assisting companies to manage costs, remain competitive and therefore improve shareholder return. The internet has allowed both suppliers and purchasers to gain very detailed information on the quality and price of goods from different competing firms. This has made the role of purchasing easier in many ways. (f) Financial and Management Accounting The Finance Director has responsibility for all the finance and accounting functions. These include:  Obtaining the funds required to run the business. This can be long term capital raised through share issues, long term borrowing possible by issuing debentures or short term working capital. Managing these funds. In large organisations this is the job of the Treasury Department that will also manage foreign exchange dealings. BP, for example, has its own foreign exchange dealing room to do business with the banks. Provision of information to the Board, shareholders and tax authorities. All the financial accounts required by law and the information for investors and analysts are its responsibility. Pay and pensions matters. These are often outsourced to specialised organisations.

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Internal budgets and financial information must be produced for every department and section. This may be carried out by Management Accountants who do these for each department. They will also provide budget control information, usually on a monthly basis. In manufacturing companies, the role of management accountant is particularly important for managing costs and pricing products appropriately. Credit management and control are important functions. There may be a large department in firms that work with huge numbers of customers on a credit basis. Ensuring that payment is made on time is essential for managing the cash flow and for maximising interest on income. This function is sometimes outsourced – debtors are handled by factoring companies, who pay the organisation a guaranteed percentage of the invoice, while deducting an agreed percentage of the invoice as their fee for collecting the debt.

 

(g)

Research and Development This department carries out research into new products and into ways of improving existing ones. Development is the process of planning, making prototypes, setting up feasible manufacturing processes and generally bringing ideas to production and sale. If a firm is to grow and/or survive, it is vital that it has a constant flow of new or updated products to replace those which have reached the end of their commercial life. R&D will liase closely with marketing, production and purchasing, so that product development will be appropriate to consumer needs and the organisation‟s resources.

(h)

Information Technology Personal computers (PCs) are an essential tool in all modern organisations and can be either physically or wirelessly networked into systems, linking everyone in an organisation. In large and small organisations, on all continents, electronic communication has transformed working practices. Although some countries still do not have extensive access to computers or the internet, this situation is rapidly changing as emerging economies that use IT extensively in business, become committed to introducing the computer to school age children. For example, in 2008, the Uruguay Government launched a campaign to provide a laptop for each primary school child. Many organisations in developed countries possess computers with more processing power per employee than they need. This has happened as prices have fallen and firms have purchased the newest models. This has meant that emphasis in some IT departments has shifted from provision of new machines to securing the data that is stored on them. This is the challenge that IT departments increasingly face as keeping confidential data is essential to retaining competitive advantage.

Outsourcing Functions In the last decade or more, many whole specialist functions or parts of the traditional functions have been outsourced. The work has been contracted out to other firms who either have greater expertise in that area and/or can complete the work at lower cost. The larger the organisation the more interdependent are its parts and the greater the problems of communication, coordination and control. Outsourcing is perceived as one way to overcome some of the problems.

Staff Relationships
Line management describes the direct relationship between a manager and his/her subordinates. "Staff" relationships describes the indirect relationships between different

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functional departments where some interact in an advisory capacity with managers in other departments. For example:  A personnel assistant who has no direct line management authority may advise or even require a line manager to take particular actions in respect of some aspect of human resource management such as performance appraisal or job description for new recruit. Similarly, a Finance Controller may offer advice (on request or as one of their responsibilities) to managers elsewhere, so that she/he can forecast budgets, raise limits of authority on budgetary expenditure and so on. Many medium to large companies have an IT department that provides a help desk for computer issues and manages all aspects of electronic communication and security within the firm.

Functional authority gives the staff manager the clear right to instruct line managers in other departments on certain specified activities or procedures, wherever these are being undertaken in the organisation. For example, the Human Resources Manager may be given functional authority over redundancies in all departments of the organisation or the Accounting/Finance Manager may be given authority over budgetary planning and control of other departments. Within these specified areas the staff expert's authority takes precedence over that of the line manager, but in all other areas the line manager's authority is unquestioned. This type of arrangement explains the dual role of many managers as a line manager within their own department and a staff manager with specified functional authority in other departments of the organisation. Issues with staff relationships Problems may arise when staff department “experts” try to control the conduct of line managers in other departments.     Line managers may reject the guidance being offered to them, because they feel that it is they who will carry the ultimate responsibility for their department's performance. Many line managers resent the interference of staff experts whom they consider to be too "theoretical". Some experts argue that having both line and staff managers, complicates the structure of authority because it infringes the principle of "unity of command". The situation is further complicated by the fact that staff managers are also line managers in their own departments. For example, the manager of an accounting department exercises line authority over his/her own subordinates and may resent the intrusion of "advice" from a staff manager from, perhaps, the personnel department about people management matters.

Functional authority can work well at the higher levels, but problems may arise when lower ranking employees, such accounts or personnel administrators are sent in to work in other departments. These assistants may be called upon to report both to their staff managers and to the line manager of the department in which they are located. This can be very frustrating and demotivating as often they will receive conflicting instructions and/or guidelines.

Matrix Structures
The matrix structure combines two structural dimensions simultaneously – for example, functional and product divisions, or geographical and divisional. BP used this type of structure extensively in the 1990s.

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A common form of such organisation is for regional managers and centralised functional divisions to have a formalised relationship as shown in Figure 2.4. Figure 2.4: A Matrix Structure Managing Director

Matrix heads

Director Marketing

Director Finance

Director R&D

Director Production

Director Personnel

Manager Region A

Manager Region B

Manager Region C

The advantages and disadvantages of matrix organisation are as follows. Advantages The organisation is seen as a network of tasks that are best undertaken by teams or taskforces which are set up to achieve specific objectives. They are effective at knowledge management – teams are made up of individuals with specialist skills and information such as different cultural or market knowledge. They are particularly useful to global organisations since they will allow the mix of global and local knowledge. Professional and operational staff are drawn together into a co-ordinated group with shared goals. Disadvantages Individuals are responsible to two managers so that there is a strong potential for confusion and conflict over authority and responsibility among both staff and managers. There may be power struggles for control. Decision making may take longer because of negotiations between managers on different aspects of the task. Dual management has a higher administrative cost. Such structures are harder to control.

Similar types of structure are often employed for organisations working in a project-based manner, when the emphasis is on multi-disciplinary teams involved in complex projects. Project teams or taskforces are important building blocks in many organisations. They may have relatively few members, drawn from higher or lower levels of specialist departments depending on the nature and importance of the task being tackled and they are also flexible, coming into being to tackle a given task and disbanding when the task is finished. This type

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of structure can help build team spirit which lives on, ready for new taskforces to be formed as needed. The most common types of such groups are temporary project groups, set up to investigate and recommend new working strategies or to introduce a new product or service. (a) Strengths of a project structure are:       (b)    its strong focus on the objectives of the project co-ordination of work to achieve those objectives designation of a project manager the employment of specialist skills and support services as necessary centralisation of decision making on the project consequent faster and more flexible response to changing needs. lack of strategic control lack of co-ordination constant breaking up and reforming of project teams can hinder the accumulation of knowledge over time.

Weakness in this structure include:

Mintzberg's Model
The structure of an organisation, then, is the formal pattern or framework of interactions and co-ordination designed by management to link the tasks of individuals and groups in the achievement of organisational goals. Mintzberg's work in the area of organisational structure is useful as it also considers management. Mintzberg, identifies five key elements to an organisation's structure. Figure 2.5: Mintzberg's Model of Organisational Structure (1) STRATEGIC APEX (Senior Management) (4) TECHNOSTRUCTURE Quality Control Maintenance Work Study Human Resource Management (5) SUPPORT STAFF Finance Functions Legal Functions Administration Press and Public Relations

(2) MIDDLE LINE (Middle Managers)

(3) OPERATING CORE

Sales

Marketing

CUSTOMERS/CLIENTS

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The elements are as follows:  Strategic Apex – Senior management takes the ultimate decisions for the organisation. It establishes the core values which are revealed in the organisation‟s mission statement. Middle Line –This reflects the authority structure (infrastructure) linking senior managers to middle managers/supervisors and then to the workers in the operating core. Information flows both ways along this line. Operating Core –This consists of the people who make the goods and/or perform the services. In small organisations, this may be most of the organisation. Technostructure –The function of this element is the co-ordination of the work of the organisation. A key technique for this is Total Quality Management (TQM) where standardised high quality production is the objective. Support Staff –The function of this element is to provide the indirect services required by the organisation; the legal, financial, press and publications experts and professionals.

 

Flexible organisations can adapt by allowing certain sections to expand, whilst increasing productivity can bring lower numbers of workers to the operating core. This model demonstrates the importance of senior, middle and supervisory management.

The Virtual Organisation
Extensive adoption of the internet has created two additional aspects to organisational structure.   The possibility of international or global business for relatively small organisations Less need for office bound staff.

Firms can do business using only their website as a means of communication with both the customer and supplier. Financial transactions take place electronically and the website can contain the database with the information concerning customers and suppliers. Web analytics provide the data the organisation needs to measure return of marketing investment and so on. Similarly, a firm using electronic business methods can operate globally from a small office and have employees, consultants or freelance associates working anywhere in the world from their own home base. There are advantages and disadvantages of the virtual organisation: Advantages Lower administration costs. Fewer and potentially lower employee costs. Bringing in specialists as necessary from anywhere globally. Instant communication. Part time and flexible working for individuals with other responsibilities such as bringing up young children. Disadvantages Control of employees working hours and quality of service. Electronic communication can be subject to connection issues. Some parts of the world will be relatively inaccessible as they have not yet adopted the technology

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B. CHANGE AND THE BUSINESS ENVIRONMENT
The term "change" refers to any situation where conditions differ from one time to another. Development is planned change that is implemented so that objectives can be accomplished. Change can be the result of many factors, not least of which is the modification in consumer attitudes and value systems. The rate of change has never been greater than now and, in particular, the business environment – both internal and external – is accepted as being subject to constant change. Many organisations find this difficult to cope with as it can have a significant effect on all aspects of their business operations. To survive and prosper, every organisation must identify the changes that affect it and adjust its operations to maximise or minimise these effects as best it can. So that we can examine the reasons why organisations need to change to survive, we will examine the impact here that the business environment can have on organisations. (We cover the external environment in outline here as a means of identifying the need for change, and shall return to it in more detail in the next chapter.)

The External Environment – PEST Analysis
There are five major questions which managers must consider when assessing changes in the external environment: (i) (ii) (iii) (iv) (v) What are the threats and opportunities from the external environment in the short and longer term? How can we minimise these threats? How can we take maximum advantage of the opportunities which may exist? What advantages do we have over our competitors and how do these changes help us? What are our limitations?

We need to understand the functioning of an organisation as it interacts with its environment. Four key elements have been identified which, taken together, make up the total environment – these are the political, economic, social, and technological sphere. (There have been extensions to the basic PEST model which we will examine in Chapter 3.) Some of the key issues in these four areas are as follows. (a) Political Organisations are influenced by government policies such as those concerning taxation, political orientations, legislative structures, trade union power and so on. Firms also attempt to influence government thinking in these and other relevant areas to their own advantage by lobbying, providing party funds and through their trade or professional associations, etc. (b) Economic Firms operate in conditions of economic booms and lows (recession). Interest rates change, tax rates change, the money supply can alter and investment levels go up and down, as people try to guess likely future market movements, etc. In the global economy, exchange rates can have an important effect on business performance and since stock markets throughout the world are linked to one another electronically, change can happen and be communicated extremely quickly, resulting in an instantaneous impact on firms. Energy costs play an increasingly significant part in business activity. The world is dependent on a few nations for its oil and gas.

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Pricing and pay policies of large organisations can affect the wider economy particularly as companies compete to recruit and retain scarce talent as well as maintaining profit levels. (c) Social The culture of an organisation is affected by the culture of the society in which it operates. Changes in lifestyles affect the market and thus the running of an organisation, not only employee practices, but the nature of products and services demanded. Social mobility, demography, family size, etc. can all contribute and have an effect on the human resources inputs and the market(s) in which an organisation operates. (d) Technological The level and focus of government and industrial research and development expenditure has an effect on technological changes in the environment. The nature of such changes and the speed of technology transfer will have an influence on an organisation's own technological preferences. Product life cycles appear to get shorter and shorter, particularly in the electronics industry, and shape change. In reality these elements may overlap.

How can the Firm Influence its Environment?
Sometimes, the potential changes in the environment can be foreseen a long time in advance. In such cases, it is possible for the firm to plan action to counteract their effect, if they are likely to pose a threat, or to take full advantage of them if they are likely to offer an opportunity. If changes in the environment happen suddenly, then it is the organisations which can best handle change that are more likely to survive. If firm X‟s competitors adapt to change faster, their actions will impact even more severely on the prospects of firm X‟s survival. Interaction with the external environment is not, though, a one-way process of being influenced by outside factors over which it has no control. It is, rather, a two-way process with the organisation able to make an impression on its environment, through activities such as marketing, use of technology and corporate responsibility initiatives. An organisation can exert influence over its customers, both existing and potential, by making a product or service available or demonstrating a social conscience in its development and so establishing a demand for it which did not exist previously.

The Internal Environment – Responsiveness to Change
Acquisitions are an example of an organisation taking action to influence its external environment, but that in itself may generate change in the internal environment which can be extremely difficult to handle. In most cases, the purpose of acquisitions and mergers is to reduce costs and increase competency levels and ultimately to increase competitiveness and company performance. Yet, if the acquired business is not integrated properly into the company‟s portfolio, the acquisition may result in poorer performance through the inability of both the acquired and the acquiring organisation to change and not deliver the enhanced performance anticipated. There are a number of areas which an organisation needs to consider in respect of its internal environment to ensure that it is prepared for change. (a) Identifying change An organisation must constantly monitor progress in achieving its objectives and identify changes in the internal and external environments that may be impacting positively or negatively on meeting those objectives. It is then in able to adapt in ways

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that will maximise performance. By integrating scheduled monitoring of objectives, identifying change will be more likely and the firm will be more prepared to take remedial action and to stay competitive as a consequence. This may mean changing the organisational structure, working procedures and systems, and management methods. (b) Change areas The organisation needs to be aware of the areas in which change is most likely – for example:    Staffing levels and, particularly, skills profiles Location of employment Working practices

Technology and globalisation are two key external influences which have enormous impact on these areas, often beyond what could have been imagined. Customer power to demand the products and services they require and the companies they will buy from has also had a great influence. Social networking sites and online purchasing have given consumers the ability to research the best products and to quickly advise large numbers of people of the shortcomings of products. These two factors alone have transformed the nature of competition and impact strongly on working practices. (c) Responses to change Some organisations are very responsive to change and have the culture and structure needed to support it. Some are proactive when it comes to change – they plan for change, making contingency arrangements to buffer any changes that may affect them. Other firms, mechanistic organisations, react to it in a crisis situation, when it is too late – change is not usually related to their corporate strategy. (d) Organisational processes involved in change In general, change is best implemented incrementally – that is, in small steps over a period of time – since this allows the firm to use the skills and values of members of the organisation, allowing a smooth transition from one situation to another. A small entrepreneurial company is able to implement change virtually instantaneously as few individuals are involved in decision making. However, in large organisations such as multinational corporations or some public sector bodies, this is very much more difficult. These large organisations will have set structures and routines, and are likely to be far more bureaucratic, slower and more resistant to change. Transformational change occurs when huge strategic movements are required. This is most often the case with bureaucratic organisations, such as the armed forces, local councils and government departments, which have not gradually adapted to modifications in the environment. Over time there has been strategic drift, the organisation has not made strong, radical decisions to deal adequately with all of the changes in its business. (e) Change and context The process of change can be complex and the less change the organisation is used to, the more extensive and painful the change process is likely to be. Change must be approached according the context of the organisation. Johnson and Scholes provide contextual features that need to be considered, these are considered in the following diagram.

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Figure 2.6:- Change and Context Scope How much change? Time How quickly? Resources Which resources should be retained?

Power and Influence Does the leader have sufficient power and influence to implement the change management? STRATEGIC CHANGE PROGRAMMES

Breadth of Experience Is there enough breadth of experience, views and opinions to assist the change process?

Attitude How well will the staff adapt to change? Capacity for Change What resources do we have for the change? Money? Time?

Capability How capable are managers of implementing change?

(Adapted from Johnson and Scholes)

C. MANAGING THE CHANGE PROCESS
The number of aspects to be considered and then implemented in a change situation means that it is often met with resistance from several perspectives such as:    Middle managers who fear that changes in structure such as moving to a flat or matrix one will adversely affect them through a reduction in their authority and power. Employees who fear that change will affect the status quo, separate them from friends and colleagues with whom they currently work or end in redundancy. Uncertainty about what the changes involve results in substantial resistance to change by individuals in an organisation, which can result in, at best, indifference to new strategies and at worst hostility and defiance.

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Resistance to change is a perfectly normal and understandable facet of human behaviour, but if strong enough, it can detract, in a major way, from the effectiveness of proposed new corporate strategies and plans. The manager responsible for the implementation of corporate plans must be skilled in the management of change and in particular must seek to try to minimise or, better still, plan to avoid resistance to change.

Planning and Communication
There are a number of factors which the manager can consider in planning to minimise resistance to change. (a) The involvement of the HR Manager in planning how to approach change and then to implement the agreed plan is a crucial factor in a successful outcome. This is particularly important during a merger or acquisition when two organisations are combining to form one bigger entity. A vital aspect to successfully managing change is effective communication.    (c) The reasons for change must be communicated effectively by focusing on the main points Communicate points in a manner that indicates their significance and acknowledges the challenges for all involved in the organisation Make communication two-way by involving all employees in planning the change itself.

(b)

If the organisation recognises a union or unions, the union representative needs to be involved at the earliest possible stage.

Communication is the key – not everyone can be involved in the change to the same extent, but everyone does have something to add. Change should be communicated through as many channels as possible so that everyone will have the opportunity to understand that change needs to happen. Channels include:      Group meetings One-to-one sessions Online questionnaires Telephone and video conferencing Traditional written mechanisms such as memos, circulars and using notice boards. Warning! Where proposed changes are significant and particularly when they involve complex issues, the use of memos and notices should be minimised. They are impersonal and make the employee feel isolated from the change, can cause low esteem and alienation if their opinions and feelings seem not relevant.

Where significant change is required and employee involvement is crucial to success, as many personal face-to-face channels as possible should be used.. Regular meetings and workshops can be particularly effective, especially if organised for groups of employees from different levels and disciplines to discuss issues, give their opinions and feedback. Cross functional and multi-level groups aid understanding of the issues faced by other departments or organisational levels, and this may help in breaking down resistance to changes that are not understood. Anonymous questionnaires, which allow some capacity to write free text, provide a method of gaining feedback that individuals may not feel comfortable to give in the group situation.

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Feedback should be treated and be seen to be treated, as valuable and important, while the use of more than one technique is likely to provide a more appropriate set of solutions. Effective communication is thus crucial to the issue of managing strategic change in organisations and in particular in trying to minimise or avoid resistance to any such change.

Change Models
Theoretical models can assist organisations in planning change. (a) Schein's "unfreeze-change-refreeze" model Schein recognised the problems that organisations face when planning and implementing change and developed a model to use to pre-empt any potential resistance. This model is known as the unfreeze-change-refreeze model and has three steps:  Step 1: Unfreeze This involves the organisation "unfreezing" existing attitudes and behaviour. Individuals go through a process of "unlearning" old habits, old perceptions and old ideas about how change will affect them.  Step 2: Change This involves a "change" in behaviour. Individuals modify their old ways and adopt new ways of thinking about change – how it should be implemented and how it can be positive rather than negative.  Step 3: Refreeze The final stage involves "refreezing" the newly-adopted behaviours and attitudes. The organisation may need to offer positive reinforcements, such as incentives, to encourage individuals to accept the changes. In this three-step model of change, the process as a whole is achieved through:    leadership communication education and training.

Effective training can be used to create a major change in the attitude of employees, which must then be made permanent by creating the necessary structures, procedures and incentives to support the new culture. A major task for management is to produce the initiatives necessary to achieve the unfreezing step. Good communication is the basis for this:       Setting up employee suggestion schemes Giving staff a greater input into the decision making process Implementing schemes which reward good effort, such as "employee of the month" Creating good team spirit through company identification schemes, such as logos advertising, badges, etc. Producing company newsletters Making managers more visible, for example by "open door" policies.

This model can be used when individuals are opposing change, or when management wants to gain acceptance for a change that directly affects employees, such as a change in working conditions.

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(b)

Lewin’s "force field analysis" model This is another model for assisting with the implementation of change. Lewin identified "driving forces" for change and "restraining forces" against change. Lewin believed that driving forces try to push change through, whilst restraining forces try to resist change and maintain the status quo. The model uses the concept of apparent immobility in a social situation representing a state of "dynamic tension" between the needs, drives, aspirations, fears and other feelings of the people involved. Figure 2.7:- Force Field Analysis Forces for Change Forces Against Change

Time saving

Record Plan change systems to become fully IT-based

Skills

Quality

Redundancy

Production

Communication Cost Global reach

Force field analysis concentrates attention on the identification of the driving forces and the restraining forces, their strengths and how they can be modified. Lewin suggested two ways of dealing with change through this form of analysis: (i) Strengthen the driving forces by encouraging those associated with the change and driving it, to educate and convince those who oppose it that it is for the organisational good. Weaken the opposing forces by:     persuading someone to act as a change agent in order to win over opponents offering concessions to opponents in order to „buy them off‟ involving individuals by means of employee participation principles such as quality circles, joint consultative committees, etc. using a manager, with positional and personal power, to coerce opponents into accepting change.

(ii)

Movement in the desired direction can most readily be achieved by firstly reducing or removing restraining forces. Increasing driving forces before reducing restraining forces often increases the restraining forces in reaction. Merely trying to force change

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through may cause its own problems – people can be uncooperative if change is forced on them. Once restraining forces have been reduced, attention can be given to the driving forces and to gaining further employee commitment through such actions as:  Training staff – although initial cost is increased, fear of technology may be reduced and implementation could take place more quickly, leading to a better revenue stream earlier than forecast. Showing staff that the new systems would introduce variety and interest to their jobs and give them skills which make them more valuable to the business and to employers generally. Raising salaries to reflect new productivity.

The force field model can be used effectively with employees in workshops as part of the process of aiding understanding of the nature of change. It is appropriate to all levels of staff and easy to administer. Each individual or group can be asked to produce two lists – the forces for and against change – and to evaluate why the change is needed. Once the analysis has been carried out, the group can asses whether the project is viable and then examine how to address the two opposite forces identified. Involvement of employees in this way can often generate new ideas that enhance the initial plan. This type of workshop activity should help to break down resistance to change and is particularly useful in getting staff to understand for themselves that change is necessary for business survival.

Activity 2
Your company is thinking of sending production to a cheaper country. They will retain all the other business operations in your location. (a) (b) (c) Write a list of all the factors for the change and another list of factors against the change? Decide whether the company should go forward with the change How could you increase the number of forces for change and reduce those against change?

See the suggested answer at the end of this chapter.

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The Role of Change Agents
Organisations can speed up and facilitate the process of change by using a change agent in a similar way to the way in which a catalyst is used in a chemical reaction. This is a good analogy in that it identifies two important aspects of using change agents:  Only a very specific chemical catalyst will change the rate of a standard chemical reaction and the catalyst used in one reaction will not work in another. Thus: Initial substance A But A Or A
Z Y

Catalyst (change agent) X

Final substance B (desired outcome) A (no change) C (unwanted outcome)

You need to ensure that you use the right change agent to achieve the desired outcome.  Similarly you can alter the rate of a reaction by an increase or decrease in pressure or temperature – i.e. changing the environmental conditions can have an effect as well. You need, therefore, to ensure that the conditions are right for the change agent to have the desired effect.

Very often a new CEO and/or senior managers are recruited to effect change, to act as a catalyst and change the working environment. Companies also seek assistance from outside agents or consultants who have not absorbed its current culture or values and can offer alternatives routes for accomplishing the same change. However, it is not always necessary to recruit new management – it may be that an existing enlightened manager who is able to look beyond traditional approaches can have the same effect. Schein describes the role of change agent as follows: "….to help the organisation to solve its own problems by making it aware of organisational processes, of the consequences of these processes, and of the mechanisms by which they may be changed. The ultimate concern is for the organisation's capacity to do for itself what he/she has done for it." The role of the change agent, then, is not to solve problems, but to be a facilitator, helping the organisation to discover how to solve them itself. The change agent is there to set in motion the collection of information and the building of models for the organisation, prior to indicating where intervention may be of use. The agent is also there to decide which techniques are the right ones to use in a particular situation and to guide their use. The change agent is also a powerful intervention tool, acting as a trigger for action. Much of their influence springs from the way they relate to the organisation. Therefore, they must live the values they are trying to implant. Change agent programmes Some companies develop change agent programmes where they bring together a group of people who are given specific training and tasks to assist the organisation in making the planned change. Change agents are leaders who work across the organisation and its business units and are not limited by the traditional organisational structure. These employees are freed from dayto-day tasks in order to focus solely on leading and driving change. They implement new

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processes, directly or indirectly, train employees on new procedures and act as role models to demonstrate new and better ways to work. Change agents might spend most of their time visiting areas undergoing change, auditing progress, or advising managers on how to improve performance. A change agent programme requires:    careful recruitment and development of personnel close integration between the change agent team and the organisational areas targeted for transformation highly detailed programme design.

Stakeholders and Change
Stakeholders also have a role to play in change, including:      shareholders managers employees customers the wider community whose lives are affected by the organisation.

The role of managers, employees and customers was considered earlier. It is not so widely recognised that shareholders and the community can impose a lot of pressure on an organisation to change working practices. (a) Shareholders Shareholders have control of strategic resources and can remove or increase the supply of money to the organisation. They can bring pressure to bear through:  their voting power at Annual General Meetings, both with resolutions supporting (or otherwise) change and the appointment of directors who will ensure that their will is put into effect their financial power by disposing of their shareholdings and precipitating reductions in share prices.

In these ways they act as a controlling influence on what the business is able to do. (b) Community The members of the wider community have a political role to play. This is clear where governmental organisations are involved and they can vote for or against particular policies and proposals on spending, etc. Public pressure can also be a strong factor, preventing or pushing for change in policies and plans. This can be effective on private companies as well, particularly where communities feel their environment is threatened.

Think Point
You should now reflect on the issue of change in the organisation in which you work, or one in which you have worked recently. Think through the following questions so that you have some of your own examples of change and the way in which organisations handle it. (a) (b) What changes have you witnessed in your organisation in the past two years? What were the main aspects of the change?

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(c) (d)

How many of these changes do you feel were a result of what was happening outside the organisation? How has the organisation handled the change?

There are obviously no right or wrong answers to this as it will depend on your particular circumstances. However, think carefully about where the pressure for change came from. Where it came from external factors, consider how PEST analysis can help to classify it – for eaxmple, economic factors such as the credit crunch or social factors such as the growing importance of corporate social responsibility. What changes were proposed in terms of the internal organisation and what issues arose because of this (for example, the threat of people losing their jobs), or was the response to the pressure to change made in respect of, say, adapting existing products to meet new customer needs or by raising prices. How well the organisation handled the change will again depend on your own perception, but do you yhink it was successful or not, and why? How was the change was managed compared to the methods mentioned here, and would some of these have supported a smooother transition?

Activity 3
Finally in this chapter, we present a short case study of the development of Lenovo, the Chinese computer company we introduced earlier. Consider the following summary of its development and then answer the questions that follow. In 1984, 11 entrepreneurs had a vision to bring the advantages of information technology to the Chinese people. With approximately US$25,000 to invest and the determination to turn their research into successful products, this team opened their business in a rented bungalow. Today it is one of the largest technology firms in the world. Its founder, Liu Chuanzhi, was determined and politically shrewd. Mr. Liu and his colleagues had no experience of running a private company, no idea about modern computers and a formal education that had been cut short by the Cultural Revolution. As they built Lenovo, they had to teach not just themselves, but a generation of Chinese bureaucrats how to run and regulate a private corporation. Much of the credit for Lenovo's success is given to Mr. Liu, who pushed boundaries while staying just the right side of the ideological line. The solutions found to the various problems of the company's development changed the way China does business. Mr. Liu launched incentive schemes and share options to motivate Lenovo's staff, handing out suitcases of cash (and risking imprisonment to avoid the government's 300% tax on bonus payments). He applied pressure for employees to own their own homes, a revolutionary initiative in 1992. Lenovo was the first Chinese company to create advertisements that did more than just name a product and its price, so introducing brand building to China. Though urged to develop a “Chinese chip” and fight Western competitors on quality, Mr. Liu resisted. Seeing that Chinese science lagged behind, he focused instead on cutting prices and copying Western technology and sales methods.

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Questions (a) (b) (c) (d) List Lenovo‟s internal strengths and weaknesses when it started its business in 1984? How did the external environment impact on the decisions the company had to make about the way it ran and expanded the business? What were the biggest challenges for Mr Wu in changing the Chinese business model? What lessons about managing change can be drawn from this case study?

See the suggested answer at the end of this chapter.

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SUMMARY
In order to survive and prosper, organisations must be aware of the need to effectively organise their internal resources to maximise performance. The internal structure chosen will depend on the organisation's purpose, size and owner preferences. All organisations will develop structures based to some degree on functional specialisation, but alternative groupings are possible – based on geographical location or types of production or service. Matrix and project structures both involve different levels of employees from diverse functional groups coming together for a specific purpose. Structures may be tall or flat. A tall structure has many hierarchical levels and is found most often in large scale organisations, including many in the public sector. Communication is likely to be poor and decision making is slow. A flat structure has fewer layers so communication will be better and decision making faster. However a manager will have more subordinates to manage – that is, a wider span of control. There is a basic distinction between line and staff relationships.  The line relationship is one of a hierarchy of management where subordinates report directly to higher ranking managers and there is a clear line of management responsibility. Information flows both ways through this line, from top to bottom of the organisation. Staff relationships refer to the exercise of management authority or advice from outside of the line management. This is usually where authority stems from specialist professional knowledge or skills.

The external environment also influences the way in which the business is run, but is harder to control as it comprises forces that the organisation can only usually minimise by adopting appropriate practices. These forces are political, economic, social and technological. They will vary at different time periods and their nature will often depend on location. The impact of these forces requires organisations to change if they wish to have continued success. Change is a continuous process for business today. However, there is often significant resistance to change for reasons such as:          Uncertainly Poor communication Perceived loss of power or authority Lack of understanding of the need for change Social working implications. Devise a change plan Involve Human Resources and the unions in devising the plan Communicate the need for change to employees Actively involve employees in planning the change by instigating activities that will help them to: (i) (ii) (iii)  Accept the need Provide ideas for making the change Gain their commitment

To be successful change needs to be managed carefully.

Employ a change agent to assist with the implementation.

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ANSWERS TO ACTIVITIES
Activity 1 (a) Tall structures are traditionally found in large organisations, particularly those where there are strong bureaucracies such as government establishments and possibly former government firms that have been privatised, for instance telephone and rail companies. However, this is becoming less common now. Flat structures are most often associated with small companies, particularly those in the creative industries such as advertising and design, and with IT companies.

(b)

Activity 2 (a) Examples of the factors for and against the change might include the following: For: Lower cost of labour Lower cost of resources Better distribution centre for global sales Better skills in the production process Against: Quality Lack of management control from the centre Loss of jobs in home country Communication Potential political risk Financial risk

The answer will depend on the list you generate. In the above list, there are more negatives that positives and some negatives seem particularly important such as risk and quality. However, it may be that high quality is not so important and the country is fairly low risk. (c) The company could instigate a joint venture or licensing agreement with a company in the cheaper country, which would reduce both sets of risk and possibly communication and control problems. The company could also put in a quality control system that could monitor the quality of products from the home country. Either of these initiatives would reduce the negatives.

Activity 3 (a) The strengths included:      Entrepreneurship and innovation Vision of the future opportunities Flexible working and excellent communication Current knowledge of the technology Working capital without borrowing.

The weaknesses included poor knowledge of business techniques in terms of how to turn their research and knowledge base into a successful commercial product – for

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example, marketing, allocation of financial resources, management structures and organisation. (b) We can see from the case study that three of the four PEST factors were in evidence:    (c) (d) The political environment, with a high level of State control, was not supportive of such a development. This meant that political risk was high. Economic factors linked with this, limiting the way in which employees could be rewarded through bonuses. Technology in China was limited and advances were not appreciated by the State.

Mr Liu had to find ways around the problems involving introducing capitalist schemes such as share incentives and cash bonuses which were, at the time, illegal. We can see the practical application of both Lewin‟s Force Field or Schein‟s models in the way in which Mr Liu addressed the problems. He had to unfreeze the existing ways of operating and did this by finding methods which reduced the negative forces holding back the development of his company and promoted the greater commitment and flexibility needed to fuel change. We can also see how a change agent, in this case a single person, can be effective in even the most difficult environmental situation.

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Chapter 3 Strategic Choices
Contents
Introduction

Page
58

A.

The Life Cycle Concept

58

B.

The Nature of Strategic Management The Strategic Planning Format

59 60

C.

Analysis of the Business Environment SWOT Analysis – Strengths and Weaknesses GAP Analysis Value Chain Analysis SWOT Analysis – Opportunities and Threats PEST, PESTLE or STEEPLE Analysis Competitor and Market Analysis Benchmarking

64 66 68 69 70 71 75 78

D.

Organisational Growth Advantages and Disadvantages of Small and Large Businesses Growing the Business Financing Growth

80 80 83 84

Summary

88

Answers to Activities

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INTRODUCTION
This chapter is concerned with the decisions organisations make and how these change during the firm’s life cycle. When an organisation starts in business it will usually have values that it wishes to operate by and these will very much influence its strategic choices. The values will not be the same for every organisation and neither will its goals. We examine profit and not-for-profit organisations to establish what the difference in their values and hence their strategic choices may be. We look at the influence of internal factors – the strengths, weaknesses, competences and capabilities – and how these affect what an organisation does and how it operates. The external environment will also affect the firm’s choices and in many ways, these will be out of its control. We examine the opportunities provided by the external environment as well as the threats to its continued survival. Not many companies will be able to ignore competitors and what they are doing. Examining the competition, to assess how to reach organisational goals, is a vital step to take in the strategic plan and helps to enhance business performance. Michael Porter is the leading ‘guru’ in this area, but we also look at the merits of benchmarking as a strategy. As small firms become more successful they make the choice of whether to grow bigger or remain as a small business. There are pros and cons to both alternatives and if growth is the chosen route, the firm needs to determine how best to structure and finance it. At the end of the chapter, we evaluate growth options and the financing methods which underpin them.

A. THE LIFE CYCLE CONCEPT
The concept of a product life cycle used in marketing is familiar to many students and practitioners. There are commonly four phases used to describe the way in which a product is developed and sold within a market – launch, growth, maturity and decline. Organisations also have a similar life cycle, but with five phases: Figure 3.1: The Business Life Cycle Market size Slow growth

Maturity Decline

Growth Development

Time

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This life cycle represents the progress of the company – slow development with low market share, followed by rapid growth, then growth slows as the organisation matures and eventually declines. We can illustrate this process by considering the case of Xerox. Xerox’s history from 1947 - 1980 demonstrates the phases of the industry life cycle well. It was originally formed in 1908 and produced photographic paper, but it was not until it became the market leader in plain paper copying in 1960s that is growth became outstanding. It reached the mature state probably in early 1970s. In 1977 its patents ran out and competition became fierce so that by the 1980s its market share had declined significantly. However, some large companies which have moved into decline, have managed to regain their industry position, at least in part, after some years. This was the case with Xerox which revived its fortunes by becoming The Document Company in the 1990s and later adapted its model to become an outsourcing business. In early 2000, the company went into administration in the US and was in danger of bankruptcy. Once again it managed to reinvent itself into what is again a thriving company. At each stage in its life cycle, a company will make different choices about how it drives its business forward, as we can again illustrate with Xerox:  In the early development stage, a new company will be innovative and seek to differentiate itself from the competition in its market sector. In this stage, Xerox developed its patents which gave it a competitive advantage and allowed it to start its growth. During its growth it was able to demand its own price as competitors were unable compete owing to patent protection (high barrier to entry) and customers were forced to pay the high price demanded. It thus underwent massive growth in the 1960s and early 1970s, and by the late 1970s it was in the mature stage. However, with its patents running out, competition entered the market. Barriers to entry fell significantly, prices reduced and competitors were now able to produce plain paper copiers with superior features. Xerox did not foresee this change in the environment in time and it passed its decline stage without realising it was happening. A new set of strategic choices was required, as its purpose turned to finding a way to survive in a different market environment.

B. THE NATURE OF STRATEGIC MANAGEMENT
The Xerox example demonstrates the constant need to monitor the external environment and make changes to its strategic direction to survive. It also reinforces the need to make different choices about how to manage business success over the life of the business, involving different types of decisions at different periods. As you will have already noticed, every organisation’s decisions are influenced by a number of factors:     Its purpose The external environment The internal environment The stage in its life cycle.

Strategic management is concerned with deciding on the organisation’s long term goal and making choices about how to achieve that goal within the parameters in which it is working –

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that is, deciding what strategy to pursue. Each firm will have a different set of parameters as the factors listed above will all vary considerably in every case. So, for example, as we discussed in Chapter 1, the business aims could be maximising:       profit market share revenue share product development growth social, environmental or ethical outcomes.

The Strategic Planning Format
This involves a number of steps: Mission Statement  Vision Statement  Values  Objectives  Implementation  Monitoring/Control/Review (a) Mission, vision and values We shall consider the first three steps together as they are closely interrelated.    The mission statement expresses the organisation’s overall business purpose. This is the starting point in the planning process. The vision statement sets down what the organisation's aspirations are – in other words, what it wants to achieve in the foreseeable future. The values are the principles the company and its employees must work within, as it attempts to achieve its vision.

These tend to be fixed for a number of years before the organisation may want to reconsider them in the light of the parameters within which it is now operating. Most organisations will spend some time formalising their mission, vision and values and will often write them out as documented statements for all their stakeholders to see. However, some organisations find these difficult to express and it is only by their actions that we can try to establish the purpose, aims and values. We can illustrate these key elements in the strategic planning process by considering three examples:

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Xerox Mission and vision statement: "Through the world's leading technology and services in business process and document management, we're at the heart of enterprises small to large, giving our clients the freedom to focus on what matters most: their real business." Core values: "One thing that never changes is our core values:       We succeed through satisfied customers We deliver quality and excellence in all we do We require premium return on assets We use technology to develop market leadership We value our employees We behave responsibly as a corporate citizen."

Lambeth National Health Service (London) Mission and vision: "Our mission is to improve health throughout the diverse communities we serve and ensure access to consistently safe and effective services which provide an excellent experience for users." "Our vision reflects our commitments to improve health and well-being and to reduce health inequalities." "Lambeth NHS, as a non-profit organisation, is focused on doing good in the community." Google Mission: "To organise the world’s information and make it universally accessible and useful."

Think Point
What differences do you notice in the mission, vision and values of these three organisations?

Xerox has a "for profit" type of mission and vision, focused on revenue generation and business to business activity. It publishes these statements given on its website and, from these, you could relatively easily evaluate Xerox’s business actions and determine whether it meets its own written standards. Lambeth NHS does not state what its core values are in its strategy document, but relies on a generalised "doing good" approach. Do you notice the differences in emphasis of this public sector organisation compared with a large private sector corporation? It is often more difficult for not-for-profit to make precise statements since they serve a variety of stakeholders.

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Google gives little information except that it appears to have a more philanthropic mission than the standard ‘for profit’ firm. Its mission is published on the investor area of its website, but there is no vision statement or list of values. It states values occasionally in other text (where one of these is "teamwork"), but does not make a conventional statement. For profit organisations' missions and visions are likely to be based on shareholder value or revenue generation, although some commercial companies in Asia Pacific, for example, have purposes which are nearer to that of not-for-profit organisations in the West such as the NHS.

Activity 1
Find out what the mission, vision and core values of your own organisation are (or those of an organisation you have worked for or studied with)? Are they stated explicitly in documents and, if so, how widely available are they? Are the organisation's stakeholders aware of them? What are the main differences between the mission, vision and core values of your organisation and those of Xerox and of Lambeth NHS? Can you explain why they should be different?

(b)

Setting objectives Following on from the establishment of the mission, vision and values for the organisation, the next stage is to set objectives. These are very specific statements of what the organisation wants to achieve in a stated period of time, in order to realise its mission and in accordance with its vision and values. Objectives mean very little if they are not SMART objectives: Specific – stating exactly what is to be accomplished Measurable – how progress will be quantified Achievable – realistic, it is possible to achieve the goal Results orientated – it is focused toward getting the result stated Time bound – within what time scale.

Activity 2
A company might state that it wishes to improve sales of product X by 10% by the end of the quarter. Is this a SMART objective? See the suggested answer at the end of this chapter.

When a company is planning its objectives it cannot do this in isolation. It must take into account a number of factors such as:   its resources and competences its weaknesses

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 

the external environment competitors.

We will examine these factors in more detail in the next section of this chapter. In setting objectives, there are two important aspects to consider: (i) Ensuring that the whole organisation understands and is geared towards achievement of the objectives. One problem can be that employees at lower levels of the firm’s hierarchy may not understand the contribution they can make to the accomplishing the firm’s objectives, and not be fully committed to them. This may be overcome by involving employees in the planning process – seeking their contribution in actually structuring the strategic plan. This approach – bottom-up planning as opposed to top-down (imposed from above) often results in generating new and more practicable solutions. (ii) Building in flexibility – objectives should be flexible enough to be modified.  To allow innovation to occur. If the objectives and/or their implementation are too rigid there will be no opportunity to take advantage of innovative ideas that might occur, owing to changes in the internal or external environment. For example, a new manager is recruited and has some useful new ideas or an existing member of staff contributes an idea to save resources. To respond to the business environment. Organisations operate in a very turbulent environment and changes in interest rates, regulations, government policy, etc. can impact on the original objectives in a positive or negative way. The organisation needs to be able to adapt its objectives to minimise the potential damage of negative changes in the environment or to maximise opportunities.

(c)

Implementing the strategy Once the objectives have been agreed, resources will need to be allocated to achieve them. Thus, financial objectives will be set and resource levels agreed. All employees will need to be briefed on what the organisation’s objectives are and what their part will be in accomplishing the stated outcomes. In some organisations, there is an Annual Conference where employees are able to share the strategic goals for the year, discuss in groups how they will be achieved and celebrate success of the previous year’s plan. This type of approach helps in communicating and implementing the firm’s targets. Ensuring appropriate resource levels for the of the objectives may also involve some training and development of staff, in order to ensure there is the necessary skills and knowledge profile required to enable specified goals to be met.

(d)

Monitoring and Control Progress towards achievement of objectives needs to be constantly monitored, with the extent of progress, against set goals, measured at regular intervals. The firm should have a monitoring mechanism with specified measurement tools and time periods. There are many different types of monitoring mechanisms that can be used, separately or together. Examples include:

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     

Budgets Quality control Balanced scorecard Customer feedback Change in market share Employee feedback.

Monitoring systems are vital to the achievement of goals. The organisation needs to measure progress and either address problems in implementation which are preventing the achievement, or amend the objectives themselves if the set goals do not appear to be feasible and/or to take advantages of new opportunities to exceed the stated outcomes. However, before the firm can get to this stage, it needs to carry out an analysis of its environment to enable it to set appropriate, SMART objectives.

C. ANALYSIS OF THE BUSINESS ENVIRONMENT
For all organisations, setting objectives is a significant task. They provide a framework for achieving goals within the core values they commit to, whether these are expressed or intuitive. Large companies and public sector bodies very often use an annual planning cycle, which begins with trying to make sense of the multitude of factors that could positively and negatively affect their potential to be successful. There are a variety of standard techniques for carrying out the process.     SWOT Analysis PEST/PESTEL or STEEPLE Analysis Competitor Analysis Benchmarking.

Note that many organisations, particularly smaller ones, do not always do these consciously or in a formal manner, but carry out certain parts of the process in an informal way. In this section we will look at each of these techniques in turn. One or more of these usually forms the basis of the choices made by organisations. We shall start by visualising the organisation as being at the centre of a layered structure such as an onion, as shown in Figure 3.2.

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Figure 3.2: The Business Environment

Macro-environment: broad environmental factors

Industry or sector influences

Competitor competences and activities

The Organisation

The individual firm is a very small part of a much larger sphere of influence which impacts on the way it manages its internal resources and reacts to changes that occur in that external environment. In many cases the organisation has little control over its environment but must adapt and make choices about how to adapt so that it can survive and prosper, as discussed in Chapter 2. The environment may be divided into the internal and external environments, and different types of types are appropriate to each. Here we shall examine the following:  The Internal Environment: – – – SWOT analysis Gap analysis Value chain analysis

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The External Environment: – – – – SWOT analysis (again! – we shall consider the differences between internal and external SWOT below) PEST, PESTLE or STEEPLE analysis Competitor and market analysis Benchmarking

SWOT Analysis – Strengths and Weaknesses
SWOT stands for Strengths, Weaknesses, Opportunities and Threats. Strengths and Weakness refer to the internal environment whereas Opportunities and Threats focus on the external environment. This difference in focus is often forgotten and this is one reason why, in this chapter, we will separate the analysis into the two environments to which the factors relate. If we think of our own situation for a moment, we can acknowledge our own internal strengths and weaknesses which impact on our lives, but we need to set these in the context of the external environment – events and situations outside of ourselves – before we can see opportunities for improving our well-being or threats which are present. The same is true of any organisation. When we reflect on our own strengths and weaknesses, it is usual to be able to think of lots of strengths and few weaknesses! We also have to think really hard to find a list of weaknesses that is as long as the strengths. For example: Strength       Hard working Generous Analytical Innovative Good communicator Ambitious Weakness    Find it difficult to relax Impatient Suspicious

Sometimes our strengths can also be weaknesses and vice versa. A person who is ambitious may not be patient with those who are happy with their life or job and so find it difficult to build relationships with colleagues at work who do not share their attitude to life. A suspicious person also may find it difficult to trust others but in some circumstances, this can be a strength, such as when negotiating for a new apartment with someone you do not know. A similar situation arises in companies. Imagine a company ABC with a list of strengths and weaknesses compiled by its managers: Strength       Cash rich Innovative Sales skills Loyal employees Customer service Market leader in product X Weakness      Technology poor Credit control Union strength Cautious in expansion Knowledge management

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While this company values "cash rich" as a strength, if the company was a plc this would be seen as a weakness by financial experts since the cash could be working to improve the company’s performance. Poor credit control may also link with being cash rich and demonstrates poor use of financial resources. However, in times of economic downturn, having cash reserves can be vital to the survival of the company. A cash rich company can be independent and its managers can innovate without having to answer to shareholders or financial institutions. The Armani business, for example, is cash rich and run without external loans, allowing Giorgio Armani to make the business decisions he chooses without pressure from outside. Many Asia Pacific companies are family run and independent of banks or other lending institutions and operate with a similar philosophy. Loyal employees can be a great strength, but they may also be unwilling to change and this might account for technology being poor. So, is the company innovative or just thinks it is? Will it lose its market leadership through the weaknesses? The power and influence of trade unions varies from one organisation to another and from one country to another. In the UK the role of unions has changed considerably in the past 30 years. Legislation has weakened their power to negotiate national wage rates and to strike. However, many unions have become involved in assisting with employee development and working with companies more closely, on health and safety issues for example. Unions also offer their members access to legal services for issues inside and outside the workplace, such as personal injuries like deafness from machine noise and road accidents. Hence trade union presence may add a strength to the organisation rather than be perceived as a weakness. On the other hand, in some countries, unions are more powerful, particularly where employee working conditions are poor, and their power can be perceived as being a weakness in terms of potential threat to the organisation’s business performance. The level of technological competence and capability is an increasingly necessary strength within the majority of organisations. It is not only important in production, but in sales and marketing, value chain and general communication. The internal technological competence that is a strength today can quickly transform into a weakness. Thus, in carrying out the internal analysis, the group responsible for doing so must look at the list they produce objectively – some weaknesses can also be strengths and vice versa.   If the organisation is to produce an analysis of its internal environment that will help it to plan for the future, being objective is crucial. Organisations must seek to build on their strengths and reduce weaknesses to improve future performance.

Competences and Capabilities In the table of strengths and weaknesses, a few skills have been mentioned. These would be termed as competences or capabilities which assist the organisation to be competitive. When analysing organisations using case studies, we need to identify the capabilities so that we can assess the potential for competitive advantage. Examples of organisational competences/capabilities are:       Marketing Customer service Strength of value chain Financial capability Talent management Innovation.

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In the Italian fashion industry, for example, design and marketing are two of its core competences. The sustainability of these competences must be monitored if the company is to continue to thrive – they may need to be updated. For example:  Companies that have talent management competence will be constantly appraising employee development issues, to ensure that training and development initiatives provide the staff with skills to make a difference to performance. Loss of key employees may well cause a decline in a core competence such as technical expertise. Organisations are constantly seeking to improve the value chain by cutting costs, reducing the time between manufacture and delivery to the customer and so on. Organisations that have patented products or services will have capability to differentiate themselves from their competitors. On expiry of these patents, the organisation can be vulnerable to the external competition, as was Xerox in 1977. Capability through patents rights may not be sustainable and ultimately become a weakness.

 

GAP Analysis
At its simplest, this planning activity is a case of establishing where the organisation is now and where it would like to be in the future and examining how to close the gap. For example, if an organisation manufactures 5,000 units and makes a profit of £50,000, what must it do to manufacture the same number of units and make a profit of £55,000. The gap is £5000 profit. How could the present operation be changed to meet this goal and what is realistic? There are many alternatives to examine to close the gap – for example:       Cut costs Increase prices Improve manufacturing techniques Reduce waste Reduce cost of materials by negotiating with suppliers Reduce marketing/administrations costs.

The technique can be used in any area of the business to improve on the present situation. It just needs the identification of the key gaps which are holding back the achievement of objectives. Examples are:   In marketing – increasing market share In HR – assessing employee skills now and those that will be needed in the future.

Activity 3
Imagine you want to start a business now offering web design to small companies and make a profit of £6,000 by the end of your first year. Make a list of what skills and physical resources you are likely to require. What might be your strengths and weaknesses in terms of reaching this goal? What activities and resources will you need to employ to allow you to reach your goal? See the suggested answer at the end of this chapter.

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Value Chain Analysis
The value chain is a term used to describe the way in which an organisation links together all the activities that form part of producing a product or service and delivering it to the customer. It is a capability (or a competitive strength) if the organisation can do this as effectively as possible so that its product of service is of the highest quality, delivered in the shortest and most effective manner. Therefore, organisations examine every aspect in their process to try to find cost or efficiency savings or enhancements to improve the linkages. Michael Porter developed this concept in regard to manufacturing systems. He used the term 'value activities' to describe the different identifiable activities of which any business is a collection, such as procurement, marketing, production, etc., and suggested that, by examining effectiveness at each individual level, rather than at whole company level, competitive advantage is achieved. Porter classified these activities as either primary or secondary (support). These are shown in the diagram below: Figure 3.3: Michael Porter's value chain Support activities Company infrastructure Human resource management Technology development Procurement Margin Primary activities

Inbound logistics

Operations

Outbound logistics

Marketing & Sales

Service

(a)

Primary activities These are:      Inbound logistics – receiving, storing and distributing inputs Operators – which turn these inputs into the final product or service Outbound logistics – storage and distribution to consumers Marketing and sales – which make consumers aware of the products or services available Service – installation and after-sales servicing.

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(b)

Secondary activities These provide the infrastructure that enables the primary activities to take place and are:     Infrastructure – systems vital to the organisation's strategic capability, which usually support the whole chain, such as planning, finance, quality management Human resource management – recruitment, training, development, etc. Resource and technology – product or process development, etc. Procurement – acquisition of the necessary resource inputs to the primary activities.

Few organisations will be able to complete all the value chain functions ‘in house’ and may be part of a larger value network. In deciding how this will work most effectively, the firm must assess in which parts of the value chain it has most expertise and then find other organisations to work with it to set up an efficient and effective network. Firms may outsource certain activities because it is cheaper to do so or the external organisation has greater expertise. Organisations often ultimately acquire companies that are originally part of their value network in an attempt to improve the value chain. For example, Coca Cola acquired bottling operations in North America in 2010, in an attempt to maintain its leadership position in response to Pepsico’s acquisition of its bottlers earlier. The value chain is now considered one of the most important sources of competitive advantage.

SWOT Analysis – Opportunities and Threats
We now turn our attention to the forms of analyses appropriate to the external environment that are considered in strategic planning, starting with the second part of the SWOT analysis – opportunities and threats. Our imaginary company, ABC, might evaluate its external environment as having opportunities and threats such as those set out in the following table. Opportunities       New markets for product X owing to closure of major competitor Decrease in rate of value added tax, more sales Initiate e-marketing to improve sales levels and margins Acquire local supplier of components New packaging methodology to reduce costs and improve image New skills owing to acquisition. Threats     Changes in employment law increasing costs Employees joining competitors Lack of skills in workforce Integration issues.

Again some opportunities also pose threats. Acquiring a supplier may well increase the efficiency in the value chain and reduce costs, but not if the newly acquired firm’s employees cannot adapt to the organisation’s working practices and/or culture.

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PEST, PESTLE or STEEPLE Analysis
The forces in the external environmental which are imposed on a organisation will greatly affect the way it operates and the choices it makes to improve its business performance. One way of assessing these is to examine them according to different headings. Initially, this was known as PEST analysis, looking at the following types of factors: Political Economic Socio-cultural Technological. PEST analysis has since evolved to several longer acronyms owing to changes in the nature of the environmental factors that impact on organisations. It became PESTLE with the addition of legal and environmental factors and then STEEPLE when ethical factors were added – ethics now have a major impact on strategic choices as organisations seek to adapt to changing societal and consumer pressure. Legal Environmental Ethical. (a) Political factors This refers to the role of governments and affects all organisations to a certain extent. Some governments work with a free market policy in which private companies can thrive while others are under state control. The latter are called planned or command economies which are state owned and controlled. There are now far fewer global command economies than in the past, and even China has evolved from being purely state owned towards a proportion of free market economy in the past two decades. Since the early 1980s the UK has privatised many former state owned industries such as electricity, gas, water and railways. However, while this has created more competition in these fields, there has also been an increase in regulation. Central and local government that are state owned and are large employers. Any changes in their policies can have a significant effect on private business. Since the Government is also a customer of the private firm, shrinking that sector has an impact on the level of private business operation. On a national basis, pressure groups exist to influence government and politicians; their activities can also have a major impact on industries and individual firms. Government departments frequently consult pressure groups about new regulations and legislation. Government policy also has substantial implications for companies wishing to globalise their operations. Some will insist on very specific conditions for an overseas firm to operate in their country. Very often the organisation is faced with increased costs, to comply with new regulations. For example, in recent years the UK, as a member of the European Union, has been forced to apply EU Law to working hours and other employment terms and conditions. (b) Economic factors Economic factors include exchange rates, economic cycles and different growth rates around the world. Organisations have to be prepared for the risk of exchange rate changes which, if their currency weakens, makes importing supplies very expensive

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but makes exporting the goods or services offered more attractive to the countries affected. (c) Socio-cultural factors These influences concern different cultural and demographic factors.    Is the population ageing and how does this impact on the sales of the firm’s product or service in that country? Older age groups generally have the most disposable income. How can the firm adjust its product or service to maximise revenue from this sector? How will the demographic change affect employee recruitment? More women have entered the workforce than in the past and demand for part time jobs has risen. This has also meant less time being spent on domestic tasks such as cooking and opened up opportunities for companies to provide larger ranges of ready-made meals. Is a change in taste/ingredients necessary in a foodstuff to make it attractive to people of another culture? If an organisation is planning to operate part of its business in a new country what cultural aspects does it need to take into account?

  (d)

Technology factors This is a rapidly changing factor that influences the organisation in a number of ways:       Communication is faster Operational costs can be reduced as fewer employees are required New materials developed Monitor and control of quality of all aspects of the business can be more effective Technical skills may be needed in the workforce which are not currently available Growth in e-commerce allows organisations to sell globally without having to set up operations in all the countries that buy their products. The whole transaction can be completed online Virtual working is now normal practice for large numbers of employees and entrepreneurs.

 (e)

Legal factors This refers to regulation which can be national or regional. An example is recent Corporate Governance Regulations which governments have applied to organisations wishing to float shares on the stock exchange. Health and safety legislation and employment law have been developed in all EU countries in the last 50 years, and are being continuously extended by the Parliament in Belgium, resulting in sometimes quite drastic changes in operational costs. Restrictions on mergers and acquisitions, to prevent the growth of monopolies, and hence the national and international power of individual large firms, operate in many developed countries, including the UK and USA. Governments are increasingly collaborating to produce legislation to reduce global emissions and regulate financial transactions and reporting.

(f)

Environmental factors The earth has finite resources which are rapidly diminishing. Organisations are under a lot of pressure from consumers and governments to conserve resources such as

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water, energy and raw materials. In addition, the manufacturing process can cause the emission of harmful substances into the air, rivers and rubbish dumps. Many large and small organisations have green corporate policies which state their specific commitment to effective use of resources and responsibility in their interaction with the environment. Such policies can have the effect of making their products more attractive to some consumers, acting effectively as a strategic marketing tactic. In many cases, these policies also allow the organisation to reduce costs, for example, by recycling waste or pursuing research to reduce the proportion of raw materials required to produce a product. (g) Ethical factors These concerns have always been present internally and externally – for example:    How does a company treat its employees? Does the company deal with corrupt governments? Is it considered ethical to use child labour?

Nations and regions of the world have different ethical principles, some of which are based on their cultures. Organisations planning their business strategy may have to take into account cultural ethical differences, but may also have a policy which states what they stand for and so, ethically, the types of business practice they will not engage in. Large multinationals such as Coca Cola have published Corporate Governance and Ethics Policies that their employees and suppliers must adhere to. We now present an outline STEEPLE analysis for you to consider the range of factors covered.

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Example - STEEPLE for Beverage Industry Political        Social            Legal    Level of undesirable contents in drinks Quality controls standards Restrictions on mergers/acquisitions What kind of products will appeal to the various age groups Use of water in process Ingredients are a health hazard Raw material wastage including packaging Collecting data from drinks machines to measure popularity Lean manufacturing to reduce costs Quality monitoring and control R&D advances for packaging, new drinks High sugar and calorie drinks offered to poor countries Consumption of water that is needed for growing food Using cheap labour in emerging countries Environmental Does the government own a share in a national beverage organisation Is the government a stable one? Government support for overseas investment Disposable income available Economies of scale possible National growth rate Favourable interest or exchange rate

Economic

Technological

Ethical

Activity 4
Think about the car industry and make a list of the STEEPLE factors that might affect the strategic choices of a car manufacturer. What changes might you see in that list in 10 years’ time? See the suggested answer at the end of this chapter.

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Competitor and Market Analysis
The macro environment affects every organisation to differing degrees and they have little control over many aspects of it. The factor of competition in their industry sector, and more particularly their category within the industry sector, is perhaps the most influential on their strategic plan. Most for-profit organisations have a purpose which involves being more effective than the competition in some way, whether that purpose is maximising shareholder value, sales revenue, market share or having a technologically superior product. In addition, public sector bodies are increasingly being tasked by their governments to adopt for-profit techniques and are sometimes in competition with private firms for contracts. Thus, local colleges compete for training business with private training companies, or hiring premises for conferences and business meetings in competition with hotels or conference centres. When planning, strategy managers will analyse what the competitors are doing and try to make those choices which will give them the best chance of succeeding, despite the activities of competitors. A number of techniques, or tools, have been developed for this purpose and we shall look at two here, developed by Porter, before moving on to examine the similar technique of benchmarking. Porter’s Five Forces According to Porter, firms must decide the section of the market they wish to exploit. Initially Porter built the model to assess profit potential within an industry but the model has developed into a tool for examining the forces of competition in a specific industry. Doing this enables managers to identify a firm’s opportunities and protect it against threats. The five forces are: (i) (ii) (iii) (iv) (v) The power of buyers The power of suppliers Threat of substitutes Threat of new entrants Extent of competitive rivalry. Figure 3.4: Porter's Five Forces Model Bargaining power of suppliers Threat from new entrants

Suppliers Industry Competitors

Potential Entrants

Rivalry between existing firms Buyers Substitutes

Bargaining power of buyers

Threat of substitutes

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(a)

The power of buyers The power of buyers will be high when:  A few organisations, able to buy in large quantities, will be able to negotiate heavily on price by promise of a secure contract, squeezing the firm’s profit margin and demanding high quality The cost of switching to another company is low – i.e. it does not cost the buyer to change its process or machinery The buyer could produce the product or service themselves and result in closure of the supplier There are many other suppliers in the same business so finding alternative suppliers is easy. If the purchase has specific qualities, then the buyer will be less powerful.

  

Large organisations who buy products, services or components from a firm also have the buying power to force down the price they pay, reducing the supplier organisation’s profits. (b) The power of suppliers If your organisation is buying components or services from a supplier, supplier power will be high and affect the cost structure of the organisation dramatically in the following cases:  There are few suppliers in the market – in which case, you will be forced to pay a higher price than if there was a wide choice of suppliers for a component or service since there is little ability to switch suppliers Switching costs may be high There are no alternative suppliers Supplies are a large part of the firm’s product or service cost.

  

Looking back at our Xerox example earlier, prior to 1977 the company had immense power as a supplier – there were no other suppliers of plain paper copiers in the market, alternatives (coated paper copiers) were both expensive and copies were of low quality. Once the patent ran out, Xerox’s power as a supplier dwindled as there were a lot of suppliers available. The power of buyers became stronger. (c) Threat of substitutes If the firm produces a product or service that is unique and/or makes large profits, there will be a huge threat from new entrants, attracted by profit margins, offering substitute products. The business needs to be aware of:       The ease and extent of cost for a customer to switch to a substitute product The threat from competitors bringing out a more advanced or technically superior product The impact of substitutes on the price they can charge. Most of its machines were rented, so the cost of switching was low The majority of substitutes were technically superior The pricing was cheaper so that the new suppliers could gain quick entry to the plain paper copier market.

Xerox’s business came under immense threat from substitutes in 1977 because:

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(d)

Threat of New Entrants This threat will be greatest to the existing firm if barriers to entry are low, such as:     Lack of patents required Low set up costs Product is not unique or technically sophisticated Low brand identity.

Any one company trying to set up a plain paper copier company prior to 1977 would have experienced impossible barriers to entry. Apart from having the patent, the brand identity is so immense that Xeroxing is still the term used by many when discussing taking a photocopy. (e) Extent of competitive rivalry The threat of a large number of competitors in a firm’s market will depend of the extent of the factors listed above. If there is a low barrier to entry, this will encourage new entrants to attempt to compete in the market with a substitute product. The result will be more suppliers, so the power of buyers will be increased. Competitive rivals have similar products and services and the same groups of customers. As well as the four factors listed above, rivalry will also be enhanced if:      There are many competitors of similar size operating in the same market Products or services are similar then buyers can easily and cheaply switch suppliers – for example, supermarket rivals There is low growth in a market and price competition is strong, this results in low profits and companies leaving the market The business has high fixed costs it will need to keep volumes high to make a reasonable amount of profit and may therefore cut prices to make volume sales Barriers to exit are high, companies will try to survive in a downturn by cutting costs owing to excess capacity in the market.

This type of analysis should allow an organisation to assess: (a) (b) The type of industry it should target or leave when making its strategic choices.  The industries where the five forces tend to work for them. How the organisation can raise barriers to entry to prevent others gaining their market share – through:      (c)   Brand awareness and loyalty Reducing the power of suppliers to reduce costs Increasing R & D to improve products Exceptional after sales service Exceptional ethics and corporate responsibility to build customer loyalty. In economic downturn, some larger organisations could be hit badly because of large fixed costs whereas a small one can be more flexible Large organisations may be able to withstand increased buyer power compared with smaller firms.

How badly its competitors are affected by the changes in the industry structure.

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Porter’s Generic Strategies When companies enter a market or reassess their competitive strategy, according to Porter they have three choices. This model claims that there are only three main strategies a business can follow:    Cost leadership Differentiation Niche/Focus.

A business which followed none of these strategies would become "stuck in the middle". Figure 3.5: Porter's Generic Strategy Model Differentiation

Cost Leadership

Stuck With No Clear Strategy

Focus

(a)

Strategy 1: Cost Leadership The company aims to produce in large quantities, at the lowest cost possible and sell at lower prices than the competition. By doing this it can capitalise on economies of scale and defeat any competitor who has not got equal production capacity, or who can keep prices to a minimum. This strategy will also attract price-sensitive buyers away from the competition.

(b)

Strategy 2: Differentiation This strategy involves offering some unique selling (or service) proposition (USP) that the competition do not have. Prices may not be too important to buyers of products sold under this strategy and it often follows that customers become brand or product loyal.

(c)

Strategy 3: Focus/Niche The company aims at very select market sectors and will be charging higher prices or offer special USPs. The company can concentrate on its key products for specific targets, acquire a reputation for being "specialist", or can simply attack sectors of the market which are being ignored by the competition.

Porter's strategy model allows a company to decide which overall "type" of marketing they want to adopt. If the firm is powerful and rich in resources they may well choose to follow a Cost Leadership or Differentiated strategy. Smaller firms may be forced to adopt a Niche strategy because their product offering has a very specific market.

Benchmarking
There are several approaches to benchmarking that allow strategic planners to make choices about their future actions.

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Historical benchmarking This is reflecting on performance in previous years to identify any changes that need making. The issue with this technique is that it is subjective and may leave an organisation feeling complacent. It is not actively looking externally to judge what changes competitors may be taking or how the external environment could impact on the organisation in the future.

Comparing with others in the same industry or sector This is also limited in so far as, if the whole industry is not performing well, then complacency could set in. Other firms which are not currently active in that industry sector may enter as they can meet customer needs more satisfactorily.

Benchmarking against best in class This can be done irrespective of the industry. Xerox actually revived this kind of benchmarking in the 1980s when its quality had declined. It chose best organisation in class and went out to observe how they operated, as shown by the following example. Case Study 1: Benchmarking at Xerox The 'Leadership through Quality' programme introduced by the new CEO revitalised the company. The programme encouraged Xerox to find ways to reduce their manufacturing costs. Benchmarking against Japanese competitors, Xerox found out that it took twice as long as its Japanese competitors to bring a product to market, five times the number of engineers, four times the number of design changes, and three times the design costs. The company also found that the Japanese could produce, ship and sell units for about the same amount that it cost Xerox just to manufacture them. In addition, Xerox's products had over 30,000 defective parts per million – about 30 times more than its competitors. Benchmarking also revealed that Xerox would need an 18% annual productivity growth rate for five consecutive years to catch up with the Japanese. After an initial period of denial, Xerox managers accepted the reality. Following this, Xerox defined benchmarking as 'the process of measuring its products, services, and practices against its toughest competitors, identifying the gaps and establishing goals. Our goal is always to achieve superiority in quality, product reliability and cost.' Gradually, Xerox developed its own benchmarking model. This model involved tens steps, categorised under five stages – planning, analysis, integration, action and maturity. Xerox collected data on key processes of best practice companies. These critical processes were then analysed to identify and define improvement opportunities. As a result of its benchmarking in Japan, Xerox eventually developed a completely new copying process by creatively improving on the concepts it had learned from its chief competitors. Xerox went on to become the only company worldwide to win all the three prestigious quality awards: the Deming Award (Japan) in 1980, the Malcolm Baldridge National Quality Award in 1989 and the European Quality Award in 1992. The success of benchmarking at Xerox motivated many companies to adopt benchmarking. By the mid 1990s, hundreds of companies implemented benchmarking practices at their divisions across the world. These included leading companies like Ford, AT&T, IBM, GE, Motorola and Citicorp Adapted from www.improvementandinnovation.com

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Xerox’s benchmarking model is now taught in business schools and regularly used by companies when making strategic choices. The impact of benchmarking, as it was with Xerox, is often to change behaviours. However, there are some potential negatives such as:  It may not be used to ascertain why the process benchmarked works so well if it does not compare competences between organisations. For what reason is distribution better in company X than company Y? What are the underlying competences of employees in both firms? It may change focus in an unintended manner. School league tables in UK were meant to provide benchmarking comparisons between teaching quality, but have led to a narrow focus on the questions that will be asked rather than improving thinking skills and application of knowledge.

D. ORGANISATIONAL GROWTH
Most firms begin as small organisations and if successful, can grow into multinationals. Hotel Chocolat began with two people making mints and has grown into a £multimillion business. Case Study 2: Hotel Chocolat Hotel Chocolat was founded by Angus Thirlwell and Peter Harris in 1993. Angus had speciality food retailing ‘in his genes’. He had spent his childhood in the Caribbean where he developed a love for cocoa and the region. A further influence on his taste for real food was the two years spent living and working in France. In 1987 his first big idea was the production of corporate mints. He and Peter Harris each contributed £5,000 and started the Mint Marketing Company from home. Most of their time was spent in Cambridge library with scissors and glue, using the library's colour photocopier to print logos off companies' literature, which were then shrunk and wrapped around packs of mints. A company in Holland was employed to make the mints. By 1990, the Mint Marketing Company had hit £1m in annual sales and had landed contracts with British Airways and various hotels.

In this section we examine the advantages and disadvantages of large and small businesses, and look at the methods by which businesses grow.

Advantages and Disadvantages of Small and Large Businesses
Statistics show that the number of small business far outweighs those that grow into multinational companies. The figures below indicate the importance of small businesses to the UK economy and their contribution to continuing innovation.

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UK Small Business Sector  There are 4.8 million small businesses in the UK (up from 4 million in 2003) of which 3.6 million businesses are sole proprietors and 444,000 are partnerships (Small businesses are defined as those with 10-50 employees) 97 per cent of firms employ less than 20 people 95 per cent of firms employ less than 5 people (Micro businesses are defined as those with 0-9 employees) Over 500,000 people start up their own business every year Small and medium-sized firms employ more than 59.8 per cent of the private sector workforce Small firms contribute more than 49 per cent of the UK turnover 64 per cent of commercial innovations come from small firms.

     

(a)

Staying Small Advantages of Small Companies           More control by owners Flexible to changing conditions Closer relationship with customers – a more personal relationship is possible and perceived quality of service is higher Lower overhead costs – potential to avoid diseconomies of scale experienced by larger companies Lower financial risk Innovation and entrepreneurship are very strong – many operate in niche markets making substitutes less of a threat Less bureaucracy. Limited scope for making profit Lack of expertise in some areas such as management and Research and Development Competition may be too strong– for example, production costs are likely to be higher than in a larger business where economies of scale can result is offering similar lower priced goods Statistically small businesses have a substantially higher failure rate – a significant proportion of companies are in business for less than three years and many fail before this point owing to cash flow problems (cash runs out or clients do not pay promptly) Customers may have less trust in a small business especially if it is selling goods or services overseas The ability to attract finance to improve areas of the business such as product development is often limited.

Disadvantages of Small Companies

 

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Personality and Entrepreneurial Character Small businesses are very much a reflection of the owners. They are often run by entrepreneurs who generate new ideas or find gaps in the market, sometimes by accident. Their contribution to innovation and invention is very important to the economy of a country. Entrepreneurship has become a global movement – universities offer MBAs in entrepreneurship whilst large companies try to re-create the environment within their own larger corporate structures. The Global Entrepreneurship Monitor (GEM) is a not-for-profit academic research consortium that has as its goal, making high quality information on global entrepreneurial activity readily available to as wide an audience as possible. GEM is the largest single study of entrepreneurial activity in the world. It was initiated in 1999 with just 10 countries taking part. (b) Grow Large Organisations may be forced to grow to meet customer demand or may make a conscious decision to expand the business. While there are many well known multinationals such as Pepsico, Walmart, Kraft Foods and BP, there are numerous large companies that are much smaller. Growth may start by exporting to some overseas markets and eventually expanding into a global company which has become considerably easier since the removal of trade barriers by many countries. Conscious decisions to grow can be a result of spotting opportunities. For example, many multinationals are exploiting opportunities in emerging markets where the disposable income of consumers is forecast to show significant growth in the medium term, and where resources, including cheaper labour, are available. Opportunities too arise where governments support external companies in order to grow their economies and increase business expertise, including the skills of their people. Advantages of large companies             Exploit more opportunities for trade and new customers Lower risk, as not all business is concentrated in one location and subject to market conditions in that location; reduces reliance on home market Potential economies of scale which reduces overall cost Access to less expensive resources which impacts on prices and profit levels Higher levels of expertise, as there are more employees with different skills/knowledge Potential for new ideas Easier to gain financial support. Innovation and entrepreneurship are difficult to maintain Loss of control by the owners Risk can be high, particularly in emerging economies where there can be political, cultural and financial risk Environmental and ethical issues increase such as pollution, use of country’s resources in production processes, corruption Tendency to bureaucracy, meaning that decision making and change can be slow

Disadvantages of large companies

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 

Communication between employees can be more difficult as size increases, particularly where employees work in different locations Marketing may not be appropriate in new locations (if company becomes global).

Growing the Business
Businesses growth occurs in two ways (a) Internal or Organic Growth The company expands using its own resources by increasing its manufacturing or office space, taking on new staff etc. Internal growth can take place in three ways:  Horizontal expansion The company continues to make the same product or provide the same service, but increases sales (market share). It may produce additional versions of the same product or service. For example, a chocolate manufacturer may move into organic chocolate production.  Vertical integration This is when the company extends its part in the whole production process – for example, the chocolate manufacturer decides to open a shop at the factory to sell the chocolate (forward integration) and/or grows the cocoa to make the chocolate (backward integration). Hotel Chocolat now grows cocoa in St Lucia, produces the chocolates and has many shops selling the chocolate all over the world.  Diversification This is the third method of external expansion. A firm decides to offer a product or service that is different from its core business. Hotel Chocolat’s ‘Boutique Chocolate Hotel’ opened in December 2010 offering guests luxury accommodation on the cocoa plantation in St Lucia. The disadvantage of this method of growth is that internal resources can become stretched as the firm grows. (b) External Growth Here, the company accomplishes growth either by joining with another company (strategic alliance) or acquires a company (merger or acquisition). The options are:  Joint venture This usually occurs when organisations work together on a specific project, the original organisations remain independent. This spreads the financial risk between them and provides each with access to a wider variety of skills and resources. The difficulty here may be in identifying a suitable partner and agreeing terms.  Merger or acquisition A merger takes place when two companies of approximately equal size form a new company by joint agreement. Acquisition is where a larger organisation buys a smaller one which becomes integrated into the larger firm

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In either a merger or acquisition, it is anticipated that competences and capabilities are increased, but there is potential for cultural clash making integration difficult and failure is high.  Franchising Franchising occurs when the company (the franchiser) permits the franchisee to carry out specific activities such as manufacturing, sales or distributions. The franchiser remains responsible for marketing activities and protecting the brand. Many of Coca Cola’s bottlers operate under franchise agreements.  Licensing In this situation another organisation pays a fee to use the intellectual property rights, such a trademarks, patents, or technology, under defined conditions. For example when you buy a Microsoft Product such as the Student Version of Office, you are the sole person licensed to use it and pay a special fee as a student. If you are not a student or you allow others to make copies, then you are not keeping to the terms of the licence. The subject of growth will be discussed in some detail in a global context in a later chapter.

Financing Growth
There are a number of methods of financing growth, some of which are applicable to different stages in the organisational life cycle. Initial capital investment is required to begin a small firm. This is usually in the form of loan from a bank or by using personal savings. Working capital is then required for the day-to-day running of the business – paying wages, paying creditors, purchasing small items such as stationery, advertisements and so on. This will either come from sales made and/or the support of a bank overdraft facility. In the early stages of the business it is quite common for firms to have cash flow problems where the amount of revenue earned is insufficient or not paid quickly enough by debtors, and the business cannot pay its day-to-day bills. The owners will often rely on a bank overdraft to relieve the problem. However, if this does not solve the issue in the short term, the firm will probably close. When larger amounts are required for purchasing large items or expansion of premises, funding research and development projects and so on, the business will need to consider longer term financing. There are several options available including bank loans and venture capital. We consider four such option briefly here. (a) Overdrafts Advantages   Easy to arrange and relatively cheap Useful as a method of easing cash flow strains during peak periods Interest charges are only incurred whilst the facility is overdrawn and only the exact amount of funding required is utilised.  Disadvantages   Security may be required Can be withdrawn by the bank at any time or may not be renewed when it is required in future Banks may require management figures at regular intervals, to monitor progress.

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(b)

Long term loans Advantages  Can be structured so that repayments can be met out of future income deriving from the expansion Cannot technically be withdrawn as long as the borrower honours all of the terms of the facility Repayments can be structured to meet the needs of the business. Disadvantages  Security will generally be required which adds to the initial costs and puts the business at a degree of risk Management figures may be required at regular intervals An agreed sum of money is lent which may be more than is actually needed for expansion Can be expensive for a small company.

 

(c)

Leasing Advantages  Assets leased can be onbalance sheet (a finance lease) or off-balance sheet (an operating lease) The period can match the life of the expansion assets There are usually no set-up costs and repayments can be structured to suit the cash flow of the business In effect, only the required amount is advanced and there are no surpluses on which charges accrue. Disadvantages  In an operating lease, the benefit of any residual value in the asset is lost to the lessor (owner) Costs may be higher than those of a bank but this may be outweighed by the absence of fees Capital allowances are lost to the lessor but the rentals will usually be tax-deductible Early settlement of the facility is usually expensive.

 

(d)

Additional equity capital Advantages  Can be a cheaper form of raising capital and dividends will only have to be paid when the enterprise can afford it Capital is raised in the longterm Increasing the equity capital should increase the ability of the enterprise to borrow in the market. Disadvantages   A degree of control over the enterprise will be lost Possibility of takeover is increased when the shares are widely held.

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Activity 5
Finally in this chapter, we present a further case study of the development of Xerox. Consider the following summary of its development and then answer the questions that follow. Case Study 3: The Company with Nine Lives Xerox can trace its roots to 1906, when a photography-paper business named the Haloid Company was established in Rochester, New York. In 1958 Haloid changed its name to Haloid Xerox, reflecting its belief that the company's future lay with xerography, although photography products were still more profitable. That balance quickly changed with the success of the Xerox 914 copier. Introduced in 1960, it was the first automatic Xerox copier and the first marketable plain-paper copier. Demand for the £650- 914 model exceeded Haloid-Xerox's most optimistic projections and Fortune later called the copier "the most successful product ever marketed in America". Sales and rental of xerographic products doubled in 1961 and kept growing. However, by 1985 Xerox's worldwide plain-paper copier share had dropped to 40 percent, from 85 percent in 1974. In 1988, Xerox underwent a $275 million restructuring, cutting 2,000 jobs and creating a new marketing organisation, to get new technologies into the marketplace more effectively. Xerox's comeback was so impressive that in 1989 its Business Products and Systems Unit won Congress's Malcolm Baldridge National Quality Award for regaining its lead in copier quality. Xerox had demonstrated its ability to change. In 1994, Xerox began calling itself The Document Company to emphasise the wide range of document processing products it produced. April 1998, Xerox announced yet another major restructuring, as its shift to the digital world led it to spend more on overheads than its competitors. The company eliminated 9,000 jobs over the next two years. The cuts came at a time when Xerox was enjoying record sales and earnings as well as a surging stock price, so the company was clearly proactive in maintaining the momentum it had gained through its impressive 1990s resurgence. This resurgence, however, came to a crashing halt during the later months of 1999. For both the third and fourth quarters, Xerox was forced to issue warnings that its profits would be well below the expectations of Wall Street analysts, sending its stock tumbling. Sales and profits were hurt by a number of factors, several of which were out of the company's control, including the strength of the dollar against European currencies, heightened competition from Japanese rivals, particularly Canon, which launched new lines of midrange and high-end copiers that ate into Xerox's market share, a slump in the sales of high-end copiers and printing systems late in the year because of Y2K fears, and a severe economic downturn in Brazil, a long-time key market for Xerox that had been responsible for about 10 percent of sales and an even-larger portion of profits. In March 2001, Xerox sold half of its stake in Fuji Xerox to Fuji Photo Film for more than $1.3 billion in cash, reducing its interest in the joint venture to 25%. In another key move, Xerox outsourced about half of its worldwide manufacturing operations to Flextronics International Ltd., at the same time selling to Flextronics

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plants in Canada, Mexico, Malaysia, the Netherlands and Brazil. Several other non core operations were also sold off as part of this overhaul, which in total culled 11,200 positions from the payroll. During 2001, a separate restructuring, which aimed to sharpen the company's focus, saw Xerox eliminate product lines aimed at the small office/home office business segment. Approximately 1,200 more employees were laid off. Xerox eliminated its stock dividend that year to conserve cash and in August, Mulcahy was named CEO. She replaced Allaire as chairman in early 2002. Late in 2000, the Securities and Exchange Commission (SEC) launched an investigation into Xerox's accounting practices for the period from 1997 to 2000. The SEC eventually found that the company had been improperly accounting for revenues associated with office equipment it leased to customers, booking more of the lease revenue up front than was proper and thereby artificially, if temporarily, inflating revenue and according the SEC, misleading investors. In April 2002, Xerox agreed to pay a record $10 million civil penalty to settle the charges. In addition to shedding unprofitable businesses and lines of business, and eliminating tens of thousands of workers from the workforce (which was reduced by one-third from the beginning of 2001 to the end of 2003, from 92,500 to 61,100), Xerox vastly improved its balance sheet. Total debt was reduced from $18.64 billion in 2000 to $11.17 billion in 2003. Perhaps most importantly, Xerox moved aggressively to regain lost market share by introducing 38 new products during 2002 and 2003 as well as a wide range of new document-related services. Through the CEO’s able leadership and dogged pursuit of a turnaround, Xerox was able to post strong results for 2003. Net income of $360 million was the firm's highest profit level since 1999. Debt was reduced further during 2004 to less than $10 billion and the now cash rich company was poised to begin pursuing acquisitions again. From the real possibility of bankruptcy when she took over, CEO Mulcahy had engineered at least the beginnings of a remarkable comeback, though the competitive environment showed no sign of becoming less brutal.

Questions (a) (b) (c) (d) (e) (f) Identify three separate and different examples that show Xerox changed its strategic choices over the years. Describe how the external environment has impacted negatively on Xerox in a way that was beyond its control. What actions did Xerox take as a result of the impact of the external environmental? What effect did these actions have on the business? From the limited information in the case study, describe the strategies Xerox used to grow the business. Which of Michael Porter’s generic strategies has Xerox focused on? Provide supporting evidence for your answer.

See the suggested answer at the end of this chapter.

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SUMMARY
Organisations exhibit life cycles in a similar way to that of products, with different characteristics at each stage. The strategic choices they will make will depend to some extent on the stage they have reached in the business life cycle. All organisations whatever their size have to make strategic choices about how the firm can survive and prosper in the future. The stage in the life cycle can be very important. An organisation in the development stage may have few or no competitors. An example of this was the early days of online recruitment when there was little competition. A company in decline will have to examine every aspect of its business and decide what it can do to either adapt its operation or change its products or services to regain momentum. In either case, when making strategic choices, firms need to carry out a structured examination of their internal and external environment so that they can make informed choices:  Internal strengths and weaknesses – identifying the competences and capabilities that can be built on and the weak areas that need to be improved, and listing the actions required to make improvements. Similar results could be obtained from a SWOT or Gap Analysis. The external environment – conducting a STEEPLE analysis to identify factors that provide opportunities and challenges, and analysing the competitive environment of the business. The aim will, again, be to identify what competences and capabilities the organisation has to maximise the opportunities and minimise the challenges that affect it. Porter’s Five Forces and Benchmarking can be used to identify the forces that provide its best advantage against rivals and consideration given to how could these be enhanced. One of the strategies here could be to benchmark its business activities against the best in class.

A company may choose to grow larger or not. This may be a personal preference of the owner, but the situation may be forced owing to customer demand. If the organisation chooses to grow it will either grow through use of its own resources or by alliance with or acquisition of another company. Again the choice made will depend on the stage in its life cycle and the STEEPLE factors surrounding the other organisation. Growth will require financing whether this is short term working capital or a long term financing vehicle. This is yet another choice for the firm to make. Making the right strategic choices is vital for organisations of any size. A systematic approach is more likely to result in appropriate decisions for an individual firm.

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ANSWERS TO ACTIVITIES
Activity 2 In terms of SMART, we can say that: S– A– R– T– This objective is specifically about sales of product X. we cannot state whether this is achievable without further information it is focused on results the time period is clearly stated as 3 months. M – 10% is measurable

The objective does appear to fit the criteria as in a real situation we would be able to look at past sales and the business environment to determine its achievability. It is, therefore, not quite a SMART objective. Activity 3 The skills and competences are likely to include innovation, entrepreneurship, marketing and good communication. The physical resources should include hardware and software of various types, working capital, work space and a business plan. Strengths and weaknesses will depend on the circumstances. Appropriate strengths may be knowledge of small business operations, experience in successful web design for small firms and technical ability, while weaknesses could be lack of knowledge of running a business, poor financial skills and so on. The activities and resources that you will need to employ again depend on the circumstances, but you may need financial backing to meet the forecast cash flow, a colleague with business and/or financial skills, and a database of growing and successful small companies. Activity 4 The STEEPLE analysis for the car industry might be along the following lines Political         Does the Government own a share in car manufacturers Is the Government a stable one? Government support for overseas investment. Disposable income available Economies of scale possible National growth rate Favourable interest or exchange rate. What kind of products will appeal to the various age groups.

Economic

Socio-cultural

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Environmental              Activity 5 (a) You could have identified any of the following:   Xerox changed the type of business it wished to be in when it switched emphasis from producing photographic paper to photocopiers. When it lost its patents Xerox could no longer ignore the competition and had to create a new marketing organisation to get new technologies into the market place quicker. (1988) In March 2001 instead of growing in size it divested companies in order to go back to core business. It decided in 2001 to move out of the small office/home business market. Use of resources in the production process Emissions are a health hazard Raw material wastage Alternative fuels available to appeal to conservationists. Lean manufacturing to reduce costs Quality monitoring and control R&D advances for new fuels or engine improvement. Level of corruption in industry and location Consumption of resources needed to provide essential energy requirements. Emission level regulation Other regulation relating to the industry specifically Quality control standards Restrictions on mergers/acquisitions.

Technological

Ethical

Legal

  (b)

In 1999 the negative impact included the strength of European currencies against the dollar, a slump in sales of high end copiers, Year 2K fears and a severe economic downturn in Brazil, one of Xerox’s key markets. It sold businesses, outsourced manufacturing, sold non-core operations and downsized in number of employees. It also paid no dividend that year. This allowed it to recover its financial strength by 2003 and to recover market share by introducing 38 new products in 2002-3. It used a joint venture with Fuji (which it subsequently sold). In 2004 "it was poised to begin pursuing acquisitions again". It acquired many non-core businesses in 2001, so had been involved in conglomerate operations previously. Initially Xerox could be said to have a differentiation strategy – it offered a unique selling (service) proposition (USP) that the competition did not have. Prices were not important to buyers of the products and they became so brand loyal that Xeroxing is still a word used globally for photocopying.

(c) (d) (e)

(f)

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Chapter 4 Market Structure and Business
Contents
Introduction

Page
92

A.

Perfect Competition Conditions for Perfect Competition Contestable Markets Views on Perfect Competition Disadvantages of Perfect Competition

92 93 94 94 94

B.

Monopoly Sources of Monopoly The Case For and Against Monopolies

94 95 96

C.

Monopolistic Competition

98

D.

Oligopoly Oligopoly and Anti-Competitive Behaviour Non Collusive Oligopoly Game Theory

99 100 101 102

Summary

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INTRODUCTION
The focus of this chapter is on how the degree of competition within a market affects prices, resource use, profit levels and efficiency. There are four different market structures and it is the difference in the number, type and size of the firms in the market, as well as the nature of the product itself, that affects the type of competition and extent to which companies can control price. We also examine the ways in which firms attempt to keep their prices high, legally and illegally, and the tactics they use in competing for market share. Competition The concept of competition is fundamental to understanding the different market conditions considered in this section. As consumers, when we think of competition, it suggests a choice – which is a desirable state of affairs. Thus, if you wish to buy a new netbook computer, there will be a choice of makes, colours and technical features. In some cases, you can negotiate on prices with the supplier knowing that some suppliers charge less than others. Owing to our ability as the buyer, to choose and apply pressure on prices, we expect competition to oblige producers and distributors to use their resources efficiently and keep production and distribution costs low. Competition is also, therefore, usually thought to be a very powerful force to ensure production efficiency. Competition is consequently regarded as a desirable feature of markets. Most of the major modern market economies have legislation and institutions concerned with preserving or increasing competition. How firms plan to effectively compete against each other will be covered in Chapter 5. However, there are variations in the degree of competition in different types of market, and this can have a significant impact on issues such as price, costs and market share: Figure 4.1: Degrees of Competition Great competition No competition

Perfect competition

Monopolistic competition

Oligopoly

Monopoly

A. PERFECT COMPETITION
Perfect competition is the state of affairs where suppliers and consumers essentially have no control over prices. This occurs because there are so many suppliers and consumers and, as a consequence, the market is very competitive and the market itself determines price. In such a market, buyers and sellers are said to be "price-takers" – that is, suppliers wish to sell all that they can produce at the market price, and buyers are indifferent as to which seller's product they buy at that price. The price is determined by the level of demand (from buyers) and supply, which will fall into balance. If demand goes up and supply stays the same, the price will increase; and if demand goes down, but the overall level of supply stays the same, the price will fall. If there is a rise in supply, but demand stays the same then prices will fall; and if supply goes down and demand remains constant, the price will rise. Surpluses and shortages will guide the price and on each occasion the market will settle at the equilibrium price where demand is equal to supply.

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Conditions for Perfect Competition
These can be summarised as follows: (a) All goods must be equally acceptable to the buyer The buyer is indifferent to which supplier s/he buys the goods from as long as they conform to any description adopted by and understood in the market. It is important that you consider the perception of the buyer. Even though the product might be identical in every way but the label, the buyer might perceive a difference. An example is supermarket "own brands" – the contents of a packet of biscuits might be identical but in two supermarkets one carries the label supermarket A and in the other the label supermarket B. The buyer perceives supermarket A as superior and, therefore, the produce is not the same (homogeneous) because the buyer considers them to be competing products. This is not an example of perfect competition. (b) Perfect information and communication All consumers in the market must have the same information. Suppliers must have access to the same information about production factors and the technical conditions of production. No producer is in a more favoured situation than any other. (c) Price established only by market forces No producer or buyer is able to influence the price by his or her own actions, nor by actions agreed with other producers or buyers. (d) Economic motives only The actions of suppliers and buyers are influenced only by economic motives. If buyers or sellers are influenced by a desire to support, say, a charity or a political party, the market will not be purely economic, however worthy the social motives. (e) No barriers limiting market entry and exit Suppliers and buyers must be free to enter and leave the market as they choose and as they are guided by considerations of profit and utility (the ability of a good or service to satisfy one or more needs or wants of a consumer). This is a very important element in any competitive market and in some modern models of market behaviour. Barriers to market entry and exit may be "natural" – i.e. arising out of the nature of the goods or the production process – or "artificial" – arising out of market regulations. Natural barriers are highest when production requires large amounts of highly specialised capital, such as in oil exploration. Only firms with access to very large amounts of finance can enter these markets. Once this capital has been acquired, the firms are committed to staying in the market, since exit barriers are also high, usually involving very large financial losses. Natural barriers are low when little specialised capital or skill are needed to commence production. When natural barriers are low, established producers may seek to protect themselves from new entry by building an artificial barrier such as membership of a trade or professional association, which takes a long time to acquire. It is not unknown for established traders to prevent new entry illegally by the use of force, as in the street trading of illegal drugs.

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Contestable Markets
The lower the barriers, both natural and artificial, the more contestable the market. Contestability is a powerful force in determining the behaviour of suppliers in a market. If producers know that they can easily be challenged by new competitors, they will behave as if they were subject to competition because they will not wish to provide incentives for new firms to come into the market. Incentives for new contenders to enter the market would include the potential to earn supernormal profit or the existence of buyers who were dissatisfied with existing goods, standards of service or prices. The market is being regulated in this case by potential competition and existing firms will act to ensure this does not occur.

Views on Perfect Competition
Economists often favour perfect competition for the following reasons:    It ensures the elimination of abnormal profit It promotes the efficient use of resources There is a tendency to encourage producers to reduce average costs as much as possible. This is equivalent to making the most efficient use of resources.

Disadvantages of Perfect Competition
(a) (b) It prevents producers from making the profit necessary to provide funds for investment and research, to find better ways of producing goods. Competition can be wasteful, as the resources of each of the competitors are doing the same things. If there were fewer competing firms, total costs could be reduced and some resources freed to produce something else. Firms dislike perfect competition because there is no price stability since prices follow changes in demand and supply. If communications are good, then supply can adapt very quickly to price changes caused by changes in demand. The result is that prices are constantly adapting to new equilibrium positions. (This is demonstrated well by the Stock Exchange – it is one of the best examples of a market that is close to perfect competition, since prices change in real time owing to the use of electronic communication methods.) (d) For manufacturers, swiftly moving prices are untenable. They can survive in such a market only if they could keep changing the prices paid for production factors, including the wages paid to workers. Producers want stable – or, preferably, rising – prices. From a social standpoint, perfect competition is far from ideal. Perfect competition, which economists perceive to be in the consumer interest, cannot exist together with stable wages and secure employment conditions.

(c)

(e)

B. MONOPOLY
Monopoly is the opposite extreme to perfect competition. It exists when there is only one supplier for a particular product and there are no close substitutes for that product. The firm has complete control over prices. Many state owned organisations are monopolies. The amount of power a monopoly has depends on the number of close substitutes that are available.

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Historically, almost all monopolies are subject to destruction by the continuous improvement in technology. For example, the Post Office used to have a monopoly in the delivery of lowprice letter mail in Britain, but did not have a monopoly in personal and business communication. Traditional mail has declined in the face of competition from mobile devices, email, online purchasing, telephone and private firms of leaflet distributors. In addition, it has failed to implement electronic sorting methods sufficiently quickly to retain its monopoly. In the UK, telephone; water; gas, electricity and railways are a few examples of monopolies that have disappeared as result of government privatisation policies.

Sources of Monopoly
Monopoly can arise in three ways.    (a) Law Possession of a unique feature Controlling the market. Law Some countries may grant a company the right to be sole supplier of a product or service (e.g. telephones) in return for some measure of State inspection and control over profits and prices. In Britain, before 1979, it was usual for such monopolies to be public corporations under public ownership and control. Privatisation changed this and resulted in a policy which separated regulation from operation. British Telecom, for instance, is a private sector company with shareholders, but is also regulated by a separate state body, OFTEL. In the case of BT, there still remains a virtual monopoly, as other firms found the barrier to entry too high. However, the extensive use of mobile phones has reduced its monopolistic status significantly. Patents and copyright law provide for a more limited type of monopoly. These concepts are similar in most countries. The essence of both a patent and copyrighting is that the inventor of a new product or idea is granted exclusive rights (usually by the state) to benefit from the product or idea for a limited number of years – in effect, monopoly control over its use. If rival suppliers are unable to develop a competing product without breaking the patent, this form of monopoly can be very valuable, such as the monopoly enjoyed for some years by Xerox as mentioned in Chapter 3 (b) Possession of a unique feature Individuals have monopoly control over the supply of their own skills and this may be a source of considerable profit. Footballers, tennis players and entertainers are all monopolists. When the skill lies in producing something written or recorded, then the monopoly position is protected by copyright laws. This protection has become more difficult to enforce as the internet has grown and downloads of copyrighted music and films have become common. (c) Market control A monopolist's output is the total market supply and the demand for its product is the total market demand. This can only be sustained, without the protection of the law, by exercising some form of control over the market which prevents competition from arising. There is evidence that Microsoft did this in the past through aggressive pricing, buying up rival companies and/or their technologies, and bundling different technologies together.

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The Case For and Against Monopolies
There is a view that monopoly is always against the public interest because it restricts output and raises price. However, there is much evidence that large firms with considerable market power may not maximise profits, but may pursue quite different objectives, such as growth or sales revenue maximisation. Is Monopoly Good? Most arguments in defence of monopoly are based on the economies of scale in production that very large firms may experience and the capacity of these firms to innovate, resulting from their superior ability to fund and undertake research and development.  The monopolist's size and ability to produce for the whole market enables it to achieve economies of scale, so that costs and, therefore, prices are actually lower than they would be under perfect competition. The monopolist employs professional managers who make more efficient use of available resources than small owner/managers, who often lack managerial skill. Monopolies can grow a market which did not exist previously – a good example being the success of Microsoft in standardising the PC market which allowed for its phenomenal growth from the 1980s. The monopolist does not always maximise profits, but is content with just a satisfactory level of profit. Some element of abnormal or monopoly profit is desirable, so that the firm can: (i) (ii) spend money on research and gather funds for further capital investment; have the incentive to take risks and innovate and sometimes suffer losses that would cripple smaller firms.

 

 

Supernormal Profit In perfect competition, firms are restricted in the amount of profit that they can make because they have no control over profits and there is very aggressive competition. In a monopoly there is no competition, allowing the monopoly to set the price and make substantial profits. It may then use those profits for R & D and investment, as mentioned in the last point above, or it may simply take the profits for the benefit of the owners. A monopoly may not have the incentive to be super efficient as is the case with firms in perfect competition who must survive. The monopoly has no competition in the market place, but it can still make substantial profit without operating at high efficiency. X-Inefficiency The points above that promote monopolists are made on the assumption that they are efficient. However, evidence demonstrates that large organisations, not just large firms with considerable market power, are inefficient when compared with smaller organisations and firms in competitive market situations. For example, large government departments and government owned firms are notoriously inefficient. The UK National Health Service (NHS) is one of the largest single organisations in the world (based on its number of staff). Many studies show that it is measurably inefficient and cost ineffective in comparison with both public and private health care providers in many other countries. The concept of X-inefficiency is used to explain the economic inefficiency of large organisations. The Oxford Dictionary of Economics defines X-inefficiency as: ‘Failure of a firm or other organisation to get the maximum possible output from the inputs it uses, or to produce its output with the minimum use of inputs. X-inefficiency

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implies that there is slack in the organisation. Its existence can be shown by a benchmark approach, demonstrating that other firms or organisations manage to get more output from equal inputs, or the same output from fewer inputs. Slack refers to under-used resources. Organisational slack occurs when firms or government bodies have more employees, equipment or buildings than they really need. Most organisations contain some slack: when demand varies, it is sometimes difficult to distinguish slack from necessary reserve capacity.’ X-inefficiency is a measure of the excess cost of the production of a unit of output of a good or service by an organisation, over the cost of producing the same output in the most efficient available organisation. It can be assessed, therefore, by a process similar to benchmarking. For example, consider an industry where there are two firms producing the same type and quality of a particular good. We assume that the two firms are of different sizes, but there are no economies of scale. One firm has a unit cost of production for the good of £3 per unit, while the other firm has a unit cost of production for the same good of £4. The second firm is X-inefficient in comparison with the first firm. Its degree of X-inefficiency is just over 30%. X- inefficiency in all types of organisations is ultimately the result of managerial failure to control costs:  When there is no incentive to make a profit, no threat of bankruptcy or closure as a result of controlling costs, organisations tend to be larger than necessary with far too many employees. They also tend to be resistant to change, defending old, established or traditional ways of operating, which prevents innovation, especially if that innovation would mean reducing the number of staff.

A key reason for this inefficiency is the lack of a reward incentive for workers to be efficient in carrying out their jobs.    Workers are paid regardless of their individual work effort, usually simply on the basis of spending the required hours per day at work. There is no reward for carrying out the work more effectively. In some bureaucratic organisations, managers' pay and promotion prospects are directly proportional to the number of staff they have working for them. This means that mangers who increase efficiency and can deliver the same or more output with fewer staff damage their own pay and promotion prospects.

So, certain large organisations tend to be both cost inefficient for a given state of technology and prevent or slow down technological innovation. The concept of X-inefficiency is very important when evaluating the case for and against monopoly. The case against monopolies We can summarise the disadvantages of monopoly as follows:     higher prices than in competitive markets due to persistence of excess profit the cost reducing advantage of economies of scale are outweighed by cost increases due to X-inefficiency wasteful expenditure on R & D and low productivity of R & D expenditure due to Xinefficiency no incentive to innovate because of high monopoly profit and absence of competition from other firms

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 

no incentive to investment in new production process and products because of existing high monopoly profit and absence of competition from other firms lack of customer focus – limited choice and poor product quality due to lack of competition.

So, can other firms enter a monopoly market? Since monopolies can make supernormal profits, the market that they operate in is attractive for new firms to try to enter. This may be easier in the provision of services than for goods. It is difficult to maintain a total monopoly over supply without the protection of the law, and a monopoly without that protection does not usually last very long. When a large rival decides to challenge the monopolist, there is little that can be done to prevent this. A badly run monopoly would also be an attractive target for a takeover bid.

Activity 1
What monopolies do you know of in your country? As a consumer, what are the main advantages and disadvantages of these organisations for you? See the suggested answer at the end of this chapter.

C. MONOPOLISTIC COMPETITION
Monopolistic competition has many of the same characteristics as perfect competition:     unrestricted entry to and exit from the market good (but not perfect) communication and transport conditions motivation by economic considerations only perception by buyers that the products of the various firms are good substitutes for each other.

It is in this last point that monopolistic competition differs from perfect competition. Although the products are considered to be good substitutes, they are not the same (i.e. homogeneous). Buyers do express preference for one seller's product as opposed to another's. It is, therefore, the buyer’s perception of the substitutes that differentiates monopolistic competition from perfect competition. Although the product may be effectively the same, it is the branding which alters the buyer’s perception of the substitute as being equivalent. Sellers use marketing to increase this preference and grow brand loyalty. This enables them to increase the price. However, the individual firm will be prevented from raising the price too significantly and taking supernormal profits, as can a monopoly, since the substitutes do not have that substantial a difference. Its price will still be closely influenced by the market price for the class of product. The negative perception of monopolistic competition is that it is not really in the best interests of either consumers or business firms:  Price is higher and output lower than would be the case with perfect competition

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  

The firm is not making the best use of its resources Profits are confined to the normal minimum required to keep firms in the market Firms cannot achieve the profits needed for investment and research or the high output levels necessary for economies of scale.

In support of monopolistic competition, it is said that consumers are prepared to accept additional prices and costs in return for the benefits they receive through greater choice of product and the ability to choose between competing brands and competing suppliers. This competition may also lead to improvements in product quality and design as well as services to the consumer. We can expect firms operating in such market conditions to seek to increase their monopoly power. They will do this by:     Brand advertising Securing favourable treatment from distribution organisations Technical improvements in their products Possibly also by patent protection or keeping processes secret from their competitors.

The best examples of monopolistic competition come from retail trade, including restaurants, clothing stores and convenience stores, and in certain technology markets, such as smartphones.

D. OLIGOPOLY
Oligopoly is the market structure where supply is controlled by a few firms that are large in relation to the market size. As a result of their being so few firms they will observe the actions taken by each other very closely and react accordingly to protect their market share. Oligopolistic firms are therefore interdependent. Very often the firms are also large, by any standards and are likely to be oligopolists in several markets. Oligopoly is common in the advanced industrial countries but there is no single model which can be held to apply under all circumstances. Examples of oligopolies in the UK          Groceries – Tesco, Sainsbury and Morrisons Chemicals/oils – Key players are Shell, Exxon, GlaxoSmith Klein, ICI, Kodak, Astra-Zeneca, BP, DuPont, BASF and Bayer Fast food restaurants – McDonalds, Burger King, KFC Bookshops – Amazon, Borders, Blackwells, Waterstones Music retailing – HMV, Virgin, Tower, Amazon, MVC Banks – NatWest, Barclays, HSBC, Lloyds TSB Electrical retailing – Dixons, Currys, Comet Mobile phone networks – O2, Vodafone, Orange, T-Mobile Home DIY – B&Q, Homebase.

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Oligopoly and Anti-Competitive Behaviour
Oligopolistic firms compete with each other for the same customers in trying to increase their market share – through marketing or product development, after sales service and so on. However, at the same time, they will try to keep the price high and/or hinder entry to their market by new firms. One means of doing this is by colluding with each other – in effect acting as if they are (together) a monopoly. This type of action is most commonly called price fixing and is illegal in many countries. Case Study In 2007, British Airways was fined £270 million by the Office of Fair Trading for price fixing after it admitted collusion in fixing the price of fuel surcharges (which were added at a time of huge, unexpected increases in oil prices) to customers booking its flights. The US Department of Justice fined it an additional $300 million for the same reason. It was stated that BA had colluded with Virgin Atlantic on at least six occasions between August 2004 and January 2006 and that during that time, surcharges rose from £5 to £60 per ticket. Virgin Airlines reported the collusion to the OFT and became, therefore, immune from legal action. Consumers who were affected by this illegal action were entitled to apply for refunds.

We know that competition reduces prices and profits, which is why it is beneficial for consumers and the success of economies. In perfect competition, the very large number of firms in the market makes it difficult for firms to get together and fix the market in their own interest. Oligopolists are likely to use more of their supernormal profits to develop better products or services. If they can demonstrate a superior product or service they will increase their market share. Product differentiation by oligopolists competing with each other thus provides more choice in the market and it can be said that the customer will benefit from the enhancements. However, under oligopoly, the small number of firms involved know all the other firms they are competing against. Each knows that if it changes its price or any of the non-price features of its marketing, it will have an effect on the other firms' market share and they will take action to restore their position. Thus, they will incur higher marketing costs and have lower economies of scale, and it is likely to make prices higher. Collusion and Cartels Oligopolistic firms that collude in formal price fixing arrangements are said to be part of a cartel. The oil industry is a very good example of this where OPEC – the Organisation of Petroleum Exporting Countries – is the most powerful cartel in modern history. Prior to its formation over 50 years ago, each oil producer set their prices independently. Members of a cartel meet at regular intervals to decide on the price that they will sell their product in the particular market. This can be done to regulate supply for the purposes of ironing out fluctuations in price caused by changes in demand and supply under normal competitive conditions, particularly where it is not possible, or at least very difficult and perhaps extremely costly, to vary supply to meet changing demand. (The fuel surcharge mentioned above resulted from the action of OPEC in 2007 to raise oil prices.) It may also be seen as a mechanism to conserve the supply of a scarce product. However, given this position, a cartel can also operate to charge higher prices than would be possible under competitive conditions.

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Cartels can, under certain circumstances, be perfectly legal. However, there are other forms of collusion – known as tacit collusion – which operate where price fixing is illegal, but oligopolistic firms find a way around the law. They can ignore the law, as we read in the BA case study, or they can watch each other’s prices and keep theirs similar. This type of action is called price leadership. Price leadership is the tendency observed in some oligopolistic market situations where the few firms in the market follow the price movements of one firm, the price leader. Such leaders can be:   The least-cost firm, which can force competitors with higher costs to follow its prices, even though they cannot maximise their own profits at the levels it sets. A firm which is typical of others in the market and which becomes a barometer of market conditions. If this firm feels that a price change is necessary, then it is likely that others will feel the same. The largest and the dominant firm in the market. The most common model of this situation assumes that this firm, because of its size and the economies of scale it can achieve, is able to achieve lower costs than the others. The lower its costs compared with the other firms' costs, the greater will be its market share and consequently, its dominance in the market. There are only a few firms who know each other well Firms are willing to share reliable information on general and production costs They produce similar products using closely related processes There is a dominant firm in the market Barriers to entry are high The market is stable with no huge fluctuations in demand or production costs No government measures exist to prevent collusion.

Collusion between firms in a cartel is more likely when:       

Collusion is unstable as demonstrated by Virgin’s whistle blowing action against BA and it is this instability that is a fundamental reason why collusion agreements break down. Other reasons include:    The incentive for each member of a cartel to cheat on the other members The incentive for a member to sell more than its quota as agreed in the cartel Reluctance of firms to share full information about their true costs, prices, sales and profits can lead to disagreements and lack of confidence that others will stick to the rules.

Collusive behaviour is more common than is generally recognised and with globalisation, many markets such as air cargo, steel, oil and cement are oligopolistic. Governments’ competition authorities try to prevent or break up collusive agreements between firms, to protect consumer interests against the monopoly exploitation such collusion is intended to achieve. Their effectiveness is, though, dependent on the power of the cartel.

Non Collusive Oligopoly
Where there are few common factors favouring collusion, firms will compete on price. Even so, the price tends to stay fairly stable. This is referred to as price stickiness. There have been attempts to produce oligopolistic models based on traditional assumptions of profit maximisation. One such model seeks to explain the observed tendency that the

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prices of some goods in oligopolistic markets remain steady in spite of fluctuations in the prices of basic commodities. This "stickiness" is apparent in more normal, less inflationary periods. For example, the price of bars of chocolate in some markets remains constant in spite of frequent movements in the prices of the basic materials required for chocolate manufacture. If there is little price competition and if consumers are not thought to choose brands on the basis of comparative price, then each oligopolist has a high degree of monopoly control over the demand for its own product and will price accordingly. Whether this is possible will depend on whether the consumer sees any difference between this supplier’s product and possible substitutes. For example, it may seem unlikely that consumers will find much to choose between various brands of plain, salted crisps. If there are price differences, customers are likely to choose according to price. In these circumstances, suppliers may seek to operate in different sections of the market, such as different supermarket chains or in hotels and pubs rather than retailers. They may also seek to differentiate their products through such devices as flavour or by developing novelty shapes or other related products and using famous celebrities for advertising. If one firm reduces it price, its competitors are likely to cut theirs so as not to lose market share. However, if a firm increases its price, others many not follow as there is the potential to increase market share.

Activity 2
Describe the type of competition which exists in the airline industry. If two large airlines merge, what do you think will be the affect on the consumer? Why is there unlikely to be a price war between competing low cost airlines? See the suggested answer at the end of this chapter.

Game Theory
Firms in an oligopolistic market situation recognise that their price and output decisions are interdependent. The significant implication of this is that the normal relationships between price changes and the consequent changes in sales and sales revenue depend on how other firms respond to a firm in the market changing its price. This interdependence creates uncertainty for firms as they determine their production and pricing decisions. One method of assessing the implications of any such decisions is to use game theory. For example, when making a decision on whether to increase the price or not, the firm will need to consider such questions as: "If I increase my price 20 per cent, can I manage it without losing market share? How will the other firms in the industry retaliate? What if my main competitor responds by reducing rather than matching my price increase?" Game theory is about strategy and deciding on the particular strategy which the player thinks will be the winner. Just like placing a bet, the firm will assess the chances involved of the reaction one action has on another, and success in the game will depend both on how the firm thinks its rivals will react and how willing it is to take the chance. In some circumstances

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the firm’s price strategy will win the game and it will achieve its goal of greater profits or price leadership. However, there is no certainty and the firm could be the loser. There are various types of game. (a) Single move games Here, companies are in a position of having just one opportunity to win in a competition. The simplest example is in bidding for a contract. The competitors have to guess what the other firms will include in their bid and prepare theirs to compete. However, the game is essentially the same when considering the implications of price rise on the competition for market share. Sometimes the outcomes of such games are predictable, especially where there is one criterion which will determine who wins. These are called dominant strategy games. The best such example is where contracts are awarded to the lowest price and the competing firms know that the lowest bid will win the contract. More complex games will not have a dominant strategy and will include more competing firms. In such cases the game will be much harder to win with firms having to investigate many aspects of their rivals’ position – for example, costs, potential effect on demand and supply, likely reactions in the market, the effects on its own profits, etc. The game could involve not only a rise in price, but aspects such as differentiated product development. (b) Multiple Move Games These involve, as the term suggests, a series of moves backwards and forwards – one firm differentiates its product, others do the same; next it reduces price to gain market share, the others follow. For example, firm 1 knows that firm 2 will only cut its price if firm 1 takes the lead. If firm 1 then cuts its price, firm 2 will follow and they will both be making lower profits. However, firm 1 will know that firm 2 will only cut its price in these circumstances so firm 1 has an incentive not to cut its price, but it can threaten firm 2 with a price cut. In game theory, threats can be implied or open and, if the rival believes that there is a real threat, it will influence the rival’s behaviour. Supermarkets play these kinds of games. The ‘local’ versions of big supermarkets often charge higher prices or have fewer special offers available to consumers because they are the only one in a small town or railway station. However, when there are a number of rival stores within easy access, price movements will be carefully examined and very often followed. In the 2008 recession, for example, several supermarkets produced lower priced versions of vegetables, fruit, salads and so on. Waitrose, which was considered a superior organisation, started to lose customers because consumers were being more careful about spending and after some time it was forced to produce a similar range. Waitrose did not initially react to the threat of lower priced goods as being credible. (c) Price Promises These are another example of the application of game theory. PC World, a large IT retailer in the UK, has promised ‘to beat the price of any other competitor and not only to match it but beat it by 10% of the difference’. Since PC World is very large it is likely that this promise will be seen as credible by other retailers and so their prices are likely to match. PC World will not want to lower its profits and gambles on the fact that no other store will want to either. However, such promises usually have some conditions. Can PC World beat every other store in the UK on price? It will not take such a big risk, so it hedges its bet by

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attaching conditions on the unit purchased requiring any rival store to be within 30 miles and have stock ready for delivery. In this situation the market is unstable. A price war is a likely consequence, even when firms have a collusive agreement, if at least one firm to the agreement thinks that it can come out the winner in such a situation. (d) The Prisoner’s Dilemma This is a classic of game theory which demonstrates why two firms may not cooperate even if it is in the best interests of both to do so. Albert W. Tucker formalised the game with prison sentence payoffs and gave it the "prisoner's dilemma" name (Poundstone, 1992). The basic set up is as follows: Two suspects are arrested by the police. The police, having separated the prisoners, visit each of them to offer the same deal. (i) (ii) (iii) If both say nothing there is sufficient evidence to sentence them for one year If one confesses he will get six months in prison and the other will get 10 years If both confess to the crime they will each get 5 years in prison.

Each prisoner must choose to betray the other or to remain silent. Each one is assured that the other would not know about the betrayal before the end of the investigation. How should the prisoners act? If prisoner 1 coperates he will get only six months and prisoner 2 will get a long sentence. However, prisoner 1 does not know how prisoner 2 will react to the same question – if he also cooperates they will both get 5 years. For prisoner 1 this is better than getting 10 years if he says nothing and prisoner 2 cooperates. They will only both end up better off if they collude and say nothing. However, the police will prevent this action. They will also try to persuade each prisoner that the other is bound to confess. Option 3 then is the safest strategy. The actual position taken by the prisoners will depend on: Their attitudes to risk. One prisoner assessing how likely the other prisoner is to cooperate.

In this game, as in most game theory, the only concern of each individual player (prisoner) is maximising the outcome for him/herself (minimising his or her own sentence) without any concern for the other person's outcome.

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SUMMARY
There are four possible market conditions:  Perfect competition – comprising many suppliers of homogenous products where price is fixed by supply and demand in the market. Firms have no influence over price and, since the market is competitive, profits are low. There are low barriers to entry and exit. Monopoly – where there is only one firm in the market and there is no competition. Monopoly firms are like to be large, very bureaucratic and demonstrate x-inefficiency compared to what the most efficient comparable firm would demonstrate. They are, though, able to charge high prices and earn supernormal profits which can be invested in R&D (innovation). Governments will sometimes intervene so that two companies cannot merge to form one larger monopoly and thus reduce competition. Monopolisitic competition – this has many of the features of perfect competition, but the buyer perceives a difference in substitutes owing to branding. The seller increases advertising to increase brand loyalty and can ultimately increase price, but only within what the market will allow – it cannot earn supernormal profits as a monopoly can. Oligopoly – where a market has only a few very large firms. The firms are often diversified into several markets. There is no model for this type of firm. Oligopolies try to keep prices high by collusion or price fixing which is illegal in some countries.

Supernormal profits are usually only possible for monopolies and in certain cases, oligopolists. X-inefficiency is prevalent in monopolies and represents inefficiency in the use of resources. Game theory can be used by firms in an attempt to determine the outcomes of competition. Oligopolies may use it to assess whether and by how much they can raise their prices and hence profits.

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ANSWERS TO ACTIVITIES
Activity 1 Your answer will probably include all state owned companies or powerful large companies with existing patents. The advantages of monopolies can be that:   The product (goods or services) they provide is standardised and you know what to expect Where it involves an important utility or similar key product, it may be argued that the supply of that product is safer under state control High prices Poor customer service Mediocre quality of service/good

Disadvantages can be:   

Activity 2 The airline industry is predominantly an oligopoly, dominated by a few firms who form alliances to keep the price high. Low cost airlines are a threat to this, although in the early days of low cost, the large airlines had the power to force the lower cost airline out of business. (Laker Airways was the forerunner of Ryanair, Easyjet and other small European airlines.) It could be argued that there, in fact, two separate oligopoly markets in operation – one comprising the main carriers and another being the low cost ones. If two large airlines were to merge this would reduce competition, which could result in higher prices and lower services. Since low cost airlines operate on low profit margins, a price war might mean that they would both end up making insufficient profit to continue in business. Competition is more likely on branding and on the cost of "add-ons".

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Chapter 5 A Macro-economic Perspective on Business Economic Systems
Contents
Introduction

Page
108

A.

Macro-Economic Systems Planned Economy Market Economy Mixed Economy

108 109 111 112

B.

The Government and Economic Activity Gross National Product Gross Domestic Product Understanding and Interpreting National Accounting Data The Business Cycle Aggregate Demand

115 115 117 123 125 126

C.

Regulating the Market Inflation Unemployment Balance of Payments Managing Economic Growth

127 128 128 130 131

D.

Government Interventions to Achieve Economic Objectives Fiscal Policies Monetary Policies Supply Side Policies

131 131 134 135

Summary

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Answers to Activities

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INTRODUCTION
An economic system can be defined as the organised way in which a nation allocates its resources and apportions its goods and services. In this chapter we will examine the three most common economic systems: (a) (b) (c) Planned (or command) economy – where the State makes all the decisions concerning production of goods and services Market economy – where the owners of private businesses make the decisions which will vary according to supply and demand Mixed economy – where production decisions are a combination of those made by the state and private business.

National economies are dependent on the flows of production and money. We will look at how the national income is measured and the information this gives us about the efficiency of work and living standards in different countries. The level of economic activity varies over a period of time in a cyclic manner. Its peaks are the boom periods and the troughs are known as recessions. We investigate the reasons for this periodic behaviour and what governments can do to smooth the extremes of boom and recession.

A. MACRO-ECONOMIC SYSTEMS
In any economic system three questions arise: (a) (b) (c)    What should we produce? How can we produce those goods or services? How will the products/services be shared? the Government decides the answers to the questions given above – giving rise to the economic model of a planned (or command) economy buyers and sellers make all the decisions and the Government plays no part – giving rise to the economic model of a free market economy a combination of both the Government and buyers and sellers make the decisions – giving rise to the economic model of a mixed economy, which has elements of the market and planned economies.

As noted above, there are three possible answers to these decisions:

Think Point
Which type of economic model has been adopted by your country? Can you identify any examples of either a pure planned economy or a pure free market economy?

The vast majority of economies around the world today are mixed economies. It is difficult to have a pure free market economy as there are certain aspects that any Government will wish to control for the good of all its citizens (and we will return to this in more detail in later chapters). Planned economies were a feature of Communist states and have become less

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popular following the break-up of the Soviet Union. Possibly the only example of a fully planned economy now is in North Korea. Cuba is also sometimes cited as an example, although it could be argued that there are also elements of a market economy present there.

Planned Economy
Central economic planning, known as a planned or command economy, is best known as the model that was adopted by the Soviet Union following the Bolshevik Revolution of 1917. The total direction and development of the nation’s economy was planned and administered by the government from that point. This type of economy has since become associated with other communist or socialist countries. The Soviet Government operated its economy on the basis of a five year plan, which attempted to arrange a balance between demand and output. The primary purpose of central planning in the Soviet Union was the attainment of the five year goals that state authorities formulated. The key features of the model are that it:      Has strong political overtones Works on a set planning cycle The government decides what should be produced and in what quantity as a result of its forecast of demand The government sets prices The government decides how the output is distributed.

In the Soviet Union everyone involved in the process answered to the State, obeyed all its directives and practised self discipline for the benefit of the State. This is common practice in planned economies. (a) Advantages of a Planned Economy Whilst it might seem difficult to imagine for those of us brought up in modern mixed economies with a substantial element of the free market present, there are a number of great advantages to planned economies.    All resources are focused on meeting a social or economic goal. Long term projects can be planned without fear of a downturn in the economy, which can result in projects being left unfinished. Resources can be allocated by the Government to any cause that it considered most beneficial. For example, in World War II, the Soviet Govenrment needed to make parachutes. These were made from nylon and as a result, all the nylon needed was deployed for this purpose and other uses, such as manufacture of ladies hosiery, were ignored. A stable, safe environment is provided for investors as production is under state control. There is a guaranteeed standard of living for all, including: – – – – Free education Free healthcare Disablity allowances Retirement benefits/pension guaranteed.

 

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(b)

Disadvantages of a Planned Economy On the other hand, there are a considerable number of down sides.   Choice is limited to the existing supply of goods and services. Planners do not take account of customer preferences, shortages or surpluses, resulting in the waste of resources that could have been employed in producing more appropriate goods. Often the forecasts are wrong and products are just left to rot – for example, in the 1960s and 1970s the Soviet govenrment quota on tractors was too high and unused ones were left to rust as they could not be sold. The price mechanism set by the State does not always benefit the State – for example, the relative income from different uses of the same materials is ignored, as in the case of nylon given above. Massive amounts of state income that would have resulted from the manufacture and sale of hosiery was missed because parachutes, which sold for a low price, were seen by the goverment as the priority. There may be issues of poor quality, probably through the lack of incentives other than to reach numeric goals. Many planners and administrative support workers are involved in each step, leading to slow decision making, lack of innovation and corruption. There is no competition to the State produced goods, resulting in lack of innovation and quality. Private decision making in regard to choice of employment, occupation and selection of workplace is severely restricted. Where unions exist, as happened in Poland, their primary role was to ensure that the production goals of the state planning commissions were met. Wages are set by the governemnt with no union input. The standard of living does not grow as quickly as in a market economy.

          

Central planning failed for a number of reasons including: Inefficient allocation of resources and labour Upward communication of distorted and self-serving information from agencies low on the hierarchical ladder Prices were set without any relation to cost, supply and demand Inefficient execution and administration of the various economic plans.

Within command economies, secondary economies often spring up. Because of the lack of choice and poor quality of goods, consumers often resort to the black market to obtain superior goods, with corruption and moonlighting being involved in obtaining such goods. Resources meant to meet central planning needs may also be diverted to satisfy consumer demand, shifting scarce resources away from the government’s priorities. All these types of behaviour conflict with the philosophy of central planning. Some of the communist governments that continue to exist are moving away from a totally centrally planned economy. China is a good example, where its government has adopted some market economy techniques, although strong State control is still in place. Its universal healthcare system, which was based on central planning, has largely been dismantled and replaced with various health insurance schemes, mostly funded by member contributions. As a result, many private sector employees and the self-employed are often without any cover and must bear the entire cost of health care themselves.

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Market Economy
A market, in economic terms, is defined as ‘an area within which forces of demand and supply for a particular ‘economic good’ can communicate and interact so that the good can be transferred from seller to buyer’. An economic good is said to afford utility (usefulness) to people. Therefore, a market economy is characterised by:   private rather than public sector control of production, distribution and consumption being regarded as an economic rather than a political system, responsive to marketplace demands.

Market economies work on the assumption that market forces, such as supply and demand, are the correct determinants of what is right for the country. Private businesses make the decisions rather than the State. The state of the market at any instant is represented by its price structure – that is, the sum total of the exchange ratios that can be established by the extent of interaction between those wishing to buy and those keen to sell. Market prices alert the producers to what they should produce, how they ought to produce it and in what quantity. (a) Advantages of a Market Economy The advantages stem from the freedom of action within the market.        Minimum goverment intervention Any individual or firm has the right to act on his/her/its own account to satisfy the needs of others Competition between different firms leads to increased efficiency Most people work harder, as the rewards act as an incentive There is more innovation as firms look for new products to sell and cheaper ways to produce goods and services Foreign investment is attracted as new opportunities emerge The size, power and cost of the State bureaucracy is reduced, as various activities that are usually associated with the public sector are taken over by private enterprise Increase in skill levels and technological advancement Lack of price fixing Free trade – no limits on franchises and licences, and a lack of export/import quotas Choice – no compulsion for any individual to buy a product Provides information about the preferences and beliefs of consumers.

     (b)

Disadvantages of a Market Economy The disadvantages stem from the lack of regulation and the way in which this exposes individuals and forms to the fluctuations in market conditions.     No industry subsidies No control on goods produced Economic cycles affect employment and income levels Exploitation of employees can occur

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  

Gap between rich and poor often results Reduced social benefits Environmental issues result, such as apporpriate use of resources and waste disposal.

The market economy is the most popular system in the current global market place. However, no economy can claim to be a purely free market economy, as some intervention from government always occurs.

Mixed Economy
Those in favour of the free market believe that central planning wastes resources, and that a free market ensures that consumers receive the goods they prefer, at an economic price, produced efficiently by competitive firms hoping to make a profit. In reality, most societies operate some form of mixed economy – partly planned and partly free market. These economies are still generally referred to as market economies as the amount of State intervention is limited. In the UK we have a mixed economy. Most decisions are made by the market – i.e. by consumer supply and demand. So, what the consumer chooses to buy creates demand, and this demand is crucial in a firm’s decision-making process about what to produce, how to produce it, as well as how to distribute and price the goods. The efficiency of the free market in the UK is very high, so the market makes most of the economic decisions. However, it is generally accepted that there a range of decisions about production and the supply of services which have a wider impact on society and must be taken by the government of that society. These decisions include those relating to infrastructure such as road building; school and hospital construction, and to public services such as military spending and the supply of medicines in hospitals. These activities are usually carried out by government employees and progress controlled centrally. (Later in this chapter we will look at how some government funded projects may be completed by market based means rather than using public sector employees). This mix in the economy is also be very political, with decisions about which parts of the infrastructure and what public services should be centrally planned varying depending upon prevailing central government policy. (a) Advantages of a Mixed Economy These are a mix of those for both free market and planned economies. In particular, the free market advantages are seen as being augmented with the addition of controls on issues such as:      (b) Employee health and safety Employee rights Environmental protection Growth of monopolies, which can be disadvantageous to consumers Collusion between oligopolies.

Disadvantages of a Mixed Economy Government intervention in certain areas will be classed as a disadvantage to a firm, but this will sometimes be a distinct advantage to society. The intervention may add to the firm’s costs. The global trend is towards the free market economy, with most countries now adopting a mixed economy that is predominantly free market with a degree of state intervention.

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Some planned economies do exist, but these are getting fewer and large economies such as China are increasingly adopting free market techniques.

Activity 1
The following case study considers the development of a mixed economy in China. Read through it carefully and then answer the questions which follow, using just the information in the case study. Case Study: China’s hybrid economy China is no longer a planned economy but it is not yet a fully capitalist economy. The State still wields power through the allocation of massive state resources and effective control of large-scale SOEs (state owned enterprises), which continue to dominate key sectors of the economy. Despite formally being transformed into joint-stock companies (selling shares to private investors), the major banks are still effectively controlled by the State. Currently, state owned and state holding enterprises account for roughly half of all (non-property) urban investment in fixed assets. At the same time, the party-state, a powerful apparatus with massive financial resources, continues to exercise general political direction over the economy. Sweeping measures taken by the regime to facilitate the recent Olympic Games demonstrated the power of the State to mobilise resources and sweep away obstacles to its policy objectives. There was phenomenal public expenditure on the Games, the Government ruthlessly cleared residents from large areas of Beijing and heavy industries were shut down in a desperate attempt to reduce air pollution for the duration of the Games. How much of the economy remains under the direct control of the state? While the class character of the State is not determined mechanically by the percentage of state ownership, the changing balance of ownership is an important indicator of the direction of change. But it is not easy to determine the state/private balance of ownership. Different studies give different figures. Will Hutton wrote in his book, Writing On the Wall: "China’s approach to private ownership means that attempting to assess how much of China is public and how much private is a fool’s errand because it cannot capture how the Party is trying to develop Leninist (in reality, ruling party) corporatism." Like many other commentators, Hutton shows how, in practice, the State has effectively retained control of former SOEs that have become joint-stock companies. With many apparently privatised companies, "the shareholder and accounting structure is such that at any time the Party can regain control if it is necessary". SOEs and corporations controlled by the State (including joint-stock companies) accounted for 49.6% of industrial output in 1998. In 2004, this had declined to 38%. Central government (as opposed to provincial and local government) accounted for 23.7% of the workforce of all Statecontrolled firms but 48% of their assets. "… the decline in the state share of output has been much more gradual than the decline in state employment. As state ownership has become increasingly concentrated in large, capital-intensive firms – and as demand

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for energy and raw materials has pushed prices up for those firms – statecontrolled companies have sustained only a small decline in their share of total output.” Agencies of State Control IN 2003, the Government established the SASAC (State-owned Assets Supervision and Administration Commission) to exercise ownership rights of State SOEs. Subsequently, local SASACs were set up to exercise ownership of State firms in every province. There are undoubtedly many tensions between the SASACs and the bosses of the powerful SOE corporations under their oversight. Nevertheless, the SASACs are powerful agencies of State control. The central government SASAC has authority over 196 key firms: "Many of the 196 ‘enterprises’ governed by central SASAC are in fact large holding corporations that evolved from the former government ministries. These corporations have hundreds of subordinate firms, control large sums of money and exercise strategic control over decision making. Moreover, these corporations typically retain their own revenues and remit only taxes (not profits) to the Government. For example, SASAC exercises nominal ownership rights over the five large electricity conglomerates that produce virtually all of China’s electricity, as well as the two primary electricity grid operators. These conglomerates, in turn, control hundreds of firms, including at least ten listed corporations. These conglomerates are highly opaque and in practice, officials with political ties and little accountability exercise government ownership rights within the organisation. There are numerous similar cases in the sprawling industrial empire overseen by SASAC. Thus SASAC has a long way to go before it can serve as a government holding company, exercising ownership rights in an unambiguous fashion, governed by law". In theory, the SASAC should be operating at an arms-length distance from the party-state, overseeing state-run firms on the basis of a clear legal and regulatory framework. However, "the demarcation of SASAC’s authority is plagued with a number of difficulties. By far the most important is the inherent conflict with the Communist Party over appointment power. Arguably the most fundamental characteristic of the Chinese political system is that the Communist Party retains its traditional nomenklatura role, in which party committees make all the key personnel appointments in the state sector". (Source: Socialist Worker)

Questions (a) (b) Describe the aspects of China’s economy that suggest it is a centrally planned economy, as suggested by quotations from this article. To what extent do you believe it is moving to a market economy? Again, use quotes from the article to support your argument.

See the suggested answer at the end of this chapter.

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B. THE GOVERNMENT AND ECONOMIC ACTIVITY
The best measure of a national economy and its level of economic activity is its Gross National Product (GNP). This is defined as the value of all the goods and services produced in an economy, plus the value of the goods and services imported, less the goods and services exported. GNP = goods and services produced in the economy + imports - exports

Gross National Product
We start examining how GNP is made up by considering two fundamental concepts – the flows of production and consumption, and the opposite flows of money within the economy. In examining these flows, we make a number of assumptions:    That production and consumption are separate That production is all organised by business firms and government organisations That consumption is decided by individuals, families and households – note that households are seen as purely a consumption and social unit, and have no role in production. That all goods and services produced are exchanged through a market based system, with households paying money to buy products and firms paying money to households for the use of production factors (land, labour and capital) A proportion of production is organised by the state and its agencies (and paid for by revenue raised in the form of taxation by the State from households).

Figure 5.1 shows the flow of production and consumption – the goods and services produced by firms/government and consumed by households that in turn provide factors of production such as labour and capital. Figure 5.1: Flow of Production and Consumption

Firms I Employ Produce

Factors of production (land, labour, capital)

Goods and services

Sold through factor markets

Bought through product markets

Households

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Figure 5.2 shows the counter-flow of money, which represent the flow of payments made in respect of the flow of production and consumption. Figure 5.2: The Counter Flow of Money

Firms I Pay Receive

Factors rewards

Revenue from the sale of goods and services

Income

Expenditure

Households

In these diagrams, households represent all individuals and families, and firms represent all the various types of organisation (including government). These basic diagrams assume that the total volume of production is immediately and totally consumed, i.e. nothing can intervene to enlarge or diminish this continuous circular flow. The models also assume that there is no foreign trade, no taxation and no government spending, and that total income is all spent on consumption. However, the real world is not quite like this, so we need to take account of a number of additional factors:  Not all the income received by households is immediately spent on goods and services; some income is saved. We can develop an important equation from this: Income (Y) is either spent on consumption (C) or saved (S). Therefore: Y=C+S Therefore, any increase in income will be divided in some way by consuming more and saving more. The amount of any increase in income which is consumed is often referred to as the marginal propensity to consume. The greater the propensity to consume, the higher will be the proportion of total income that is consumed at any given income level.  Another part of the total income of households is not actually spent on goods and services, or saved, but handed over to government authorities as taxation, either taken directly from income or indirectly through taxation included in the purchase price of certain goods and services. Yet another part of the total income is spent on goods and services produced by other national economies; imports from other countries.

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Firms enter the general flow as buyers of goods and services, such as factories, machines and research, so that they are able to increase their capacity to produce. This is called investment or capital accumulation. The Government must also be seen as a separate element within the flow, producing goods and services on behalf of the community as a whole. (These include building roads, schools and hospitals, maintaining law and order and a defence against external aggression.) All of these are combined under government expenditure. Firms supply other countries with exports of their products. Trade is a two-way process.

When these adjustments are taken into account, an amended flow diagram is produced. The first three items can be regarded as leakages from the main flow of economic activity, because they reduce the purchasing power of total incomes. The second three can be regarded as injections into the flow, because they increase total purchasing power and demand. Figure 5.3: Leaks and injections into the main flow Injections of expenditure Business investment Government expenditure Exports Households National Product, Income and Expenditure We can now see that this total flow of economic activity, modified by injections and leaks, is that encompassed by the term Gross National Product. The term emphasises that it is the total production of goods and services that is the really important matter (as per Figure 5.1). The counter flow of money in the second diagram (Figure 5.2) can be seen as both the total income of households and as the total expenditure of households. These three aspects, total product, total income and total expenditure, are all really describing the same essential flow. They can be regarded as equal provided that Total value of leakages = Total value of expenditure So we can say that, if P denotes total product, Y denotes total income and E denotes total expenditure, then: Total Product = Total Income = Total Expenditure or P=Y=E Firms Leaks from Income Savings Taxation Imports

Gross Domestic Product
One of the key sets of data in the accounts for GNP is that for Gross Domestic Product (GDP). In general GDP is the economic activity taking place within a country’s borders. So, the UK GDP is defined as "the sum of all economic activity taking place in UK territory".

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Data on aggregate economic activity in the UK is published each year in the United Kingdom National Accounts (the publication which is also called the Blue Book). It defines economic activity as follows: "In its widest sense it could cover all activities resulting in the production of goods and services and so include some activities which are very difficult to measure. Economic activity or production generates output that is carried out by organisations using inputs of labour or capital and good and services to produce outputs of other goods and services. These activities range from agriculture and manufacturing to service producing activities to the provision of health, education, public administration and defence: they are all activities where an output is owned and produced by an organisation, for which payment or other compensation has to be made to enable a change of ownership to take place." The annual value of the Gross National Product (GNP) is an estimate of the total money value of all the final goods and services produced in a given one-year period by the factors of production owned by a particular country's residents. (This includes economic activity outside the country’s borders). To avoid double counting "final" goods and services means goods and services sold or otherwise provided to their final consumers. An example of this is that the value of steel sold to a car manufacturer to make a car will not added separately into the GNP or GDP totals because its value is already included when we add in the final sales price of the car to the customer. GNP and GDP are very closely related concepts in theory and in actual practice the numbers tend to be very close to each other for most large industrialised countries. The differences between the two measures arise from the fact that there may be foreignowned companies engaged in production within the country's borders and there may be companies owned by the country's residents that are engaged in production in some other country, but provide income to residents. For example: Country X receives £10 billion in income from its overseas investments in country Y in a given year. In the same period, country Y receives £3 billion from its investments in country X. The GNP of country X will be larger than GDP in that year. Calculating GDP Gross Domestic Product represents the gross value added by the whole of the community’s economic activity; it does not include indirect taxes and government subsidies. The Blue Book actually show two versions of GDP based on expenditure. (a) At market prices, which takes no account of expenditure taxes or subsidies paid to producers. This measure shows the totals of spending at the prices actually paid "in the market". The second measure of GDP is calculated by deducting the total value of expenditure taxes and other indirect taxes and adding back the total of subsidies paid to producers. This measure shows the "true" cost of production of output, since indirect taxes are not a true cost of production despite the fact that they appear as part of the cost when the goods and services are purchased. Similarly subsidies reduce the prices paid for goods and services below their true cost of production.

(b)

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The figure for GDP based on basic prices is the one normally used. It is considered to be the fairer reflection of true expenditure on goods and services – total expenditure includes government spending on final consumption and much of this is paid for from expenditure taxes. If we value GDP at market prices, then we are, in effect, including expenditure taxes twice; once when they are paid by the consumer and again when they are used to pay for goods and services by the various government bodies. Similar adjustments need to be made to take account of subsidies. These are payments made by government to producers and have the effect of reducing market prices. To obtain the true cost of goods and services any subsidies need to be added back. Given that, though, there are a number of issues which mean that some economic activities remain outside of the scope of the official figures – for example:    The desire to evade taxes – the extent of the hidden (or black) economy in some countries is estimated as being as high as 20–50 per cent of the official economy. The contribution made to economic and social welfare by unpaid parents and others who perform services within the family. The official figures also ignore unpaid voluntary activities within local communities and amateur sporting activities.

The way in which production, especially service production, is valued may cause further problems.  Where goods and services are distributed through unregulated markets in a market or mixed economy, we accept that market price is a fair method of arriving at their value. However, in a planned economy, where the State is the sole provider of a service and the sole employer of the factors used to produce that service, we cannot be sure that the recorded value bears any relation to the value to the community – or to their value in another country where similar services are distributed. Any comparison or calculation is likely to rely on money as a measuring device. However, money value is not a constant – its value is eroded over time by price inflation. The rate at which prices increase (or sometimes decrease) differs greatly over time and from country to country. The rate of change in prices in a country can be measured using price indices and in many countries various price indices are compiled for this purpose. These cannot be entirely accurate and the longer the period over which comparisons are made, the less reliable the figures become. (In the UK National Accounts, allowance for changes in the value of money is incorporated into the figures.) There is also the problem of comparing accounts when these are prepared in different national currencies.

Note, too, that equivalent estimates of GDP (or GNP) produced in a given year may theoretically be arrived at through at least three different accounting approaches, depending upon how the transactions that determine the prices of final goods and services are calculated:    by focusing on the buying by focusing on the proceeds from selling by focusing on the nature of the products themselves.

Therefore comparison between countries will require knowledge of the basis of the calculation.

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Trends and Comparisons in GDP In 2008 the UK GDP by industrial sector was broken down as follows:    Services Sector – 76.2% of UK GDP Industry & Manufacturing – 22.8% of UK GDP Agriculture – 0.9% of UK GDP.

The share of GDP accredited to manufacturing has been declining for many years and is a common trend in the older industrialised countries in North America and Western Europe. In recent years, manufacturing has moved increasingly to Far Eastern countries, particulary China. The move away from manufacturing to services reflects both rising living standards in these countries, where people spend an increasing proportion of incomes on services instead of goods and changes in the pattern of world production. Financial services, for example, accounted for 8.3% of UK GDP in 2007 having risen steadily from 5.3% in 2001. The proportion of GDP accounted for by education, health and social work has also increased in recent years for a number of reasons:    changes in technology affecting the work performed and equipment used by these services the age structure of the population, as the rising numbers of older people put more pressure on the health services changes in economic and social conditions, with the expansion of education, to cope with the demands of a technology based society and social work, to cope with the casualties of that society.

Manufacturing still provides a very large part of the wealth of the community, but it has changed from the labour intensive manual process of the past into a complex, computer based process, with ever more focus on ‘lean’ manufacturing to reduce costs and to enhance quality. The borderline between the new manufacturing processes and services is blurred – for example, assembling a computer is clearly a manufacturing process but designing the software and systems that control the computer and all the other equipment in the factory, depend on the services. Fewer people are currently employed in manufacturing than in the past owing to the increasing use of technology and the outsourcing of services such as design, catering and distribution. The UK Office for National Statistics produces a number of economic indicators relating to the UK economy. At the end of 2010, the five year trend in GDP growth is demonstrated in Figure 5.4.

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Figure 5.4: Trends in UK Domestic Product – Real GDP quarterly growth 4 2 0 -2 -4 -6 -8
2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3

Quarterly percentage change Cumulative annual percentage change Source: www.statistics.gov.uk As the bar chart above demonstrates, the Gross Domestic Product (GDP) increased 0.8 per cent in the third quarter of 2010, compared with an increase of 1.2 per cent in the previous quarter. The ONS (Office for National Statistics) explained these trends as follows: ‘Total services output rose 0.6 per cent in the third quarter, compared with a rise of 0.9 per cent in the previous quarter. The largest contribution to the growth in this quarter was from business services and finance and government and other services’. The trend in the UK’s GDP as measured per head of population is shown in Figure 5.5. Figure 5.5: Trend in UK GDP and GDP per head 1990 - 2008
160 150

Index (1990 = 100)*

GDP GDP per head

140 130 120 110 100 90 80 70 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

1990 baseline

* Chained volume measures re-referenced to 1990 = 100

Source: Office for National Statistics

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The UK Department for Envrionment, Food and Rural Affairs (DEFRA) placed these trends in context:  Between 1990 and 2009, GDP grew in real terms by 47 per cent. However, following a steady increase between 1992 and 2008, GDP decreased by 4.9 per cent between 2008 and 2009. GDP per head followed a similar trend. Whilst there was an overall increase of 36 per cent between 1990 and 2009, GDP per head decreased by 5.5 per cent between 2008 and 2009.

The growth in GDP as compared with that of other nations gives a measure of the relative strength of the UK economy. The graphs below (Figures 5.6 and 5.7) indicate that the UK GDP per head was growing faster than that of other nations (shown in the graph) up until 2006. Figure 5.6: GDP per Head for Several Industrialised Nations, 1990-2006
GDP per capita ($US) (1990 = 100) 250 220 190 160 130 100 70 1990 1992 1994 1996 1998 2000 2002 2004 2006

UK Australia US Germany Sweden Japan

Source: United Nations Statistics Division GDP per capita is an indicator of a country's economic strength, and has been linked by economists with the standard of living in the country (although note the comments on this below). Output per worker (or efficiency) for UK, can be compared with other countries using government GDP statistics.

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Figure 5.7: Ouput per Worker for UK and Selected Countries, 2008
150

Index (UK = 100)

100

50

0
Japan Germany UK France G7 (Excluding UK) US

Source: Office for National Statistics DEFRA noted that, between 1991 and 2008, the UK experienced faster productivity growth (as measured by GDP per worker) than all other G7 countries. During the period, output per worker increased by 39% compared with the G7 average (excluding the UK) of 29%. However DEFRA also emphasises that "a degree of caution should be taken when comparing the productivity estimates of individual countries. Differences should be only seen as significant when they reach a threshold of five percentage points". In 2008, GDP per worker was higher in the US and France than in the UK (by 33% and 9% respectively). Germany had a similar output to the UK in 2008, whilst Japan’s GDP per worker was 8% lower than the UK’s. A country’s growth may look very different when output per head is examined; a nation may have high growth but still be inefficient in terms of per capita output.

Activity 2
(a) (b) What is the difference between a country’s GDP and its GNP? In interpreting Figure 5.5: (i) (ii) (c) Why do you think there was a decrease in UK GDP and GDP per head in 2008-9? Can you give reasons why the GDP line is higher than the GDP per head line?

How useful are calculations of GNP and GDP?

Understanding and Interpreting National Accounting Data
The detailed calculation and publication of annual national product figures is a practice with only a relatively short history. United Kingdom figures have been compiled regularly only since the early 1950s.

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After the Great Depression of the 1930s, the economic role of the government changed and there was a widespread belief that the government should become involved in some degree of economic planning. The realisation that the periodic economic problems arising out of industrial activity could not be measured and properly understood unless accurate figures were available, eventually led to acceptance by the government of its duty to prepare these figures. If a government is to try to manage the national economy, it needs national accounts in the same way as business managers need business accounts for the firms they are seeking to control. The existence of national accounting figures also helps us to understand how an economy actually works. Without precise figures, issues such as the influence of interest rates on savings or of income levels on consumption, cannot be measured. When we have continuous records of interest rates, savings, incomes and consumption over a reasonable number of years, then we can produce evidence of cause and effect. The more we know about the workings of a modern economy, the more hope there is that action can be taken to produce results that are beneficial to the community and that solutions can be found for the great problems which beset industrial societies, such as mass unemployment and price inflation. Accounting records make comparisons possible. We can find out whether the economy is operating more or less effectively than in the past, or more or less efficiently than the economies of other countries. As mentioned earlier, caution is required when making comparisons but, without national accounting figures, no comparison is possible. One very practical use for national accounting figures is as the basis for a number of United Nations calculations. Member contributions to some UN institutions depend on their national product. National Income and Product figures are the starting point for many UN investigations, designed to improve the economic and social performance of poorer nations. Note, though, that some countries may have an interest in ensuring that figures are not too accurate. A country hoping to obtain maximum help from and make the smallest possible contribution to United Nations institutions will wish to keep its national income figures as low as possible. National Product and Comparative Living Standards Owing to all the points outlined above, careful use should be made of national product or national product per capita or per head figures for the purposes of comparing living standards. This becomes particularly important when we make the comparisons between countries with different economic and social systems, or attempt to measure changes over long periods of time. When we talk about the standard of living, there are important aspects that cannot be measured in terms of economic activity. A person may have a higher real income if employed in 2010 than his/her mother had in 1990, but if they are unemployed and have little prospect of employment, is their standard of living any higher? Elements in the standard of living that are not included in any Gross National Product calculations include opportunities for travel, for changing employment, freedom of speech and religion, freedom to walk the streets without fear of violent crime, arbitrary arrest or political coercion. Working hours and leisure time are also ignored as is the value of the environment. Some countries attach great importance to protecting their environment and preventing pollution and other actions that degrade the physical environment, whereas in other countries the environment may be ignored in both private and government decisions. The physical environment may be so damaged and polluted that it damages people's health and reduces living standards. Some countries, such as China and India, are currently achieving very high

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rates of real economic growth using conventional measures of national income but at the expense of large scale damage to their physical environments (including their supplies of water). Material living standards measured by real GDP per capita can increase at the same time as the quality of life deteriorates and the former is the cause of the latter.

The Business Cycle
As we have seen in the graphs showing trends in GDP, there are fluctuations in economic activity which affect the quantity of goods and service produced. When there is an exceptional output of products and services this is called an economic boom and the opposite situation is termed recession. In the global economy the interdependence of nations means that a recession in one area of the world is likely to affect many other distant countries too, as was the situation in the 2008-10 recession. This cycle of booms and recessions is called the business or trade cycle. Figure 5.8: The Business Cycle GDP Maximum output Boom upturn Recession Recession downturn Trend

Boom

Time

Formatted

Periods of recession occur when demand is far below the maximum potential output of the nation. There is little or slow growth and perhaps even a decline. Businesses tend not to invest. In the boom period, there is rapid growth, business confidence and investment. Each nation will only have limited resources (labour, land and capital) and so there is a maximum possible output. Sometimes in a boom this maximum output will be reached as shown in the first boom on the diagram. Maximum possible output can grow over a period of time due to:   Changes in demographics – more labour becomes available, owing to changes in the population size or more people of working age being available Increases in productivity/use resources – new technology means more efficient resource use or more efficient working practices being employed.

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Just as there is a maximum output level there is also a minimum amount of products and services that a nation needs to consume – a minimum consumption. In a recession there has to be a ‘bottoming out’ after which there is an increase in demand again. Between recession and boom the stage is called an upturn in the economy, demand increases, growth in GDP occurs and businesses gain confidence. They begin to invest in the business again. After a boom there is a downturn in the economy, growth slows, demand falls and business confidence dwindles. The periods between boom and recession are not predictable. Some booms can be for several years followed by a short recession. In 2008-9 the recession was deep and some countries took two years or more before the upturn was detected. However, as shown by the trend line on the graph over a long period, booms and recessions even out to generally give a general rise in GDP. The following table shows the pattern of recessions in the UK during the 20th century. It is interesting to note that economics has not been able to predict booms and recessions in many cases and could therefore be said to be an imprecise science based on these results! Duration (Months) 23 13 24 23 7 18 14 13 43 13 Duration (Months) 8 11 10 8 10 11 16 6 16 8 8

Date Sept. 1902-Aug. 1904 May 1907-June 1908 Jan. 1910-Jan. 1912 Jan. 1913-Dec. 1914 Aug. 1918-March 1919 Jan. 1920-July 1921 May 1923-July 1924 Oct. 1926-Nov. 1927 Aug. 1929-March 1933 May 1937-June 1938

Date Feb. 1945-Oct. 1945 Nov. 1948-Oct. 1949 July 1953-May 1954 Aug. 1957-April 1958 April 1960-Feb. 1961 Dec. 1969-Nov. 1970 Nov. 1973-March 1975 Jan. 1980-July 1980 July 1981-Nov. 1982 July 1990-March 1991 March 2001-Nov. 2001

Source: National Bureau of Economic Research

Aggregate Demand
This is the sum of all demand in an economy: Aggregate Demand = Total expenditure on consumer goods & services + investment + net exports Net exports = Total exports – Total imports The trade cycle is affected by aggregate demand and this can change if any of the four components that are used to calculate it alter:  Total expenditure will depend on consumer income and confidence – if wages rise or taxes are cut this will boost consumer confidence and they will buy more goods

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  

Amount of Investment depends on business confidence and interest rates – low interest rates encourage investment Exports will decrease if the country’s currency is strong as goods will be too expensive for other nations to buy Imports will increase if the goods imported are perceived as inexpensive.

How does aggregate demand start to rise again? Even in a recession, equipment will wear out and businesses will have to replace it. Similarly, consumers will have to replace products such as washing machines, televisions and kitchens that wear out. Both of these natural occurences will increase aggregate demand. As demand starts to rise after a recession it starts to accelerate at a rate faster than the producer can supply, resulting in the need for increasing investment. The Government can influence aggregate demand by altering taxes and influencing interest rates. Goverments often do intervene to get ‘the economy moving’ by instigating a demand policy, but it takes time for businesses to gain the confidence to invest again and the consumer to spend more of their disposable income on goods and services. We will look at this in more detail later in this chapter. A change in goverment can also affect the aggregate demand – for example, if an incoming government was to seek to stimulate demand by lowering taxes and interest rates. Random events can also affect aggregate demand. These can be national or international, and may be political – for example, September 11 and the 7/7 bombings in Central London affected consumer confidence. In a long boom period, continued fast growth can influence price rises and create inflation. Recession means lower demand, resulting in rising unemployment, lack of growth and investment. Governments will adopt policies in an attempt to reduce inflation in a boom and stimulate growth employment and investment during a recession to increase demand.

C. REGULATING THE MARKET
We saw that government will try to influence aggregate demand with the objectives of:       Managing inflation Reducing unemployment Controlling the Balance of Payments Managing economic growth. Stimulating demand by use of "Fiscal Policy" Controlling the money supply and demand, known as "Monetary Policy".

They usually adopt one of two methods of to achieve this:

We shall look at each of these interventions in detail in the next section, after revisiting the terms inflation, unemployment and balance of payments.

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Inflation
Inflation is the term used to describe a condition of constantly rising prices. There are several cause of inflation: (a) (b) Continuous rises in aggregate demand – termed demand-pull inflation and associated with a booming economy. Continuous rises in costs result – termed cost-pull inflation. Firms attempt to respond partly by raising prices to pass the costs on to consumers and partly by reducing production.

Inflation is a problem because it results in production and distribution systems becoming less efficient since:     it creates uncertainly about prices makes planning more difficult long term agreements are hard to make inflation creates a situation where consumer and business confidence reduces as there is no constancy in the purchasing power of money.

In inflationary periods, savings lose their value and people who have saved for future needs feel a sense of injustice. If inflation is not checked, it increases in intensity until prices rise daily and all confidence in money is lost. This condition of hyperinflation is usually associated with extreme political and social unrest and uncertainty for the future. The best relatively recent example of hyperinflation was in Germany in the 1920s, which caused social and political unrest providing the opportunity for Hitler’s rise to power. Germany recorded an astronomical inflation rate of 3.25 million percent in a single month in 1923. Since the 1950s, hyperinflation has been confined to developing and transition economies – examples include Argentina (1989-90), Ukraine (1991-94) and Zimbabwe more recently. Trade difficulties are closely associated with inflation, which increases the prices of exports and reduces the relative price of imports in world markets. Countries that have the most severe rates of inflation find that their exports become more expensive and are difficult to sell in world markets, while imports become cheaper and grow in volume. Trade difficulties are detected in the structure of a country's balance of payments accounts and are usually associated with deficits on the current account of the balance of payments (see below).

Unemployment
Unemployment is an economic and a social problem. Economic because production that could have been achieved is lost, since not all available resources are employed in the production process. It is also social because generally work is an important element towards a person’s self esteem and standing in the community. Someone who feels that they ought to be working, but who cannot find work can feel rejected by society and sometimes resort to antisocial behaviour as a result. Disequilibrium and Equilibrium Unemployment Disequilibrium unemployment occurs when: (i) (ii) the aggregate (total) supply of labour exceeds the aggregate (total) demand; and there is a ‘stickiness’ in wage rates such that those rates remain above the equilibrium point where the supply of labour equals the demand.

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As a result, there can be seen to be two main causes of disequilibrium unemployment:  Demand-deficient unemployment – which is associated with recessions. As consumer demand falls, firms will eventually cut back on the number of employees, so aggregrate demand for labour becomes less than the supply. As the economy recovers, the demand deficient unemployment will start to fall. Real wage unemployment – where wages in a particular sector of the economy are set above the equilibrium wage level due to legislation or by negotiated agreement (perhaps by unions). This results in a reduced demand for labour as profits fall.

Equilibrium unemployment occurs where there are excess job vacancies in some parts of the economy, but a lack of vacancies in others. There are a number of reasons for this:   Regional unemployment – unemployment that is concentrated in a specific region of the country (see below). Structural unemployment – unemployment that results from a change in the pattern of demand and supply in the economy. For example, large scale redundancies may occur when there are huge changes in technology and fewer people are required to produce the same production output. This type of unemployment may also result from major shifts in economic activity on both the regional and world level – for example, the decline in UK coal mining during the 1980s under pressure from cheaper sources of coal from abroad. If, as in this case, there are lots of redundancies in the north-east of the country these individuals cannot suddenly move to other parts of the country to find work. An example of this is when a big employer closes a site in a particular location. Structural unemployment may also occur Seasonal unemployment – which occurs when work is associated with events that occur at particular times of the year. For example, people working in the tourist industry in the UK are likely to be unemployed for most of the winter months, and agricultural workers experience fluctuations in employment associated with the timings of crop harvests. Frictional unemployment – which is the term used where someone leaves or is sacked from their job and looking for a new job, but not necessarily taking the first one offered.

Measuring Unemployment Unemployment is usually quoted as a number of people or as a percentage of the working population (or labour force). Labour Force = employed people + unemployed people In the UK, the unemployment figures are based on the number of individuals claiming unemployment benefit. The method of measurement changes from time to time. The International Labout Organisation (ILO) defines unemployed people as people of working age without work who are available to take up a job offer within two weeks and who are actively seeking work or waiting to take up an a work position they have been offered. Countries have different ways of calculating their unemployment rate so it is difficult to compare figures. Regional Problems In the United Kingdom and in other countries,the problems associated with inflation and unemployment do not affect all areas of the country equally. In the UK there is north-south divide. The south of England is much richer than the north. The City of London as a prime global financial services centre has a marked effect on this divide. In the southern areas of the UK, inflationary pressures seem to be greater, whereas

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unemployment is generally more severe in the northern areas. In the less industrialised regions or areas with a less developed service sector, the unemployment rate is likely to be higher. A lot of manufacturing industry was based in the north of England in the early 20th century but as this declined, services did not fill the void. In Italy the divide is the other way around, a rich industrial economy in the north and a poor, mainly agricultural economy in the south.

Think Point
Is there a regional divide in unemployment in your country? Unemployment can be seen as both an economic and a social problem. What are the implications of a regional divide in terms of both economic activity and social issues?

Regional differences in unemployment mean that certain areas have failed to develop as successfully as others. Production is being lost to other parts of the country and this can be self-perpetuating, with a lack of investment and the underuse or inefficient use of available scarce resources. It also causes social problems and political discontent since individuals and groups tend to think that they are well off or badly off, according to the comparisons they are able to make with other people. Standards of living, based purely on disposable income, are generally much lower in the north of England, although the pace of life tends to be slower and the community is more intact. Where there are such problems this can invoke large scale movement of people from one region to another to find employment and this is a further possible cause of social unrest. Families are divided and pressures build up on housing and other services in the more prosperous areas. In the UK, migration to the south has been significant, although many workers will commute south on a weekly basis rather than move away from their families and communities. Of course another factor is the very high cost of property and of living in the south compared with that in the north of the country.

Balance of Payments
A country’s balance of payments is a record of all the money flows between that country and the rest of the world.   (a) Money received from abroad is recorded as credits (positive amounts) Money sent to other countries, outflows, are recorded as debits (negative amounts). Current Account This account records (i) (ii) (iii) (b) exports (+) and imports (–) of goods and services incomes flowing in and out of the country – wages, dividends on shares, profits net transfers of money, such as money sent abroad from migrant workers or support for, say, students in the UK received from abroad.

The Balance of Payments Account comprises:

Capital Account This records flows of money into (+) and out of (–) the country that are associated with: (i) acquisition or disposal of fixed assets such as land

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(ii) (iii) (iv) (c)

transfer of funds by migrants payment by the govenment for overseas projects receipt of payments from other bodies for capital projects in the the country (such as money received for capital projects in the UK that were funded by the EU.

Financial Account The financial account records cross border changes such as: (i) (ii) (iii) (iv) shares property bank deposits and loans government securities.

These are funds for the sale and purchase of fixed assets For a balance of payments to actually be in balance, credits must equal debits. However, if there is a deficit (debits are greater than credits and there is a net flow of funds out of a country), the government will need to take action to balance the payments or to convert it into credit balance. Although your own financial affairs are likely to be much simpler than this, a deficit will probably cause you concern and you will take measures to change it into a credit.

Managing Economic Growth
Nations all perceive adequate growth in a different ways. If the UK growth was 1% a year, this would be seen as inadequate if that of other developed nations was much higher. When a country’s economy is growing at a fast rate and living standards are rising, its government is likely to be in a relatively secure position as it has the resources to carry out popular measures. Low growth means an inability to carry out popular measures and this will make it difficult for governments to stay in power in countries where there is a democratically elected government. People's aspirations may be raised by what they see being achieved in more successful economies and there is dissatisfaction and unrest at the failure to make similar progress at home. Hence the economic growth prospects are one of the areas that governments will wish to regulate.

D. GOVERNMENT INTERVENTIONS TO ACHIEVE ECONOMIC OBJECTIVES
In this section we are going to examine the two strategies that governments use in an effort to achieve their economic objectives.

Fiscal Policies
Fiscal policies relate to the use of government spending and taxation as instruments to influence the economy. The origin of this type of strategy is the work of John Maynard Keynes, a UK economist who, in 1936 at the height of the great depression, published a book entitled ‘General Theory of Employment, Interest, and Money’. The main theme of the book was that the aggregate demand created by households, businesses and the government was the most important driving force in an economy, not the dynamics of free markets. His theory also states that free markets have no self-balancing mechanisms that lead to full employment.

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Keynesian economists urge and justify a government's intervention in the economy through public policies that aim to achieve full employment and price stability. These ideas have greatly influenced governments across the world into accepting a responsibility to provide full or near full employment through measures that stimulate aggregate demand. Keynesian economics established the following principles.     During times of economic hardship, governments should work to set up employment programmes for the people Governments should increase government spending to stimulate the economy Lower interest rates should be used to combat rising prices, and interest rates raised during times of deflation Governments must spend money in order to maintain full employment because consumer spending is imperative for economic growth.

How does fiscal policy work? In simple terms, the adjustment of tax rates and government spending are the means of controlling unemployment, growth and inflation. (a) Deflationary fiscal policy is used in a recession. The government increases government expenditure and/or cuts taxes. The effect of this is to create demand resulting in a growth in GDP and reduced unemployment. In practice an increase in government expenditure to reduce employment has often taken the form of government investment in new projects that create jobs. (b) Expansionary fiscal policy is used if the economy is expanding too rapidly, causing rising inflation. In this case, the government could decrease its expenditure and/or raise taxation.

A combination of these policies is intended to smooth out the uncertainties of the business cycle. We can see the operation deflationary fiscal policies in response to the 2008-2010 recession:  In the USA, President Obama implemented spending programmes such as Dollars for Dishwashers in the hope of stimulating the economy. The idea was that consumers would trade in old dishwashers and receive a rebate when they bought a new one, stimulating production. Obama also attempted to create jobs through the American Recovery and Reinvestment Act, another government stimulus package intended to create jobs and promote investment and consumer spending during the recession. In the UK, the government scrapage scheme for trading in cars 10 years or older, with a £2,000 rebate given for the traded in vehicle, was a similar attempt to stimulate growth in the rapidly declining car manufacture sector.

Measuring unemployment and GDP are the direct result of Keynesian economics. The work of John Maynard Keynes also contributed to the understanding of foreign trade, interest rates and currency speculation. Public Finances Deficit and Surpluses Since a deflationary fiscal policy involves an increase in public expenditure and/or lowering taxes: (a) (b) The government's budget may show a deficit because government spending exceeds the amount collected in taxes. The level of national debt will increase.

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Keynes believed that this was a necessary short term measure to stimulate the economy. He also believed that the amount invested had a multiplier effect on growth – for example:   Investing £1 million into the economy (increasing aggregate expenditure by £1m) produces a disproportionately high increase in GDP, say £30m. The multiplier in this case would be 30.

In recent times most governments have run budget deficits. A budget surplus will occur only if level of taxation collected is greater than government expenditure. Limitations of Fiscal Policy The government may decide to deliberately alter expenditure or taxation levels, such action is termed discretionary fiscal policy. Fiscal policy does, to some extent, automatically have an effect on stabilising the economy through changes in expenditure and taxation. However, this cannot prevent fluctuations – it can only reduce their scale. Cutting taxes has less effect on GDP growth that raising expenditure since:   Raising expenditure tends to ensure that all the money is spent and GDP rises significantly, but Lower tax rates will increase the disposable income of consumers but there is no guarantee that all of the increase will be used to consume more goods/services.

The effect of fiscal policy on GDP, unemployment and inflation is very difficult to forecast for the following reasons.  Crowding out If the government raises expenditure by £xm, this action may lead to injections into the economy of less than £xm. This is because other types of injection into the economy may decrease at the same time – for example business investment. Check this by looking back at Figure 5.3. The government will increase the budget deficit by increasing expenditure, but it will have to either increase the supply of money to do this, or alternatively it can borrow money from individuals and firms. When it borrows money it will compete with the private sector to raise its finance from similar sources, resulting in an increase in borrowing interest rates and so depressing the amount businesses will wish to borrow and hence invest into the economy. This action is said to ‘crowd out’ businesses from borrowing and individuals from buying products/services on credit. Ultimately the increase in government expenditure could be negated by the lack of consumption and the fall in business investment.  Taxes It is also not easy to predict how a change in taxes will affect savings, If individuals feel that a cut in taxes is only temporary, or they lack confidence in the future for some reason, they may not consume all of the additional disposable income.  Unpredictability of the multiplier Time lag is an additional uncertainty – how long will it take businesses to invest and the consumer to begin spending when the government increases expenditure or lowers taxes? In a recession the government will wish to encourage investment and consumption, but lack of confidence may prevent this until the economy begins to recover and moves towards a boom.

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Fiscal Rules The UK, like many other governments is less likely to change fiscal policy automatically each time the economy is in recession or boom. Instead, it will set a rule for the level of public finances, usually annually. Government expenditure and taxation levels are then adjusted to meet the level of public finances required.

Monetary Policies
Monetary policy is fundamentally concerned with managing the money supply. It involves government using interest rates and other monetary tools to influence the levels of consumer spending and Aggregate Demand. In many countries, the government sets a target for the rate of inflation and the Central Bank must adjust interest rates to keep within this target rate. The government will also other monitor other macro-economic variables such as growth and unemployment. In the UK, monetary policy is set by the Bank of England’s Monetary Policy Committee, which is independent of the Government. If the MPC fails to keep inflation within the target rate they must confer with the Chancellor of the Exchequer. How does Monetary Policy Work? In the UK, the Bank of England studies inflationary trends in the economy. This involves looking at a range of economic variables such as:       (a) Unemployment Consumer confidence Spare capacity in the economy Exchange rate index House prices Economic growth. Stimulating growth The government or central bank will increase the money supply to stimulate growth in a recession. Lowering interest rates is aimed at increasing the demand for money and increasing its supply to stimulate investment, consumption and growth. Quantitative easing, or simply printing more money, is one method of increasing the amount of money in the economy. (b) Reducing inflation Increasing interest rates is intended to have the opposite effect – decreasing the money supply and reducing inflation. The government can also sell government securities on the open market, which are bought by investors who take money from their banks to purchase the securities. This results in the banks having lower reserves and, therefore, there is less money in circulation. An example of use of Monetary Policy occurred during the 2008 -2010 when both the UK and the USA introduced ‘quantitative easing’ as a part of monetary policy in an attempt to ease the effects of recession. This involved creating money electronically to buy assets (such as government bonds from banks). Depending on whether the authority wishes to expand money supply, keep it steady or reduce it, monetary policy can be described as accommodative (or loose), neutral or tight.

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Limitations of Monetary Policy Interest rate rises may not have the desired effect on decreasing demand for money until they have risen to a high level. Fluctuations in the demand for money also make managing aggregate demand through interest rates difficult. Speculation about exchange rates, interest rates and inflation add to this. However, using interest rates as a means of controlling inflation has come to be accepted globally as an indication that a government is serious about keeping inflation under control. The EU, for example, also has a target inflation rate which it controls by altering interest rates.

Supply Side Policies
Keynesian and monetarist ideas that we have focused on in this section have concentrated on demand and ignored supply. In reality, supply must be also taken into account. There are a number of strategies for achieving this.  The UK Coalition (Conservative and Liberal Democrat) government in 2010 and the Margaret Thatcher’s Conservative government in 1979 reduced the public sector massively. They perceive the public sector as being inefficient, and look to encourage growth by stimulating supply in the private sector through better use of resources. Such governments encourage increases in supply by rewarding individual enterprise and initiative. Conservative governments in the UK have also seen this as a way of reducing public expenditure and reducing the size of the public sector.  Governments often give direct incentives and rewards to businesses, for example: – –  Monthly allowances to support the owners of start up businesses while the business grows Cuts in the taxation of company profits (Corporation Tax) which increases the after tax profits of the business.

Restricting the power of trade unions to improve pay and conditions can be used as another means of ensuring that private sector firms’ profits are sustained or improved. In the Thatcher era, laws were passed to prevent strikes, picketing and ‘closed’ shops. Encouraging competition by, for example: – – – – Privatising nationalised firms such as rail, electricity and other utilities and telephone Introducing private sector (or free market) practices into public sector departments Promoting free trade initiatives and movement of money across borders Using private businesses to carry out government projects and then maintaining it on completion – called a Public-Private Partnership.

Increased competition in general also reduces the power of unions, and globalisation has created increased competition and has impacted significantly on the power of unions, particularly in developed industrialised countries.

Activity 3
Summarise the main advantages and disadvantages of Fiscal and Monetary Policies.

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SUMMARY
Countries make decisions about how production will be managed. This will usually be    Planned economy – where all decisions of what is produced, methods of production, distribution and price are the responsibility of the State Market economy – where supply and demand dictates the decisions which are made by private business owners A mixed economy– which has elements of both systems as the State will wish to produce goods and services that it considers vital for the community. Gross National Product (GNP) which takes into account all products and services produced and purchased by the country’s citizens wherever the live. Gross Domestic Product (GDP) – which is the market value of all final goods and services produced and purchased within a country during a given time period. There are two ways to measure GDP:   Nominal GDP is the value of production at current market prices Real GDP is the value of production using a given base year prices, here presented at constant (2005) market prices measured in millions of British pounds.

Governments measure their economic output using two main categories: (a) (b)

GDP per capita is calculated by dividing either nominal or real GDP for a given year by the population in that year. These numbers can be thought of as the average share of output per person. Calculations of GNP and GDP are useful for comparing the economic health of different countries, but these should be use with caution as they may be calculated in different ways. Governments intervene in the economy to manage unemployment, inflation, manage growth and control the balance of payments. The main methods used in an attempt to control these factors and so reduce the booms and recessions of the business life cycle are fiscal and monetary policies.

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ANSWERS TO ACTIVITIES
Activity 1 (a) Aspects typical of a centrally planned economy are shown by the following quotes:     ‘allocation of massive State resources and effective control of large-scale SOE’s’ ‘state holding enterprises account for roughly half of all (non property) urban investment in fixed assets’ ‘continues to exercise general political direction over the economy’ ‘Olympic games demonstrated the power of the state to mobilise resources and sweep away obstacles to its policy objectives. There was phenomenal public expenditure on the games, the government ruthlessly cleared residents from large areas of Beijing and heavy industries were shut down in a desperate attempt to reduce air pollution for the duration of the games’ ‘the state has effectively retained control of former SOEs......that at any time the Party can regain control if necessary’ ‘As State ownership ....increasingly concentrated in large, capital-intensive firms...’ SASAC are powerful agencies of State control...authority over 196 key firms’ SASAC exercises nominal ownership rights over five large electricity conglomerates that produce virtually all of China’s electricity ‘inherent conflict with the Communist Party over appointment power....makes all key appointments in the State Sector’

     (b)

The evidence here suggests there is only a very slow move away from the planned economy. The signs of market economy described in this article are few:   ‘joint stock companies (selling shares to private investors)’ ‘it is not easy to determine the state/private balance of ownership’

Activity 2 (a) GDP is the total market value of goods and services produced within the borders of a country regardless of the nationality of those who produce them. GNP is the total market value of goods and services produced by the residents of a country, even if they are living abroad. (b) (i) (ii) There was a recession in 2008-9 so that GDP decreased. There are two possible answers to this:   (c) There are different ways of measuring GDP – at market prices and ‘true cost’. The GDP per head may be based on different calculation method The growth in population may have been greater than the growth in GDP.

The estimation of GNP or GDP assists in government economic policy, in planning by decision-makers in private business, in estimating how efficient workers are compared with other countries and the potential reasons for this.

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Activity 3 Fiscal Policies Advantages Uses taxation and government spending to:   Create more jobs/reduce unemployment in a recession Create demand for products/services to stimulate the economy out of recession Disadvantages Can send the balance of payments into a debit situation. Cutting taxes does not necessarily make consumers spend the extra income – they may save and demand is not increased. The extent of the multiplier cannot be easily forecast. Government borrowing to increase spending can reduce private investment and raise interest rates by ‘crowding out’. There can be a considerable time lag between injection of capital and economic growth.

A small injection of capital into the economy is said to create a much larger result – multiplier effect. Reduces inflation by decreasing expenditure or increasing taxes. Can smooth out the booms and recessions of the business cycle. Monetary Policies Advantages Governments manage the economy by restricting the flow of money, usually using interest rates as the mechanism Inflation targets are set and the central bank must adjust the money flow to keep inflation within that target. Increasing the flow of money by lowering interest rates or printing more money (quantitative easing) stimulates borrowing by firms and consumer spending. Reducing the flow of money by increasing interest rates reduces borrowing and stems consumer spending. Enterprise and innovation are encouraged with certain monetary based incentives. Encourages competition.

Disadvantages Raising interest rates does not guarantee a reduction in spending; sometimes rates have to become very high before there is any effect. Fluctuations in interest rates and speculation make it difficult for interest rate policy to be effective.

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Chapter 6 Governments and Business
Contents
Introduction

Page
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A.

Pressure Groups What is a Pressure Group? Lobbying Pressure Groups and Business The Trade Unions as a Pressure Group

141 141 142 142 143

B.

Reasons for Government Intervention in Business Market Failures Anti-Competitive Behaviour

143 143 146

C.

Forms of Government Intervention Taxation Subsidies Advantages and Disadvantages of Taxes and Subsidies Regulation and Legislation Consumer Protection Employee Protection

146 146 147 147 148 149 150

D.

Equality and Diversity Discrimination and Less Advantageous Treatment Equal Pay Disability Managing Equality and Diversity in the Workplace

151 151 152 153 154

E.

Fair Treatment of Employees Dismissal Redundancy Harrassment and Victimisation Health and Safety at Work

154 154 155 156 156

(Continued over)

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Answers to Activities

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INTRODUCTION
Chapter 5 concentrated on the use of fiscal monetary policies to manage the economy. In this chapter the focus is on the reasons national governments intervene in the business activities of firms at the micro-economic level and the forms that this involvement takes. The extent to which governments intervene in the economy depends on their political agenda. This will determine how much and in what ways it becomes involved.   As we discussed in Chapter 5, socialist governments favour a larger role for the State than a non-socialist one. The State acts as both a regulator and a producer. In non-socialist governments, there is a smaller State role and firms are encouraged to improve operations in a free market environment.

A. PRESSURE GROUPS
Firms interact with government in various ways in order to influence policy on matters relating to the operation of their business – for example, on the extent of proposed new legislation. Acting on their own, very large organisations are likely to have the greatest influence on government policies. This may result in being of advantage to business generally. However, since some multi-national companies have a turnover greater the GDP of single countries, many perceive this as business practice being too powerful and potentially damaging to society as a whole. Also acting on their own, some large organisations are government suppliers and have direct contact with ministers, and so have a powerful negotiating position. There is no guarantee that these firms will persuade government to take certain actions or desist from others, but normally that their view will be considered along with those of others. More usually, though, businesses work together to influence the actions of governments, and the groups which are formed to pursue this come under the general heading of pressure groups.

What is a Pressure Group?
A pressure group is a group of people who believe in the same cause and who come together in order to influence some aspect of society to act in accordance with their views on that cause. The cause may be anything from issues about the local, regional or global environment, through the defence or promotion of the rights and influence of particular groups, to specific issues of consumerism. For example, high profile pressure groups include:      Shelter - aim to help homeless people and promote policies to address their problems Amnesty international - defends human rights Greenpeace - campaigns on environmental issues CBI (Confederation of British Industry) - promotes business interests TUC (Trade Unions) - promotes workers' interests.

These groups act on Governments to try and influence their policies, but perhaps one of the most successful pressure groups of recent times was CAMRA – the Campaign for Real Ale, which campaigned against the practices of the large breweries in the 1970s in what they saw as changing the nature of beer in the UK. Within a few years, its high profile campaigning had such an influence on consumer behaviour (independent breweries selling "real" beer flourished and the big breweries started losing trade) that there was a complete about-turn

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among the large breweries, who started producing traditionally brewed beer again themselves and also selling the produce of independent breweries. The activities used by pressure groups varies with the nature of the cause and the bodies they are trying to influence. They can exert direct pressure on these bodies through letters, petitions, demonstrations and direct actions against particular sites or activities (which, although usually illegal, can be particularly effective). However, most pressure groups also aim to build public support for their cause through these activities, as well as various publicity campaigns, as a means of getting their cause recognised as both valid and widely supported.

Lobbying
When established pressure groups want to influence the decisions of governmental policy makers, there is the option of direct approaches to the people involved in the decision making process. Lobbying is the practice of individuals and organisations trying to influence the opinions of MPs and Members of the House of Lords. Methods of lobbying vary and can range from sending letters, making presentations, providing briefing materials and organising private meetings. In the UK, anyone can lobby a Member of Parliament or a Member of the House of Lords, including:      individual members of the public groups of constituents local businesses, usually through Trade Associations and local Chambers of Commerce organised pressure groups/campaigners commercial organisations.

MPs and Lords are the target of many different lobbying interests, attempting to persuade them to vote a certain way on a specific issue. Whilst, their decision will ultimately be down to their own judgement and the influence (if any) that existing party policy has on them, lobbying remains an important method of influencing government policy and decision making. Indeed, there are firms specialising in lobbying and these are often employed by large organisations to advance their own interests. The same processes operate at local level where local councillors may be lobbied on matters of interest to local constituents and businesses.

Pressure Groups and Business
Pressure groups of varying kinds have always tried to influence firms about issues such as pollution, using animals for testing and expansion plans in built up areas. Often this is intertwined with pressure on government to act on the way firms operate. There are now a whole range of groups, some large and relatively powerful, that pressure government and business regarding types of ingredients in foodstuffs, obesity, use of resources, climate change and other concerns. In recent times, this has extended a great deal further to cover what is now termed corporate responsibility. Pressure groups and lobbyists, therefore, exert pressure on both groups to change practices for the social good. Corporate responsibility is not a well defined term. In this manual it is regarded as covering the areas of:  Corporate governance

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 

Social responsilibility with regard to the environment and the well-being of people affected by a firm's actions Ethics.

We will be examining these areas in some detail in Chapter 9.

The Trade Unions as a Pressure Group
The Trades Union Congress in the UK has approximately 6 million members, making it Britain‟s largest pressure group. The TUC comprises 58 affiliated unions representing working people from all walks of life. It campaigns for a fair deal at work and for social justice at home and abroad. It negotiates both in Europe and in the UK to build links with political parties, business, local communities and wider society. The TUC‟s stated activities include:        Bringing Britain‟s unions together to draw up common policies Lobbying the Government to implement policies that will benefit people at work Campaigning on economic and social issues Representing working people on public bodies Representing British workers in international bodies, in the European Union and at the UN employment body – the International Labour Organisation Carrying out research on employment related issues Running extensive training and education programme for union representatives.

Union representatives work voluntarily in the workplace to support their colleagues at work. Members receive assistance, support and representation on a range of issues from achieving a better work-life balance to improving access to training and skills. Although their power to influence the employer has been much reduced in the UK, the unions still have a major role in some organisations and have contributed much to training and development initiatives in recent years.

B. REASONS FOR GOVERNMENT INTERVENTION IN BUSINESS
Market Failures
Free markets do not operate is a perfect manner and, without any intervention, the market economy would not always operate in socially or economically practicable way. In other words, free markets are rarely socially efficient. In economics, the term social efficiency depends on the balance between two terms: (a) (b) Marginal Social Benefit (MSB) is seen as „an extra benefit to society from producing (or consuming) a good or service' Marginal Social Cost (MSC) which is the cost to society of producing (or consuming) a good or service. This cost includes all aspects – both financial and non-financial.

Socially efficiency occurs when Marginal Social Cost = Marginal Social Benefit. A practical example of this concept is to assess the social efficiency of building a high speed rail link between London and Birmingham, which goes through the countryside. Is the cost to the environment, of taking away the public‟s leisure activities in that countryside and residents' quality of life, plus the financial cost, greater than the benefit of passengers‟

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journey being one hour shorter than at present? If the marginal social cost is calculated to be higher this project will be socially inefficient. All governments intervene in business to ensure that social efficiency results, an outcome which firms would not pursue if they were able to make their own decisions on this matter. Imperfect Information A perfect market is only possible if there is perfect knowledge of all the costs and benefits that affect the individual. This is one of the basic assumptions about the operation of free markets. However, it is rarely true. Often a consumer will purchase a good or service without really understanding its features until it has been used. The lack of accurate information may be worsened by the way that firms market their products or services. In business, firms are usually not well informed about their competitors, market opportunities, costs and the potential productivity of their employees. Business forecasting is made in conditions of uncertainty and ignorance about the future. Type of Market Failure There are two main types of issues which the market cannot efficiently deal with and require some form of government intervention. (a) Externalities When producers or consumers take actions that affect other people, but not themselves, these effects are known as externalities. There are good and bad externalities: A good production example could be planting new trees which benefit the community in many ways such as the visual impact, the exchange of carbon dioxide and oxygen in the air and a haven for wildlife. For consumption a desirable externality is car sharing when three or four people go to work together in one car, reducing the traffic congestion as a result and making travelling easier for others. The provision of street lighting in an urban area is funded by local government, which in turn raises revenue from local taxation. The residents of the area in which the lighting is installed benefit from it through greater physical safety and less risk of road accidents. However, others will benefit, such as people from other districts and towns who did not pay for the lighting but nevertheless gain some advantage from it. Bad examples include firms dumping used tyres in a private parking area, factories dumping waste into rivers, air pollution from cars and factories and so on. The local council has to pay to have these types of situations rectified; the cost is incurred by the community and not by the firm. Individuals also cause externalities; examples of consumption are dumping, excessive noise in public places, litter etc. Since nobody owns rivers or the air, no individual or group can be charged for cleaning them so the cost is borne by society; it is a social cost. (b) Public Goods These are goods that are not practical or profitable for any private firm to produce and can only be provided by the Government or by the Government paying private firms to produce the goods or service. (i) Merit Goods Merit goods and/or services are those of benefit to the public , but which are likely to be under-produced or provided for by the private sector. Education,

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community centres and libraries are services that the government perceives the public may consume too little of if decisions on levels of supply were left to the free market. The government, acting in the public‟s interest to ensure they consume sufficient, can either provide them free or give subsidies. (ii) Demerit Goods On the other hand when there are goods that people consume which the government consider harmful, such as smoking and drinking alcohol, they act in an attempt to decrease consumption, perhaps through taxation. These are termed demerit goods.

Activity 1
(a) Which of the following externalities are positive and which are negative, and why? (i) (ii) (iii) (iv) (b) (i) (ii) Litter Man Made Lakes Official Rubbish Tips Drinking alcohol What is the externality that the UK government is trying to address using this policy? What are the negative implications of the immigration cap for British and Japanese firms? Japanese firms lobby British government to rethink immigration plans Japanese firms are threatening to review future investments in Britain if the Government goes ahead with plans to put an annual cap on immigration levels. Company bosses have told ministers that moves to limit the number of skilled citizens from outside the European Union that can be employed in Britain will seriously harm their businesses. Japanese firms are particularly concerned about plans to curb the number of senior staff who can be transferred from Japan on a short term basis, or intra-corporate transfers (ICTs), as well as limits on recruiting skilled staff from outside the European Union. The new centre-right Coalition government has decided to impose a cap on immigration due to growing concern that non EU citizens are taking jobs that could be done by skilled British people. An interim cap was previously only imposed on skilled workers, but ICTs are currently exempted. A new cap is planned for next year and ministers are consulting on the size of the cap and which sectors should be covered, including possibly ICTs.

Consider the following short case study and then answer these two questions:

See the suggested answers at the end of this chapter.

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Anti-Competitive Behaviour
We examined anti-competitive behaviour in Chapter 4. This behaviour is typical of some powerful large suppliers and often results from collusion between them to fix prices. In turn the consumer is forced to pay the asking price. Some governments do not condone this activity and instigate legal means to minimise it. The present UK legislation will be examined later in this chapter.

C. FORMS OF GOVERNMENT INTERVENTION
Governments intervene in business activities to a substantial extent mainly to protect the interests of consumers, workers and the environment, for example in respect of:        Health and safety in the workplace Terms and conditions of employment Firms colluding against the interest of consumers Use of resources Environmental damage Advertising legislation Product safety.

Governments adopt policies to adapt the market to offset the failures in these areas and there are three main methods of intervention:    Taxation Subsidies Regulation and legislation

Taxation
Apart from its role in raising revenue to fund government expenditure, taxation is also used to encourage either:  Lower consumption of those goods and services which are deemed harmful. Thus, tax on cigarettes is used in an attempt to encourage people to stop smoking, which is both bad for the health of individual consumers, but also has an externality in „passive smoking‟ which results in injury to the health of others and induces extra costs to the National Health Service.  Lower production of those goods and services which the market produces in excess of what is required or deemed appropriate. Thus, green taxes have been introduced by governments in an attempt to reduce environmentally harmful practices. These have become an increasing concern to members of the public with issues such as acid rain, air and land pollution and climate change now under scrutiny. Globally, green taxes and charges cover many different situations including: – – Fuels – for example, leaded petrol being taxed more heavily than unleaded Landfill tax – to encourage more recycling and re-use

The range of taxes and charges varies by country.

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To be fully effective the charge or tax should be equivalent to the degree of marginal extra cost that it causes although this is not usually the form it take (see legislation and regulation below).

Activity 2
Find out what green taxes your country imposes.

Subsidies
Subsidies are used to incentivise production of goods and services when the market is likely to produce too little. A very good example is the EU system of subsidies for agriculture – the Common Agricultural Policy (CAP). The EU agricultural policy continues to evolve. In the 1950s it focused on providing enough food for the European population, emerging from over 10 years of warinduced shortages. It subsidised food production and brought up surplus production. Now the policy is used more selectively and helps farmers when they are faced with natural disaster or when their production is halted because of diseases such as foot and mouth. When subsidies are awarded they are dependent on compliance with broader objectives such as farm hygiene, food safety, animal health and preservation of traditional rural landscapes.

Advantages and Disadvantages of Taxes and Subsidies
(a) Advantages  As we noted earlier awarding a subsidy can be linked to improvements in practice such as in the CAP, where farmers get a subsidy on condition that they comply with improvements in animal care. Taxes force firms and individuals to become more aware of the social cost of the externalities they cause. They also encourage firms to improve practice such as lowering their pollution levels by changing working methods and/or equipment. It is difficult to assess the cost to the public caused by each externality, whether this is caused by a firm or an individual. There is no way of measuring the longer term effect of various forms of pollution so that their cost to society cannot be accurately assessed. The regulation of non-compliance would be extremely costly if each firm, for example, was monitored individually.

(b)

Disadvantages   

In the past the European Union has continued to pay subsidies to farmers for producing foodstuffs such as beef and milk. Stockpiling these foodstuffs kept prices unnaturally high and there was a great deal of public opposition to the continuance of this practice.

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Regulation and Legislation
In terms of their application to business enterprise, legislation is used to:    Prevent or regulate the behaviour of firms in their productive operations Prevent firms from providing misleading information Prevent firms from producing products which are harmful to individuals and/or society.

We shall examine two such forms of legislation – in respect of consumer and employee protection – below. Regulation is primarily used to regulate the activities of monopolies or oligopolies such that they do not exploit their position in the market to act against the interests of consumers. This has generally taken the form of discouraging firms from adopting anti-competitive practices, particularly in respect of prices. Thus, in the UK, privatised former nationalised industries such as rail, telephone, gas, water and electricity are now regulated by the Government. Each has a „watchdog‟ regulator to which the consumer can complain if the firms try to raise prices above inflation – for example, Ofgas is the regulatory body for the gas industry. A general regulatory body is the Office of Fair Trading (OFT). The OFT's mission is "to make markets work well for consumers. Markets work well when businesses are in open, fair and vigorous competition with each other for the consumer's custom.” It offers the public information and advice on subjects such as product safety, consumer debt agreements and appraises mergers and acquisitions. Control of environmental issues Command and control (CAC) regulation has traditionally been used to control environmentrelated issues. Under this, specific guidelines are given by a government on how to comply with mandatory requirements about, for example, emissions levels. Thus, a maximum limit on emissions is imposed with firms being subject to inspection and failure to keep within the specified limits resulting in substantial fines. The main disadvantages of CAC are that it is a costly method to enforce and it does not provide any incentive to reduce levels below the maximum permitted. An alternative is pollution taxes, such as the landfill tax. This is a more effective deterrent in that the firm gets charged for the amount of pollution it generates – the lower the pollution the lower the tax bill. The other advantage is that it encourages firms to invest in cleaner technology to reduce emissions. Another form of regulation which has gained popularity in recent years is the concept of tradable permits. These work on the basis of a firm paying a fee for the amount of pollution it produces above the permitted limit. However, if it reduces its level of pollution below the limit, it receives what is known as a tradable credit. This can then be sold on to another firm that has exceeded the limit. There are permits for each type of pollution – waste disposal, emissions into the air or water, etc. This practice links well to the CAC method and is regulated by the market.

Think Point
What disadvantages might there be with tradable permits?

The main problem is that the overall level of pollution may not change. In addition, pollution could become concentrated in one geographical area. The practice may reduce the incentive for dirtier factories to reduce their pollution.

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Consumer Protection
There are a number of laws intended to protect the consumer against unfair practices. The main ones for the UK are summarised below. (a) Consumer Protection Act 1987 This includes sections related to product liability and consumer safety. It has undergone several revisions since it was first passed. Product liability is the term given to laws affecting the rights of indiviudals who are injured by defective products. Injured individuals may have the right to sue the supplier for damages whether or not the product was sold to them personally. In broad terms, the injured person can take action against the producer (usually the manufacturer) and/or, if appropriate, the importers who brough the product into the EU, not just into the UK. If the supplier has branded a product with its own name, it can also be liable as it has given the impression that it is the producer. Liability under the Act is joint and several, so the injured party may sue both (or all, if more than two) defendants. (b) The Consumer Protection from Unfair Trading Regulations, 2008 This introduced a general duty not to trade unfairly and seeks to ensure that traders act honestly and fairly towards their customers. These regulations apply primarily to business to consumer practices. (c) Distance Selling Regulations These have become very important with the increasing role of e-commerce. They apply to any firm selling goods or services to consumers by:       internet digital television mail order, including catalogue shopping phone fax. giving consumers clear information, including details of the goods or services offered, delivery arrangements and payment, the supplier's details and the consumer's cancellation rights. This information has to be provided, in writing in addition to verbally, before they buy (known as prior information) giving the consumer a right to a "cooling-off" period of seven working days within which they can cancel the purchase.

The regulations provide for:

 (d)

The Consumer Credit Act 1974 This requires most businesses that offer goods or services on credit or lend money to consumers to be licensed by the OFT. Trading without a licence is a criminal offence and can result in a fine and/or imprisonment. The Act also requires certain credit and hire agreements to be set out in a particular way and to contain specific information.

(e)

Anti-Competitive Behaviour Legislation The Competition Act 1998 is designed to make sure that businesses compete on an equal footing. It is intended to eliminate collusion and price fixing by firms.

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The Office of Fair Trading states that, in the UK, anti-competitive behaviour is prohibited in two main ways: (i) Anti-competitive agreements (such as cartels) between businesses are prohibited by Chapter I of the Competition Act 1998 (CA98) and Article 81 of the European Community Treaty. Abuse of a dominant position in a market is prohibited by Chapter II of CA98 and Article 82 of the EC Treaty.

(ii)

The laws contained in the CA98 and Articles 81 and 82 of the EC Treaty are similar, but not the same:    CA98 prohibits anti-competitive behaviour that affects trade in the UK. Articles 81 and 82 prohibit anti-competitive behaviour that affects trade in the EU. The OFT has a wide range of powers to investigate businesses suspected of breaching these laws and, for example, can force firms to cease offending agreements or specific conduct. Businesses that break the law can be fined up to 10% of their worldwide turnover and third parties (including injured competitors, customers and consumer groups) can bring damages claims against them. Individuals found to be involved in cartels can be fined and imprisoned, currently for up to five years. Directors of companies that breach the prohibitions can be disqualified for up to 15 years.

Anti competitive behaviour is taken very seriously:

Employee Protection
Government regards the rights of employees as an important area where some employers would fail to act reasonably. The basis of the legal relationship between an organisation and its employees is that of a contract of employment (a voluntary agreement into which employer and employee freely enter under the terms of common law). Both sides have a duty to behave reasonably and responsibly.   Employees should give faithful and honest service There should be a legal framework to ensure the fair treatment of employees at work and to prevent discrimination on various grounds.

The interests of employees are sometimes channelled through trade unions, although this has become less usual in recent years as UK legislation concerning trade union activities has considerably weakened their involvement. Firms, through their managers, need to ensure that they do not discriminate unfairly in the decisions or actions that they may take in regard to employees, whether prior to or during employment. In the next section we consider the existing legislation which has been made to protect the interests of employees.

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D. EQUALITY AND DIVERSITY
Unequal treatment of individual employees often results from prejudices and preconceptions of the people with whom they have to work. Within the United Kingdom, the following areas are the main ones where unfair treatment has been experienced and which the Government has addressed through legislation:        Sex/gender – including people who are having or who have had a sex change, transvestites and transgender people, and also covering pregnancy and maternity Race/ethnicity Disability – which includes mental health and people diagnosed as clinically obese Age – including both older and younger workers Marital status – including civil partnerships Religion and belief Sexual orientation – covering people who are gay, lesbian, bisexual or transgender.

Under the Equality Act 2010, these categories are termed "protected characteristics". This Act combines and replaces most of the previous discimination legislation. The word "discrimination" itself can be seen as having negative associations and has been replaced, in some instances, by the term "less advantageous treatment" which perhaps has a broader interpretation. We shall consider the application of this term first, and then go on to review other aspects of equality in the workplace.

Discrimination and Less Advantageous Treatment
Discrimination, or less advantageous treatment, may take place in relation to any of the following work processes:        Recruitment and selection Opportunities for training and development Promotion and career development Benefits, including pay Dismissal. Direct discrimination – less advantageous treatment because of a protected characteristic. Indirect discrimination – when a rule or policy that applies to everyone, disadvantages a person with a protected characteristic. This includes, for example, the specification of unnecessary conditions which certain groups are not able, or are unlikely, to meet.

The main forms of discrimination which may occur within these categories are:

There are circumstances where what would otherwise be unlawful discrimination is permitted. These are where “less favourable“ treatment may be justified on specific grounds such as that the less favourable treatment cannot be removed or made non-substantial by a reasonable adjustment on the part of either the employer or the employee. There are also exemptions for particular types of employment where the holding of a specific characteristic is a requirement of the job – for example, women carers to work with women in certain circumstances.

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Note that the law applies not just to the actions which employers do take, but also to the actions they omit taking. Claims against an employer or a potential employer In the event of a claim, the burden of evidence is upon the employer to prove that the person was treated fairly – the organisation must demonstrate fair and equal treatment in the case of a claim of discrimination. The legislation applies from the moment an individual has contact with an organisation as s/he does not have to be employed currenty to be able to make a claim. This may apply, for example, in respect of applications for employment. It is not necessary for a claimant to demonstrate that the organisation committed unlawful discrimination. They can claim if they suspect that treatment was for unlawful reasons. Firms should keep complete written documentation on every aspect of interaction with the employee or potential employee to protect their interests.

Equal Pay
This issue forms part of the Equality Act 2010. Although legislation dating back to 1970 has addressed it, this has had limited effect in bringing the pay of women in line with that of men, as shown by in Figure 6.1. Figure 6.1: Gender UK Pay Gap Pay gap between women's and men's median hourly earnings excluding overtime (employees on adult rates, pay unaffected by absence)
30 25 20 Percentages 15

All

Full-time
10

5 0 -5 -10
1997 1999 2001 2003 2005 2007 2009

Part-time

Source: Office for National Statistics The Equal Pay Act 1970 was the first piece of legislation that attempted to promote equality at work. It sought to address the issue of parity between the pay of men and women who were doing work of equal value in the same employing organisation. This does not necessarily mean simply doing the same job. The Act specifies the occasions when the pay of a woman should be equal to that of a man as follows.  ‘Like’ work This is relevant when a woman can show that she is doing the same, or very similar, work as a man – that is, where two people of different sex are doing exactly the same job.

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A good example of this is two teachers, one male and one female, each teaching the same subject to children of the same age in either the same or different schools. If the work is the same, so should the rate of pay.  Work rated as equivalent This comes into force when a woman can show that the job she is doing could be rated at the same level as that of different job held by a man and paid at a different level. Different jobs are often grouped together in “families“ where they are considered equal, even though the actual tasks involved may vary.  Work of equal value This term concerns work that may be shown to have an equivalence of value to the organisation, such that to pay one job less, on the basis that a woman holds it, would amount to unfair treatment. Women and men may claim equal pay under this legislation, although the latter case is rare.

Disability
The Equality Act 2010 aims to protect disabled people and prevent disability discrimination. In addition to employment rights, it provides legal rights for disabled people in the areas of:      Employment Education Access to goods, services and facilities including larger private clubs and land based transport services Buying and renting land or property Functions of public bodies, for example the issuing of licences.

The Act also provides rights for people not to be directly discriminated against or harassed because they have an association with a disabled person. This can apply to a carer or parent of a disabled person. In addition, people must not be directly discriminated against or harassed because they are wrongly perceived to be disabled. Definintions Under the Equality Act 2010, a person has a disability if:   S/he has a physical or mental impairment The impairment has a substantial and long-term adverse effect on his/her ability to perform normal day-to-day activities. 'Substantial' means more than minor or trivial 'Long-term' means that the effect of the impairment has lasted or is likely to last for at least twelve months (there are special rules covering recurring or fluctuating conditions) 'Normal day-to-day activities' include everyday things like eating, washing, walking and going shopping.

For the purposes of the Act, these words have the following meanings:   

Individuals who have had a disability in the past that meets this definition are also protected by the Act. There are additional provisions relating to people with progressive conditions. People with HIV, cancer or multiple sclerosis are protected by the Act from the point of diagnosis. People with some visual impairments are automatically deemed to be disabled.

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Some conditions are specifically excluded from being covered by the disability definition, such as a tendency to set fires or addictions to non-prescribed substances. Adjustments to working conditions and practices Legislation specifies there is a duty to make reasonable adjustments for disabled people. This applies in cases in which an individual would be at a substantial disadvantage compared to a non-disabled individual if the adjustment was not made. Such adjustments include adaptating the premises, part time or modified work schedules and provision of readers, personal assistants or interpreters. The Disability Equality Duty In addition to the less advantageous treatment considered above, since December 2006 all public sector organisations have had a legal duty to promote equality of opportunity for disabled people. Public sector organisations include:      Hospitals Schools and colleges National health service (NHS) Trusts Police forces Central and local government

The Disability Equality Duty (DED) covers everything public sector organisations do, including policy making and services that are delivered to the public.

Managing Equality and Diversity in the Workplace
Establishing a culture of diversity needs commitment from the top and active encouragement throughout the organisation. It needs to be supported by appropriate management policies and practices. For example, the development of more flexibility in working conditions can be a key feature of enabling different groups to be involved in the organisation. This may be seen in the growth of more flexible and individual contracts of employment, the introduction of career breaks and the establishment of flexible working hours. Most larger organisations try to formally integrate equality and diversity into their business strategy. Most would see a commercial business case for being an „equal opportunity employer‟. Such an approach would move beyond simply complying with the legislation. It involves promoting equality and diversity, through its employment policies and encouraging the concept of an integrated workforce by ceasing to treat the issue of equality separately.

E. FAIR TREATMENT OF EMPLOYEES
In addition to specific legislation about the treatment of groups with protected characteristic status, there is also protective legislation for all employees in certain areas.

Dismissal
Employees should only be dismissed if, despite warnings, conduct or performance does not improve to the required level within the specified time period. Dismissal must be reasonable in all the circumstances of the case.

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Unless the employee is being dismissed for reasons of gross misconduct, s/he should receive the appropriate period of notice or payment in lieu of notice. Legislation in the UK lays down minimum periods of notice. Can an employer dismiss without notice? Employers should give all employees a clear indication of the type of misconduct that, in the light of the requirements of the employer's business, will warrant dismissal without the normal period of notice or pay in lieu of notice. So far as possible, the types of offences which fall into this category of 'gross misconduct' should be clearly specified in the rules, although such a list cannot normally be exhaustive. No dismissal should be instant. A dismissal for gross misconduct should only take place after the normal investigation and disciplinary meeting to establish all the facts. The employee should be told of the complaint and be given the opportunity to state their case, as in any other disciplinary meeting. The employee has the right to be accompanied at any such meeting. What is gross misconduct? Gross misconduct is an action generally seen as serious enough to destroy the contract between the employer and the employee, making any further working relationship and trust impossible. It is normally restricted to very serious offences, for example, physical violence, theft or fraud, but may be determined by the nature of the business or other circumstances. Except in very exceptional circumstances, the full three-step statutory procedure (written statement, hearing and appeal) should be used before deciding whether to dismiss.

Redundancy
Redundancy is dismissal which is not related to the conduct or capability of the individual or to retirement or resignation. It may apply only if:     the business is ceasing to trade the business is reducing in size the purpose for which the employee was recruited is no longer required the business is changing work location.

Employers are expected to have redundancy procedures in place. Failure to follow appropriate and reasonable procedures could lead to employers being liable for claims of unfair dismissal even if they have potentially good grounds for dismissal. Employees that are threatened with redundancy should be are made aware of the contents of any agreed procedure and of the opportunities available for consultation and to make representations. If the employees being made redundant belong to a trade union the employer should involve the trade union in the redundancy plans as early as possible. Alternatively, employee representatives should be notified. The employee representatives or the unions should share the problem and explore the options:    ways of avoiding the dismissals reducing the number of employees to be dismissed mitigating the effects of dismissals.

The employer must carry out this procedure with a view to reaching agreement with appropriate representatives on these issues; it must not be pretence, even when the employees to be made redundant are volunteers.

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These procedures must be completed before any redundancy notices are issued. In the UK there are statutory minimum time limits. The consultation process should precede any public announcement of the redundancy programme and notices of termination should not be issued until consultation has been completed.

Harrassment and Victimisation
Harassment and bullying in the workplace can be a major concern and result in claims being made against the employer if the issue is not dealt with. This is an awkward subject to define, but is usually interpreted to cover:  Unwanted actions or comments viewed as humiliating and unacceptable to the recipient – such actions including pushing, tipping up, gestures, etc. and comments being either verbal, by email or text, or graffitti Unwarranted actions or comments which are detrimental to the recipient‟s dignity, such as being isolated and contributions being ignored.

Note that, in both these circumstances, it is the perception of the recipient which is key to determining whether the actions/comments complained of constitute harassment. Victimisation is the act of the employer treating someone less advantageously because of some characteristic unrelated to the reasons for the treatment complained of. This may be, for example, because he/she had previously complained about a discriminatory act or had supported someone else who had complained, or for trade union activities.

Health and Safety at Work
Employers are responsible for ensuring that they create a safe and healthy workplace for their employees. There is specific legislation for each industry but in general, the employer is responsible for       making the workplace safe and eliminating or controlling health risks ensuring that plant and machinery are safe and that safe systems of work are set and followed ensuring that articles and substances are moved, stored and used safely providing adequate welfare facilities giving workers the information, instruction, training and supervision necessary for their health and safety consulting workers on health and safety matters.

The extent of the issue and the cost to employers and employees are demonstrated in the figures released by the UK National Statistics Office in its 2009/10 Annual Report:  1.3 million people who worked during the last year were suffering from an illness (long standing as well as new cases) they believed was caused or made worse by their current or past work. 555 000 of these were new cases 152 workers were killed at work – a rate of 0.5 per 100 000 workers 121,430 other injuries to employees were reported under RIDDOR (see below) – a rate of 473 per 100 000 employees 233,000 reportable injuries occurred, according to the Labour Force Survey – a rate of 840 per 100 000 workers 28.5 million days were lost overall (1.2 days per worker) – 23.4 million due to work related ill health and 5.1 million due to workplace injury.

   

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The Reporting of Injuries, Diseases and Dangerous Occurrences Regulations 1995 (RIDDOR) place a legal duty on employers, self-employed people and people in control of premises to report:     Work related deaths Major injuries or over-three-day injuries Work related diseases Dangerous occurrences (near miss accidents).

The Health and Safety at Work etc Act 1974 The Health and Safety at Work etc Act 1974, also referred to as HASAW or HSW, is the primary piece of legislation covering occupational health and safety in the United Kingdom. The Health and Safety Executive is responsible for enforcing the Act and a number of other Acts and Statutory Instruments relevant to the working environment. Important regulations have been created to cover areas including:     Hazardous substances Noise Manual handling (lifting and carrying) Violence in the workplace

The Act was last updated in 2006 and its full content can be viewed at the HSE website. Most of the developments in Health and Safety in the UK are now driven by European legislation. Employers are required to keep records of all incidents as mentioned earlier. The HSE provides information on the different types of records and explains exactly what the employer needs to record and why. Complementing Health and Safety legislation are Codes of Practice. These codes offer practical advice to employers and others. Failure to comply with a code is not an offence in itself. Employers are expected to provide safety training. There are three methods of doing this:    Induction – setting the scene for an organisation that is safety conscious. On the job – via colleagues and managers; at team meetings and in appraisals. Through specialist training for those moving into jobs which are particularly vulnerable.

Many firms now use short videos which are viewed regularly by employees so that they are reminded of the key points. Since there is a relatively high proportion of workers in the UK who do not speak English as a first language, videos in the form of cartoons which demonstrate the safety aspects simply are used to communicate all the key messages to employees of all nationalities. Trade Unions and Health and Safety A recognised trade union has a legal right to appoint safety representatives and managers must consult with these representatives. They can inspect, investigate complaints, communicate with an HSE inspector and sit on the local H&S committee. The employer is obliged to allow them reasonable time off for their activities, for training and cannot ban someone from being a representative. The HSE supports the role of unions and other employer health and safety representatives in their contribution to maintaining and improving health and safety in the workplace. It provided the TUC with the “Brown Book” (Safety Representatives and Safety Committees Regulations 1977, Approved Code of Practice and guidance) for training purposes.

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Working Time Regulations The UK‟s Working Time Regulations limit the average working week to a maximum of 48 hours (unless the employee has voluntarily opted out), give a minimum of 20 days paid leave and limit night working hours. The 48 hour week is averaged over 17 weeks. However, this does not apply if the job is:     One where the employee can choose freely how long s/he will work – for example, a managing executive In the armed forces, emergency services and police, although only in particular circumstances As a domestic servant in private houses As a sea transport worker, a mobile worker in inland waterways or a lake transport worker on board sea-going fishing vessels.

Anyone over 18 years of age can opt out of the 48 hour a week restriction, but this must be a voluntary action and not applicable to all the firm‟s workforce. Employees cannot be sacked or unfairly treated for refusing to do so.

Activity 3
Answer Yes or No to the following questions, and note the reasons for your answers: (a) (b) (c) (d) (e) (f) (g) (h) Can an employer be guilty of discriminating against a person who is not an employee? Does the individual have to prove an accusation of discrimination? Does a company have to report workplace accidents to the HSE? Can a firm refuse to employ a disabled person? Does disability include learning difficulties and poor sight? Can a firm make you work a 65 hour week? Can an importer be responsible if you are injured by a faulty good? Do you have any rights when you buy goods from the internet?

See the suggested answers at the end of this chapter.

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SUMMARY
Business and individuals interact with government in an attempt to exert influence on government policy affecting business.   Pressure groups use a variety of means to attract the attention of other members of the public and to influence the actions of businesses and the government. Businesses also attempt to influence government decision making through their role as suppliers to government, or by direct representations using professional lobbyists or intermediates such as their trade association.

Governments intervene when the market fails to provide goods and services that the public needs.   It will examine the social efficiency of goods and services produced and will try to limit the amount of market failure. Externalities are a result of market failure and can be positive or negative. If the marginal social cost of a good/service is greater than the marginal social benefit then the externality will impact on the public in a negative manner.

Government intervenes in the activities of businesses in the interest of public well-being and safety. It imposes legislation, taxes or subsidies in an attempt to discourage poor practice or encourage better practice.    Taxes are often imposed to discourage the public and firms from doing social harm such as emitting excessive pollution. Subsidies will be given to firms to produce goods that are not available in sufficient quantity. Legislation on equality, consumer protection, health and safety and employee protection are all examples of intervention into the working practices of firms so that they operate in a responsible manner.

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ANSWERS TO ACTIVITIES
Activity 1 (a) (i) Litter – negative The person dropping the litter may get no adverse reaction, but the social cost to others is that of making the environment unpleasant (and possibly a health hazard) and the cost of the local authority employing someone to clean up. (ii) Man made lakes – positive or negative depends on circumstances If the lake is artificial and trees and wildlife were removed to make room for it, then it could be classed as negative as it has disturbed the eco-system and taken away a lot of public pleasure. If it is made to improve an area, for example where there was an old quarry, then it will be positive. It will attract the public as somewhere pleasant to be and wildlife will return to the area. (iii) Official rubbish tips – in general, positive Although these have to be financed by the local authority, the cost is much lower than collecting discarded items singly. If it is equipped to divide waste into categories, then recycling can occur and sometimes discarded goods are suitable for sale with money being raised for charities. (iv) Drinking alcohol – positive and negative The amount is one issue. If it is in reasonable amounts it can give people pleasure when eating a meal or socialising with friends, stimulating a relaxing and pleasant atmosphere. These would be positive. The negative externality arises through excess drinking of alcohol. There is a health risk, of course, whereby the person may have an incident or accident and have to use the facilities of a hospital, with a consequent cost to the health service. There is also the fact that excess alcohol can often make people very rude or violent so promote unpleasantness and harm to others. (b) (i) (ii) The cost to the British employee of being unemployed while a non-British or and EU citizen takes a job they could have done. These may include: – – – The lack of opportunity to exchange ideas and improve learning Britain may not be able to acquire the specific skills when it wants them There is also the negative effect on relations between the two countries and Japan could easily retaliate.

Activity 3 (a) (b) (c) Yes. No. The responsibility is on the employer to prove that it acted fairly and without any discrimination. Yes, if the injured person is on sick leave for 3 days or more or if there are dangerous incidents or diseases.

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(d)

Yes, but only if it is not possible to make reasonable adjustments to the physical environment of the workplace or working practices in order to accommodate the disabled person. Yes. Yes, if this equates on average with other weeks to a 48 week during a 17 week period. Otherwise, the employer cannot enforce a 65 hour week without your written agreement. Yes, if the importer brought the product into the EU. The manufacturer can also be held liable. Yes. You must be given all terms and conditions, delivery and cancellation arrangements in writing and are entitled to a 7 day cooling off period.

(e) (f)

(g) (h)

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Chapter 7 Business in the Global Context
Contents
Introduction

Page
164

A.

The Characteristics of Global Business International Trade Comparative Cost Advantage The Multinational Enterprise

164 165 166 167

B.

Free Trade and Globalisation Advantages and Disadvantages of Free Trade Barriers to Free Trade Trading Blocs The Role of the World Trade Organisation in Free Trade

168 168 170 172 174

D.

Technology as a Driver of Globalisation Impact of Technology on Global Business Impact of Technology on Global Trade Costs and Benefits of Changing Technology on Business

175 175 176 179

E.

Theories of Globalisation Porter‟s Diamond International Product Life Cycle

179 180 182

Summary

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Answers to Activities

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INTRODUCTION
In Chapters 1- 4 we focused our attention on national business and covered concepts that will now be expanded in a different context. In the remaining chapters our concentration will be on the facets of global business and what extra factors have to be considered in addition to those of a firm that essentially operates in a national environment. Here, we shall examine what is meant by a global business and the drivers and triggers that influence firms to expand all over the globe. Several aspects of those factors, positive and negative, will be explored in the context of real world examples and you will be asked for your thoughts on the impact these factors have made in your country and on your life style. Lastly, you will have some case studies to look at, where you will apply what you have learnt in the Chapter.

A. THE CHARACTERISTICS OF GLOBAL BUSINESS
Global business has the following distinctive characteristics:    Movement of people across borders Movement of money across borders Extensive trade across borders.

A global organisation must think global and act local if it is to succeed. These three characteristics demonstrate how this can work in practice. (a) Movement of people across borders generally occurs in managing projects or teams in new locations. It is important to have cultural awareness and business understanding from managers and leaders who can exchange practice and maximise performance. Large companies with a global presence look for potential leaders who possess a world view and are able to move from one location to another with ease. Multinationals such as Coca Cola build up extensive experience in a variety of locations when developing future managers. (b) Money movement is demonstrated in many ways, but investment in company growth illustrates this well. Whichever option(s) the organisation chooses for growth, financing will be necessary for that growth. For example when Kraft, the American based multinational acquired UK based Cadbury in 2010, it paid $18.9 billion. Acquisitions and mergers in countries other than the firm‟s head office location and the purchase of offices and manufacturing facilities in other global locations indicate the movement of money which is a characteristic of globalisation. The impact of exchange rates on global profits is yet another indicator of global money movement. For example, notes to a firm‟s accounts might state „The unfavourable impact of currency fluctuations decreased net operating revenues by approximately 5 percent. The unfavourable impact of changes in foreign currency exchange rates was primarily due to a stronger U.S. Dollar compared to most foreign currencies, including the Euro, South African Rand, British Pound, Brazilian Real, Mexican Peso and Australian Dollar, which had an unfavourable impact on the Eurasia and Africa, Europe, Latin America and Pacific operating segments.‟ (c) Trade across borders can be indicated by the countries in which the firm operates and by the data it produces to demonstrate market sector growth for products in various countries. For example, in their 2009 Annual Report, Coca Cola stated “Coca-Cola

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Company is a truly global company, and we operate in over 200 countries around the world.” Its regional data from Africa and Eurasia demonstrates their global coverage and market share growth: „In 2009, our unit case volume grew 4 percent, led by 31 percent growth in India, 21 percent growth in Algeria, 17 percent growth in Pakistan and 9 percent growth in Kenya‟.

International Trade
What is the difference between international trade and global trade?  As we mentioned earlier a global company is regarded as any company which owns and controls the production of goods and/or services in several different countries. This is often referred to as "direct investment" overseas. They are "multinational", although this term is usually associated with very large companies. Leading multinationals include BP, General Motors and Pepsico, which are giant enterprises. In the past 20 years, though, this situation been transformed by advances in technology and many much smaller companies now operate across national boundaries. An International company, by contrast, is one that has a home base in a specified country and simply owns shares or loan stock in foreign enterprises. It does not directly control their activities. This type of arrangement is called “portfolio investment".

Terms of Trade The terms of trade are defined as the: Average price of exports of and the average price of imports These are measured by using an index which has a base year with an assumed value of 100. If in a year the average price of imports has risen by 30% with respect to exports, the terms of trade will be 70%. This will be a worrying situation as it will affect the balance of payments (see later). The terms of trade will have „worsened‟. If the average price of exports rises faster than average price of imports, the terms of trade will have been „improved‟.

Activity 1
If the average price of exports in your country has risen by 50% with respect to the average price of imports. (a) (b) What will the terms of trade be? Will this be a good or bad situation for your economy? Give a reason for your answer.

See the suggested answers at the end of this chapter.

The Benefits of International Trading Global trade provides benefits for individual firms and countries including: (a) Better supply of goods A country may obtain goods which it could not have obtained otherwise. For instance, Britain could not enjoy tropical fruit or manufactured goods made of copper, nickel, and many other metals if it were not for the existence of international trade.

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(b)

Lower costs A country can obtain goods, which it could only grow or produce at higher cost than in other countries. Opening up the whole world for trading purposes increases the size of the markets for various goods. Production on a larger scale is then possible, allowing full advantage to be taken of economies of scale. For example, if Switzerland only made watches for its own comparatively small domestic market, the cost of production per unit would be much higher than it is.

(c)

Monopolies can be curbed The existence of international trade is an obstacle to the development of monopolies. Even if there are monopolies in existence in one country, their control over prices will be limited by the ever present threat of foreign competition.

(d)

Encouragement of international cooperation The existence of international trade also leads to a greater degree of interdependence between states and this should be a factor making for international peace and friendly cooperation between nations.

(e)

Shortages can be prevented World trade reduces the likelihood of shortages of supply since it is possible to offset temporary domestic shortages by getting additional supplies from abroad. One significant outcome of this is that it makes famines less likely in trading nations.

Comparative Cost Advantage
Countries have different natural resources. They also differ in population density; age ranges; skills, equipment and climate. Hence different countries will produce different types of goods and services and the cost of producing the same good will vary. This gives rise to one of the key concepts behind international trade. Absolute advantage is a situation where a country can produce a good with fewer resources than another country. Examples of absolute advantage would be the production of grapes in Italy and wheat in Russia. However, countries buy goods that they could produce themselves. According to economic theory, this arises from the concept of comparative advantage. In simple terms, comparative advantage occurs when a country specialises in the production of a certain good because it can produce more of it at a lower price per unit than other goods. It may then import the other goods that would cost it more to produce itself. For example, imagine that two countries A and B that can both produce both copper and wheat. For a given outlay (which might be measured in terms of labour and money) their production is as follows:   A can produce 300 units of wheat and 150 units of copper B can produce 150 units of wheat and 100 units of copper.

Country A apparently has an advantage over country B in the production of both wheat and copper as it can produce both more cheaply for the same cost. Will there be any scope at all for trade between the two countries?

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The answer is yes provided that A's advantage over B is not proportionately the same for both commodities:   For wheat the ratio A:B is 300:100 or 3.0:1 For copper the ratio A:B is 150:100 or 1.5:1.

Country A will thus tend to specialise in the production of those commodities in which it has the greatest comparative advantage, or the least comparative disadvantage. As A's comparative advantage in the production of wheat is greater than its advantage over B in the production of copper, it will pay A to specialise in the growing of wheat and to leave copper production to B. Therefore, A will produce wheat and B will produce copper. The law of comparative advantage states: If countries are to gain competitive advantage they should trade goods in which they have comparative advantage and import those in which they have comparative disadvantage.

The Multinational Enterprise
Growth of the multinational enterprise has been stimulated by       Decrease in barriers to trade Improvements in technology and communications Efficient international capital markets Encouragement by developing countries Rising costs and production difficulties in the industrial nations Extending the product life cycle.

We shall look at some of these triggers for change in more detail throughout this chapter. Multinational enterprise involves a transfer of production capacity from one country to another. It has consequences for the multinational‟s home country, the host countries where new enterprises are established and for the whole pattern of global trade and production. (a) Consequences for the Home Country If a British manufacturing company decides to locate a new factory in Brazil rather than in England, then England loses the investment to Brazil. From the British point of view, this is called "divestment" – that is, the loss of productive investment. The decision may mean a loss of some capital. In the home country there is consequently a loss of production work and jobs are lost. Most of these jobs are likely to be in the routine work of manufacturing, in unskilled and semi-skilled jobs and the work of supervision. The more highly skilled manufacturing work, as well as research, planning, marketing, etc. is still likely to take place at the home headquarters of the multinational company. In the last few years there has been a trend to keep highly skilled manufacturing in the developed country as, it is argued, the skills and attention to quality needed cannot be reproduced in some overseas locations. In the past, home country nationals were more likely to be asked to fill managerial and skilled technical jobs in the overseas country. While this is still probable, the extent of the practice has reduced. Key staff are difficult to find, are sourced from all over the

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world and are sent to work in other locations as part of their development. This results in more management roles disappearing in the home country than in previous years. Another consequence of divestment for the home country is that visible exports fall and visible imports rise. Invisible earnings rise, as the overseas sections of multinationals pay fees and royalties for patents and services and remit profits to the home country. Of course, profits go to the owners of capital and there is a real possibility that the profits will be reinvested in further foreign production and not used to develop business at home. (b) Consequences for the Host Country The host country gains jobs and some capital investment. It will also gain export earnings and saves some import payments by having producers of products for world markets within its own economy. There is doubt as to whether it gains the full value of production though, because the home part of the multinational company may require heavy payments for technical and managerial services, as well as a substantial share of profits. Host countries gain benefits from importing managerial skills and technical know-how, which may help in developing their own production capacity in the future. It will usually be in the interests of the multinationals to keep factor costs low – particularly labour costs – and for labour to be non-unionised and often with substantially worse working conditions than those which would apply in the home country. If factors (especially wage costs) do start to rise, then the multinational may be able to transfer production to another country, leaving the original host country worse off than before. In addition, there will be little encouragement from the multinational enterprise for the development of domestic industries which may prove to be competitors, both in selling products and as employers of production factors. (c) Consequences for Global Trade The growth of multinational enterprise has radically changed the pattern of trade. Visible trade is no longer a matter of a flow of basic materials to the western industrialised countries and a counter flow from them of manufactured goods. Manufacturing is now carried out in a very wide range of countries, although some of it is still controlled by and relies on technology supplied by the advanced industrial nations.

B. FREE TRADE AND GLOBALISATION
The barriers to free trade have reduced significantly in recent years. This has encouraged firms to take advantage of the opportunities available in many countries.

Advantages and Disadvantages of Free Trade
(a) Advantages of Free Trade The principle of comparative advantage shows that free trade and specialisation brings gains to the participating countries. As long as a country has a comparative advantage in producing something, it can benefit from specialising in its production and trading the surplus for other materials and products from abroad.

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The advantages of free trade can be summarised as follows:      Countries can specialise and increase production, confident that they can export any surpluses. Resources can be allocated more efficiently. Countries can export surpluses and import what they need. Countries gain economies of scale as they are able to access to the world market to sell more of their products. Competition from imports increases efficiency as it encourages countries to upskill their workforce, promote research and development and to gain access to newer technologies. Limits the creation of monopolies or oligopolies within the country that could keep prices high. It helps to keep inflation low. Countries are able to diversify into producing other products and services making them less dependent on just a few. For example, a single item, such as cotton or coffee, for which the harvest is subject to climatic conditions, leaves the population vulnerable. Free movement of capital allows countries to develop their industries, economic growth to occur and the nation becomes wealthier. Political links develop between countries. "Infant" industries or small new businesses can be crushed by foreign competition before they have had time to develop. Dumping of excess or low quality goods by other countries who may sell them abroad at a lower price than at home. This is done partly to avoid swamping the home market with a surfeit of goods which would bring down home prices. It may also include products that are no longer acceptable to consumers in the country of production. Reduces demand for home produced products and may increase unemployment. Free trade may not be in the interests of national security – goods produced for defence purposes, for example, need to be produced in the home country to ensure that it is not dependent on foreign suppliers in times of conflict. Foreign companies may create monopolies in the home market. Externalities such as increased pollution from industry or heavy lorries used in distribution. Increases the influences of external consumer tastes and attitudes, such as consumerism, reduction of community values and a tendency towards western fast food.

  

  (b)  

Disadvantages of Free Trade

 

  

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Barriers to Free Trade
All trading nations engage in some form of trade protection, as governments face political pressures from powerful domestic interest groups. It is, though, very unlikely that a country would ban international trade altogether. By using a variety of devices to delay imports or make them more expensive, countries can effectively create barriers to free trade. An example is to impose bureaucratic import procedures with complicated documentation, so slowing down the completion of the import. Formally imposing blanket restrictions on trade is rare as it would cause other nations to take retaliatory action and court disapproval from the World Trade Organisation (WTO). Nevertheless, formal trade protection measures are still employed by individual countries and regional groups such as the European Union. The main measures are: (a) Import tariffs These are also known as customs duties and are taxes imposed on goods when they enter a country or one of a group of countries, such as the EU. Tariffs are usually applied to selected items. The advantages of tariffs are: (i) (ii) (iii) The objective of imposing the tariff is to raise the cost of the imported goods so that importers have to raise prices or accept reduced profits They raise money for the government The tariff raises the price paid for the imported good by the domestic consumer and reduces the quantity purchased – hence, the imports suffer a competitive disadvantage compared with home produced substitutes Domestic producers supply more to the market and foreign suppliers provide less than if there were no tariff.

(iv)

Customs duties may be imposed as a specific duty of a fixed amount per item or per tonne or by the total value. Specific duties work best for goods of low value and high weight, such as iron. By-value is best applied to items like jewellery and those whose prices change often. The amount received by foreign exporters may be the same or less than before the tariff. (b) Import quotas These are restrictions on the quantity of goods that can be imported. The purpose of import quotas is to lay down the exact quantity of a commodity which may be imported in a given period of time. Import quotas may be accompanied by customs duties. (c) Embargoes Embargoes are a total ban on imports or exports, usually applied for political reasons. An example would be the export of arms to a certain country in a war zone. (d) Non-tariff barriers These are barriers applied through safety rules and administrative controls, as noted above. They can be seen as a subversive method of protectionism. (e) Exchange Control Control is enforced in many countries to redress an adverse balance of payments, by requiring all buying and selling of foreign exchange to be done through the central

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bank. It limits the amount of foreign exchange purchases so that it is equal to the amount of foreign exchange receipts. Disadvantages of Trade Barriers Trade barriers are usually introduced to protect domestic industry from foreign competition and/or to control the balance of payments account of a country. There are, though, significant problems with their use.   International retaliation – Other nations are likely to take similar action, hence reducing the opportunity of the protectionist country from trading its own goods easily. Unemployment ultimately rises – If all countries sought to reduce and impose barriers against imports, total trade and production would fall and unemployment would increase in all countries. Thus, the spread of protectionism would increase unemployment overall. Reduction in industrial efficiency – Protecting domestic industry against foreign competition makes firms less able to compete in world markets. The longer controls last, the more they are needed and the country loses the variety of products provided by imported goods. Its standard of living would fall with this loss of choice, as increasingly inefficient firms required more and more resources to produce less and less. Cost and corruption – Enforcing trade barriers is costly and officials are prone to taking bribes from importers so that they can trade their goods in the country.

Think Point
Think about the benefits and disadvantages of free trade to your own country and to others you may be familiar with. (a) (b) (c) Does your own country operate a policy of free trade and, if so, what do you see as the benefits and disadvantages of that policy for the country? Why do you think a country might be opposed to free trade? On a social level, what are the positive and negative aspects of free trade for you personally?

You need to assess the application of the arguments about free trade to the countries you have selected. Some of the benefits include the opening up of markets and greater opportunities for exporting, wider choice of products available at a lower price to consumers, increased employment opportunities and increased skills levels in less developed countries. All these factors are likely to increase GDP in all countries and lead to greater prosperity and higher income levels. The disadvantages, economically, tend to be the threat to domestic production by the import of cheaper goods. This may lead to domestic business closures and rising unemployment. If free trade has not been embraced, the decision may have been made so as to protect the country‟s own industries and/or its culture. The latter is often overlooked, but the influence of, particularly, Western or American goods and ideas, can threaten the indigenous culture. It may also be that the government wishes to continue receiving the income it gets from tariffs. It is also important to consider the effects on society of free trade. On the one hand, we probably all benefit from the variety of goods and services which become available and, at

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least for some, the generally higher standard of living and improved life styles. However, there are problems created by the threat to domestic culture and traditions, and the exploitation of lax labour laws and environmental protection in some less developed countries,

Trading Blocs
The activities of trade blocs have huge importance in the economic and political scenarios of the contemporary world. Trading blocs have played a major role in regulating the trend and pattern of international trade. Trade blocs are free trade zones designed to encourage trade activities across nations, while making it difficult for non-members to trade there. The formation of trading blocs involves a number of agreements on tariff, trade and tax. What is included in the trading agreement depends on the political will of the members. For example, they may be unwilling to expose a trade such as agriculture to competition or to accept the full degree of international specialisation which goes with completely free trade. Creating a trade bloc has two major effects on trade:  Trade creation – whereby countries which previously placed tariffs on imports from other members and produced the goods themselves, allows free trade in such goods between members Trade diversion – whereby the removal of barriers inside the bloc results in trade being switched from a more efficient producer outside the union to a less efficient one inside.

In addition to the benefits of trade creation there are other benefits from setting up a free trade area:      Economies of scale develop because the member countries now have a much larger "home" market. Specialisation in products having a comparative advantage creates greater opportunities for economies of scale. Greater efficiency is enforced because the members' industries are exposed to more competition. Consumer welfare is increased as people have more, better quality and cheaper goods, with more variety, to choose from. Increased political cooperation as the member countries develop common policies and become more dependent on each other.

The larger the trading bloc, the greater the potential benefits because of the better chance of including the lowest cost producer and the bigger opportunities for economies of scale. There will also be more opportunities for trade creation, whereas previously there was lot of duplication and large cost differences between the production of the members. In addition, the gains from specialisation will increase, especially if there were high tariffs before the creation of the trade bloc. Previously there would then have been a lot of domestic production for relatively small markets. The lower the external tariffs imposed by the union the better, as this reduces the possibilities of trade diversion. One of the biggest disadvantages of trading blocs is loss of political and economic independence because the countries must take into consideration the policies and rules of the bloc when deciding their own policies. For example, the UK has had a number of significant disagreements on policy with the European Union (EU) on matters such as working hours and employee rights.

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The effects of trading blocs have to be carefully evaluated to see if they really do benefit the citizens of the member countries and not just protect inefficient producers. Examples of Trading Blocs (a) EU – The European Union This began in the 1950s as the „European Economic Community', comprising six member states: Belgium, Germany, France, Italy, Luxembourg and the Netherlands. They were joined by Denmark, Ireland and the United Kingdom in 1973, Greece in 1981, and Spain and Portugal in 1986. Reunification of Germany in 1990 brought in the East German Länder. The Community was enlarged in 1995 to include Austria, Finland and Sweden, and a further enlargement in 2004 brought in Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovenia and Slovakia. Bulgaria and Romania joined in 2007. Croatia, the former Yugoslav Republic of Macedonia and Turkey are currently candidate countries. The EU opened its common internal market on 1 January 1993 with the following main effects:    Citizens of the member countries can live and work anywhere in the EU Capital can move freely and there is a continuing programme of harmonisation of standards Regulations permit the free flow of goods and services.

The 1991 Maastricht Treaty agreed a programme to move towards economic and monetary union and to take the first steps towards political union by agreeing common foreign policies. Since 2003, a single european currency, the Euro, has replaced the previous national currencies of 15 member countries (in what is known as the Eurozone). (b) MERCOSUR This is South America's leading trading bloc and is known as the Common Market of the South. It aims to bring about the free movement of goods, capital, services and people among its member states. It has been compared to the European Union but is four times as big. The bloc's combined market encompasses more than 250m people and accounts for more than 75% of the economic activity on the continent. Its full members are Argentina, Brazil, Paraguay, and Uruguay. Associate members are Bolivia, Chile, Colombia, Ecuador and Peru. Venezuela awaits ratification of its full membership at time of writing. The combined GDP of the groups is US$ 1.1 trillion. (c) NAFTA – The North American Free Trade Agreement This is a comprehensive trade agreement that sets the rules of trade and investment between Canada, the United States and Mexico. Since the agreement came into force on 1st January, 1994, NAFTA has systematically eliminated most tariff and non tariff barriers to free trade and investment between the three countries. (d) ASEAN – The Association of Southeast Asian Nations This bloc aims to accelerate economic growth, social progress and cultural development in the region and to promote regional peace and stability through the rule of law and adherence to the principles of the United Nations Charter. ASEAN comprises ten countries: Burma, Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Philippines, Singapore, Thailand and Vietnam.

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A free trade agreement came into force between ASEAN and China in January 2010, creating the world‟s third largest free trade bloc behind EU and NAFTA. (e) BRIC BRIC is not an official trading bloc, but a term used in economics to refer to the combination of Brazil, Russia, India and China, which make up over 42% of the world's population. These nations are progressively playing a major role in the future of global economy. Examples of trade agreements are:   In the first six months of 2009, China became Brazil‟s biggest single export market for the first time. In 2010, the China Development Bank and Sinopec, a Chinese oil company, lent Brazil‟s state-controlled oil company, Petrobras, $10 billion in return for up to 200,000 barrels a day of crude oil for ten years from the country‟s deep sea fields.

The Role of the World Trade Organisation in Free Trade
The World Trade Organization (WTO) is responsible for the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible. Nearly all decisions in the WTO are taken by consensus among all member countries and they are ratified by members' parliaments. Any conflict over trade is handled by the WTO's dispute settlement process, where the focus is on interpreting agreements and commitments and making sure that countries' trade policies conform to them. As a result of this, the risk of disputes leading into political or military conflict is reduced. By lowering trade barriers, the WTO‟s system also breaks down other barriers between peoples and nations. The WTO‟s agreements, which are known as the multilateral trading system, are contracts guaranteeing member countries important trading rights. The terms are negotiated and signed by a large majority of the world‟s trading nations and ratified in their parliaments. These agreements are the legal ground rules for international commerce and bind governments to keep their trade policies within agreed limits. Although agreements are negotiated and signed by governments, their purpose is to support the producers, exporters and importers of goods and services in the conduct their business.

Activity 2
(a) (b) What other trading blocs can you find? Look for those which include emerging economies in particular. Why might emerging economies want to form a trade bloc without any advanced developed countries as members?

See the suggested answers at the end of this chapter.

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D. TECHNOLOGY AS A DRIVER OF GLOBALISATION
The development of technology over the past 20 years has made a transformational impact on communication and management and has triggered the fast growth in global business. Consider the following forms of technological change: (a) (b) Email – which has made fast internal and external communication possible and become a significant marketing tool. The internet – which has become the promotional showcase for many businesses who can now advertise themselves to the world very economically. Consumers can interact with each other and with businesses in a variety of ways, resulting in growing consumer power. Management Information Systems – which are capable of collecting and analysing huge amounts of data, providing reports on a variety of subjects in „real time‟ at the desktop of company personnel. Manufacturing technology – which has become so sophisticated that less people are required to do most jobs and robots can be employed for many manufacturing tasks. Travel – which is faster and less expensive and, using mobile phones and portable computing devices, individuals can do business globally while travelling.

(c)

(d) (e)

Technology has not only assisted the global growth of businesses but changed practices dramatically, allowing control of the global company to be effective and hence it has impacted on performance. Global communication, using the whole range of techniques described above, has enabled this transition.

Impact of Technology on Global Business
Examples of the contribution to growth, business performance, innovation and management are listed below. (a) Instant feedback – Companies can gain customer feedback quickly and directly, and this assists in managing the quality of products and the research, development and designing of new ones. They can also advertise their products in all media and take views on proposed new ventures. Strategic decision making – Company data can be input and analysed in real time, allowing managers to make quicker decisions, track the growth of market share and sales by product and country. This has a big impact on making strategic decisions. Virtual working – People working in remote locations can quickly and effortlessly communicate with other staff or managers around the world, using a variety of techniques, such as:   Web, video or telephone conferences, which allow teams dispersed across distant locations to discuss issues in real time Email, phones and the internet to maintain contact to the workplace and to access company information and feed information back to the company.

(b)

(c)

The technology also allows managers to maintain contact with staff working remotely and monitor their performance, ensuring that management control is not lost. (d) Purchasing, sales and customer relations – The internet has allowed consumers and businesses to access data on the products and services of other organisations. This has resulted in customers and commercial purchasing staff being able to compare price and quality, which then enables them to negotiate more effectively. It provides access to more choices.

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Companies are able to interact directly and quickly with customers, and customers can also interact with each other to recommend a company‟s products and services or to deter others from the use of a certain product or service. Company websites, email and social networking sites all contribute to this two way process (e) Process and Systems Management – The speed of information transfer makes it possible to access costs and revenue instantly and to estimate the profit and loss on a project at any time, compare the efficiency of processes, identify sales trends and hence profit margins on each type of product and service, track foreign currency fluctuations and their effect on profit levels, and so on. The accurate measurement of resource use is crucial to costing the manufacture of any product or service, accurately pricing it and forecasting sales volumes and hence profit. Management Information Systems enable a quick accurate calculation. In a fast moving global environment, this type of information is necessary to maintain competitive advantage; examining where cost savings could be made, which products to produce more, how to maintain quality levels. Knowledge management and competences– This is a key tool in ongoing success and there are many definitions of such capacity within the company‟s workforce. GlaxoSmithKline define it as: "The capabilities by which communities within an organisation capture the knowledge that is critical to them, constantly improve it and make it available in the most effective manner to those who need it, so that they can exploit it creatively to add value as a normal part of their work”. The firm needs to estimate what it has, how retain it and how to best use it for competitive advantage. Storage of information electronically, sharing through internal blogs or recorded VOIP or telephone conferences are all useful in this quest to maximise the capability of the organisation. (g) Organisational learning – Improved communication channels allow firms to access information directly from stakeholders of every kind. This assists in improving overall performance and the value chain. In contrast to traditional employee developmental learning, employees can gain access to virtual learning resources 24 hours a day at their convenience and take part in developmental activities alone or in groups using electronic means. Instant feedback of the level of learning can be given.

(f)

Impact of Technology on Global Trade
Two main aspects are discussed here – the trade channels that have been developed, and the advances in engineering that allow more goods, of better quality, to be produced more quickly and at lower cost. (a) E-commerce The development in electronic communication forms the basis of a huge and continuing growth of trade by electronic means or e-commerce. This has enabled individuals and firms to interact between locations anywhere in the world, where the technology is available. Firms are able to promote their products through the internet, on their websites and on social networking sites. Other electronic means such email and sms messages support website promotions. By promoting their products using search engines such Google and Yahoo, individual consumers or purchasing organisations are enabled to find accurate details of firms that supply the products and services they want within seconds. All these promotions can also be accessed through mobile devices such as the mobile phone. Customers can interact with the firm to make enquiries, order and pay online, and complete a transaction within minutes. They can also provide feedback on the product/services that assists in the development of higher quality and/or more sophisticated versions. Customers‟ data is automatically stored and can be processed

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over time to indicate individual preferences for marketing appropriate further products and services. Firms can measure the success of their websites as a promotional tool by using web analytics to provide information on:     (b) the number of times the site is visited which are the most popular pages how long individuals spend on each page how the individual has found the website, such as search engine uses.

Manufacturing Techniques The continuous advancement of technology has also transformed manufacturing. Manufacturing technology is at the heart of all production of goods and has been since the days of the Industrial Revolution in the 18th century. The tools which enable manufacturing magnify the effort of individual workers and give an industrial nation the power to turn raw materials into the affordable, quality goods which are now essential to society. As they have developed, they have also given us affordable agricultural products, efficient transportation, innovative medical procedures, communication systems of increasing power and scope, space exploration and all the everyday conveniences we now take for granted. Production tools include machine tools and other related equipment and their accessories which are used to perform specific operations on man made materials to produce durable goods or components. Related technologies include Computer Aided Design (CAD) and Computer Aided Manufacturing (CAM) as well as assembly and test systems to create a final product. (i) Robots Modern industrial robots are marvels of modern engineering. A robot the size of a person can easily carry a load over 50 kilograms and move and position it very quickly with a repeatability of +/-0.015 cm. They can work 24 hours a day repeating exactly the same task for years without failure, and in many cases are reprogrammable so that they can perform a range of different tasks. They have been used in car manufacturing in this way for many years and have significantly increased production of a more consistent product, at a significantly cheaper cost. In the 1970s, UK and American car manufacturers were maligned for the poor quality and bad engineering of their vehicles. Robotic manufacturing now allows a car to be made with much more precise welds, closer tolerances and more accurate engineering overall than could be achieved by human means alone. Robots reduce labour costs and have no sick days, strikes, work slowdowns or other problems as humans do. They have also reduced worker injuries. They can also work with a minimum of human supervision. (ii) Advanced manufacturing Advanced manufacturing is a term that has been used to explain many of the manufacturing operations that have reached a level of sophistication not easily replicated by competitors. It is most commonly referenced as the use of hightechnology processes, often involving factory automation, or the development of innovative products. A few of the technologies that fit into the advanced manufacturing category are:    Nanotechnology Direct digital fabrication Micro manufacturing.

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Another definition of advanced manufacturing is that it includes operations that:    create advanced products use innovative techniques in their manufacturing invent new processes and technologies for future manufacturing.

Advanced manufacturing is also described as the process of mass producing products on demand, using the latest technology. Although most manufacturing processes can be easily executed by what has been traditionally referred to as "unskilled labour," this higher level of manufacturing requires specialised training. For this reason, levels of skill available in some third world countries would not be appropriate for using cheaper labour. Advanced manufacturing is a more flexible technique than traditional methods, as it can be specifically adjusted to changing needs. Instead of manufacturing to put products into stock for later sale, advanced manufacturing takes a different approach. It builds for immediate, or nearly immediate, sale. This means products being produced are not months or years old at the point of sale or first use. In contrast, they may be just days or weeks old, depending on how far they must travel to get to their final destinations. Advanced manufacturing facilities are often suited to produce more than one thing. When demand slows for one product, staff can be redeployed to manufacture another. (iii) Computer simulations and scenario planning Technology is used in decision making as a forecasting tool and in scenario planning. In a rapidly changing and turbulent external environment, important future threats may be overlooked. Scenario planning is a technique to consider all the potential changes that may impact on a business in the future by building alternative scenarios and planning how the firm will deal with each one should it arise. Shell was one of the first companies to develop scenario planning as a business tool and was able to deal with the oil shock that occurred in 1973 and greatly improved its competitive advantage in subsequent years. Among the many challenges facing industry executives and high level decision makers are those of envisioning how policy, market, technology and other uncertainties will affect future economic, environmental and social conditions and the associated needs for science and technology. Companies need to make strategic decisions that will be sensible for all plausible futures. No matter what future then takes place, a company and its management team is much more likely to be ready for it and influential in handling it, if it has seriously thought about possible scenarios and has potential plans to minimise or maximise them to the benefit of the business. In an increasingly fast moving global environment, organisations will have to make more complex predictions and this is where technology has radically facilitated this process. The process begins by defining the scope of the scenario – gathering information on the key stakeholders, analysing trends and identifying driving forces and critical uncertainties. The company‟s strategy can be continuously monitored for signals and adjusted as required. Modelling is used as a complementary, quantitative approach for planning in the face of uncertainty, by using computer simulations of how the future might unfold under alternative policy, market, technology and other contingencies.

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Costs and Benefits of Changing Technology on Business
We have touched on many of the positive effects earlier such as:  Performance evaluation of every part of the business has become possible. This allows firms to act to maximise opportunities and minimise risks ahead of the competitors and so to maintain competitive global position. The value chain has been considerably strengthened, allowing costs and wasted resources to be identified and minimised. Communication is possible in a variety of ways, allowing company personnel, customers, suppliers and other stakeholders to interact more effectively and rapidly. As the hardware and software have advanced, the costs have decreased and many companies now have more computing power than the majority of their employees will ever need. The technology used in the firm must be constantly reviewed and this can mean incurring considerable and sometimes unnecessary cost, as many employees already have more computing power than they will ever use. The speed of change makes it imperative that firms identify changes in the external environment and adapt their working practices. This may be impossible if the workforce does not accept the need for any change. A firm must ensure that the skills of the workforce are developed to use new technological advances and so retain competitive position. Security issues have become a major problem, particularly keeping key information – both about the company and about its customers – secure from external hackers or internal theft. Ensuring the security of information has now become one of the most important aspects of an IT manager‟s role. Information overload can occur, with too much data being generated for individuals to handle efficiently, as with the problem of too many emails. Communication is instant and shocks to one economy immediately affect other economies, as in the world economic crisis of 2008. Job stress and reduced quality of life caused by a variety of factors such as (i) (ii) (iii) (iv) Always being connected – employees receive emails at all times of day and night and are under pressure to provide quick responses Personnel are contactable even when on holiday or at weekends Personnel feel pressurised to work outside of the agreed hours because the job can be done anywhere anytime Change is more rapid and constant.

  

Negative effects include: 

 

  

E. THEORIES OF GLOBALISATION
New theories of international trade have been developed, to explain some of the changes in the patterns of world trade we have seen in recent years. These reflect on some of the marketing and competitive strategy aspects that have contributed to the changes in the way trade has taken place. There are many problems with the standard theory of factor comparative advantage when applied to modern trading practices. The theory of comparative advantage assumes:

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     

There are no economies of scale Technologies everywhere are identical Products are undifferentiated The pool of national factors is fixed Factors such as labour and capital remain unmoved All companies follow the same strategy.

It also makes no allowance for the competitive forces that operate within industries. Amongst the most important theories to emerge as a result of these shortcomings are the „Diamond‟ developed by Michael Porter and Raymond Vernon‟s theory of an „International Product Lifecycle‟ .

Porter’s Diamond
Michael Porter developed this theory as he was not satisfied with the scope of comparative advantage based on factors of production to explain changes in trade. He concluded that, at best, comparative advantage theory is useful primarily for explaining broad tendencies in the patterns of trade – for example, its average labour or capital intensity – rather than whether a nation exports or imports in individual industries. His "diamond" attempts to explain why some nations achieve international success in a particular industry. Figure 6.1: Porter’s Diamond Strategy, structure and rivalry

Government

Factor conditions

Demand conditions

Related and supporting industries Source: M.E Porter (2008), On Competition The four broad attributes that shape the competitive environment and that help or hinder the creation of competitive advantage are placed at the four points of the diamond. These are:   Factor conditions – the types, availability and quality of the factors of production Demand conditions – the demand patterns in the domestic market for the company‟s product or service

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 

Related and supporting industries – the existence or otherwise of internationally competitive companies that provide components, systems and other services Company strategy, structure and rivalry – this point includes much of Porter‟s original work on the competitive forces facing companies in an industry: – – How are companies created, organised and managed? What are the competitive pressures in the country for this industry?

A significant factor appears to be the development of sufficient expertise and support to enable the industry to grow. However, the growth must be accompanied by the strong shaping force of competition. In this way the industry becomes internationally competitive and will be able to export goods and services to other countries.

Activity 3
Consider the following case study about the Italian fashion industry and then answer the question that follows. Case Study 1: The Italian Fashion Industry The Italian fashion industry is one of the largest in the world, with revenues of 48 billion euro, 70,000 companies and 700,000 people employed. This makes Italy the most active in the world and, in terms of quantity, second only to China and holding leadership in the prêt-à-porter market. However, Italy is not favoured by significant resources of raw materials or the cost of its labour force. 50 years ago, Italy had virtually no fashion industry and no Italian designer enjoyed an international reputation. The country‟s wealthy commissioned their exclusive hand made clothes from tiny specialist tailors in Rome, and most Italians found their dressmaking requirements met by small, local, businesses. Gentlemen ordered suits from traditional bespoke tailors, while their wives and daughters patronised whichever local dressmaker exhibited the greatest skill in replicating the latest fashions from Paris. Italian women with less income had to search the markets for fabric and sew their own clothes at home. The war years changed everything and provided opportunities. There were three significant developments at this time. After the Second World War, an investment plan, the Marshall Plan, was implemented to rebuild Europe and to create a stronger economic foundation. New factories were built in Italy which employed skilled craftspeople who came from the small hill towns of the north and the vanishing villages of the south and who needed to find work. The combination of the very latest machinery with an exceptionally skilled workforce created an unparalleled garment manufacturing capability. The designers no longer followed the French lead by copying their style, but created a fashion identity that seemed distinctively Italian. This benefited greatly from the huge trend to acquire everything Italian, from espresso coffee to leathergoods, which was particularly noticeable in America throughout the post-war years. Unlike the French sophistication, the Italian clothes emphasised wearable elegance, which was particularly appreciated by the Americans. Actresses such as Audrey Hepburn favoured the glamorous evening dresses and the stylish but simple daywear.

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At the same time the emerging Italian fashion industry quickly developed a natural marketing flair, together with something what would now be called brand focus. Talented new designers certainly showed impressive commercial expertise in addressing an important emerging fashion consumer who was, as yet, poorly served by more established fashion centres – the post-war working woman. They also developed an unrivalled ability to produce high quality apparel in luxurious fabrics which led British, French and American designers to entrust the production of their garments to Italy, even though nowadays there are very much cheaper labour markets. 700,000 Italian professionals represent the basic pieces for a process which still needs quality, specialisation and ability to deliver. Italians have a reputation for many other fashion items, one of these is leather goods including shoes. „A recent study by the Italian bank Banca Nazionale di Lavoro (BNL) said that the Italian shoe industry "… is the largest in the world and accounts for 14.5 percent of footwear production globally". Despite the number of large global companies that that can produce shoes cheaply, the Italian companies are surviving even after a decline in the 1990s – for three years, production fell significantly, dropping by more than 10 percent in 1999, but since 2001 the country's footwear industry has been on a rebound. However, the downturn caused some smaller businesses to close while others were forced to join bigger groups to survive. It also stimulated the Italian industry to reflect on how new technology and design techniques could improve their business performance. "A significant part of the recovery in the Italian industry can be seen in the move to increase the quality of the shoes. The companies reacted to the downturn by investing in research and design so that innovation in models and colours was a feature of last year's production," said Pulisia Di Falco, one of the two authors of the BNL study. Italian shoemakers believe that the Italian „artisan‟ approach can be adapted to more modern production techniques without losing any of its tradition or style.

Question Identify the four attributes that explain the Italian Fashion Industry‟s national advantage according to Michael Porter. See the suggested answer at the end of this chapter.

International Product Life Cycle
The standard product life-cycle (PLC) concept was applied in the 1960s to international markets by Raymond Vernon. The basic idea was a „trickle down‟ from advanced countries to the less advanced countries. It assumes that advanced countries will innovate products and services. Over time, these new products will mature in their domestic markets and will, then, be introduced into the developing and the less-developed countries. Thus, products would be developed in, say, the USA, but the PLC for that product would overlap with the export of the product to less developed markets.

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Figure 6.2: The shower approach Co-ordinated Launch Programme

Advanced Country (e.g. US)

Developing Countries

Less Developed Countries

The concept of the international PLC needs further modification to take account of changes that have occurred in 21st century and the full global trading environment that now exists. In particular, note that:     The original concept of the product life cycle, as discussed in Chapter 3, will operate for each product in each country market: New products and services are being developed in many different countries, not just advanced countries. There are significant differences in preferences and tastes even within the current trading environment. Environmental and social factors have a major impact on what is produced and how.

As result of many changes, it has become possible for the first time for tens of thousands of companies to offer manufactured products to customers across the whole six continents. For many of these "global products", there are potentially more than a billion customers. There is an enormous opportunity for increased sales and profits, but the new environment is not easy to manage and the risks are high. Among the challenges companies have to resolve are:       Meeting the various requirements of customers from a range of countries Choosing the most suitable locations for the different stages of development and manufacturing Deciding what can be global and what must be local Implementing suitable processes and systems Accommodating different national regulations Efficiently dividing the workload between diverse sites.

Product Lifecycle Management is now used worldwide to manage the innovation, development and support of global products. This key new business activity manages a product anywhere in the world, at any time in its life and from the first idea through to recycling and disposal. An example of this is Coca-Cola. Its original beverage produces enormous profits that provide the finance needed for research and development of new beverages that will satisfy the varying tastes and changing preferences of global buyers. The original Coca-Cola product‟s life itself has been extended continuously by, for example, adding different flavours, reducing sugar and producing no calorie versions. Some of these flavoured Coca-Cola drinks are only sold in specified locations where they can still make revenue for the company.

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Activity 4
Finally in this chapter, we present a further case study for you to consider. Case Study 2: Petrobras Petrobras has operations all around the world, with recent ventures in Portugal and Turkey, where it seeks to get involved in the energy battle around the Black Sea. It generates and distributes electricity and side products from oil production such as synthetic rubber. In 2008, a big oil field was discovered in the deep waters off the Brazilian coast. The oil is located 7000m under the sea. That makes the extraction very difficult and poses many risks to the fragile ecologic system at that depth. But the third largest oil field of course means a lot of money and power. In the reformation of the economic world order this is an important asset for Brazil to have. Petrobras raised $10 billion from China‟s government earlier this year, in return for promising Sinopec, a Chinese state oil firm, a guaranteed supply of up to 200,000 barrels of oil a day for ten years. Mr Gabrielli, the CEO, wants more such deals. Apart from the sub-salt fields, Petrobras is exploring 270 blocks in the Gulf of Mexico and over 200 more onshore in Brazil, and may approach China to fund this, too. Despite the adverse working conditions, there have been several big deepwater discoveries in recent years. Until the mid-1990s there was a general view that successful offshore oil-drilling operations were limited to a water depth of around 600m, but advances in computing at the exploration stage have become important when it comes to tapping deepwater oil. In this most physically demanding of industries, software, as much as hardware, is changing the game. Striking an oil reservoir with a drill pipe is like hitting a coin at the base of the building with a strand of human hair. The penalties for getting it wrong are enormous. An industry rule of thumb puts the cost of drilling a deepwater “dry hole”, i.e. a well that does not strike oil, at around $100m. BP says it can be as high as $200m. BP‟s recent fortunes in the Gulf of Mexico have reinforced the financial, social and political risks of deep sea drilling as well the impending raft of new regulations that are likely to occur as a result of the disaster. With the stakes so high and the margin for error so small, the knowledge takes the form of precise data on the composition and structure of the geological formations beneath the seabed, which provide insight into the areas likely to hold oil deposits. The mechanics of new acquisition techniques are simple compared with the challenge of making sense of the resulting vast amount of data produced. The amount of computing power used for such calculations is staggering. BP‟s computer centre in the Gulf of Mexico operates 270 trillion calculations per second, nearly 3,000 times faster than a decade ago. Petrobras declares that its advanced technological know-how for deepwater ultra-deep exploration is one of its competitive strengths. In developing its offshore operations over the past 36 years, Petrobras has acquired recognised know-how in drilling techniques and technology for developing deepwater production. The company‟s know-how in drilling, exploration, development and production in deep waters has been instrumental in achieving high rates of success and production and a reduction in lifting costs. Reduced costs have also been achieved due to operations being executed on a large scale and to the integrated

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nature of its operating segments – for example, the location of the larger part of the company‟s refineries in the Southeast region close both to the Campos Basin (which has significant proven reserves) and of the most densely industrialised and populated markets in the country, and the relative equilibrium between its current production, refining efficiency and the Brazilian market‟s total demand for hydrocarbon products. The company believes that these cost efficiencies arising from its integrated nature, existing infrastructure and equilibrium allow it to compete effectively with other sector companies and imported products. Another Petrobras activity is the extraction of ethanol from crops such as soy, corn, wheat sugar cane. The latter is the most popular as it is the cheapest to produce.

Questions (a) (b) (c) (d) (e) To what extent could Petrobras be considered a global company? Describe the options that Petrobras has used to grow its operations? Please give examples. Explain how technology has influenced Petrobras‟ operations. How does this case illustrate the economic strength of the BRIC countries? What competences does Petrobras have to give it competitive advantage over other oil companies?

See the suggested answer at the end of this chapter.

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SUMMARY
A global company has operations located in all areas of the world, its people move across borders regularly and it finances its new and existing operations by transferring money from one location to another. The growth in companies with a global presence has been driven by factors such as:       Development in technology making communication fast and effective The access to physical and human resources at lower cost Global capital markets making finance available for expansion throughout the world The lowering to trade barriers and access to free trading globally The sales and marketing opportunities using e-commerce The opportunities to increase shareholder value.

Free trade has also improved the economic growth of countries throughout the world, and also developed the skills of their workforce. Trade blocs between groups of countries have allowed them to share resources and knowhow, providing access to economies of scale and preferential trading agreements. However free trade and globalisation also bring negative aspects to countries such as: the death of infant industries, the danger of monopolies being created by powerful companies who enter the country and undesirable changes in the local culture. The changes in international trade and the dominance of certain countries have been studied extensively. Michael Porter‟s theory of national advantage is one such attempt to explain why some nations have specialisations that make them dominate world markets.

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ANSWERS TO ACTIVITIES
Activity 1 (a) (b) The terms of trade are 150%. (The average price of imports/average price of exports). The terms of trade have improved; fewer exports have to be sold to purchase any given quantity of imports.

Activity 2 (a) Two other trading blocs that include emerging economies are:  OPEC – Organization of Petroleum Exporting Countries. This was made by the petroleum producing countries in the year 1960. The member countries of this group are Algeria, Ecuador, Gabon, Indonesia, Iran, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela. SAARC – South Asian Association For Regional Cooperation. Countries such as India, Bangladesh, Pakistan, Nepal, Bhutan, Maldives and Sri Lanka have formed SAARC with an objective of making better trade in the region.

(b)

Developed countries may be viewed as wishing to exploit the resources and local knowledge with little concern for the poorer nations' business culture and national values.

Activity 3 (i) Factors of production Land, labour and capital were acquired after the second world war: Capital was given by the Marshall Plan, factories were built of land devastated by the war and highly skilled labour was available locally from small hill towns. (ii) Related Supporting Industries There was an existing shoe making industry. Fabrics were obviously easily available (not stated) as there was a thriving tailoring and home made clothes industry. Design flair could also come into this category as talented new designers are mentioned. (iii) Demand conditions These were already in place before the factories came into existence, with individual tailors for men and women making clothes in the latest fashion at home. Since the products made by the factories were stylish and distinctive this appealed to the new consumer. (iv) Company Strategy, Structure and Rivalry The case states that marketing strategy and design flair were two of the strategic thrusts of the fashion companies. There was a wearable elegance about the clothes and designers had the commercial expertise in addressing the emerging fashion consumer. Innovation and entrepreneurship were key factors. The ability to change strategy is shown by the comment on the rebirth of the Italian shoe industry. The companies appear to have been well structured and organised with new factories and skilled labour with commercial competences, plus capital and a welcoming market sector. The competitive pressures at the time internally were low, but people were buying French and American garments which were more costly and did not fully complement the Italian stylish but less formal culture.

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Activity 4 (a) Petrobras has trade in several other countries – Portugal and Turkey are mentioned here – and is also trading in oil with China. It appears that expansion by organic growth is taking place in the Gulf of Mexico where Petrobras is carrying out oil exploration activities. There is no evidence in this of people movement. Hence we do not have enough evidence for a definite statement on its status as a global company, but with the limited information available it does appear to be global. Petrobras has operations in two other countries, according to the case. However, we cannot determine the growth option used for those operations from the evidence given. Petrobras has a trading agreement with China which has provided the finance for Petrobras to explore for oil and for China to be supplied with the product. It is made clear in the case that the advanced technology has enabled Petrobras to consider drilling in areas that would otherwise have been impossible – that is, under the sea bed. It has „precise data on the form and composition of the structure below the sea bed‟. The description acknowledges that without advanced computing power it would be impossible to make any sense of all the data it has collected. It has also developed technology for deep underwater exploration. The case shows the close relationship between Brazil and China and, although there is no formal trade bloc, huge trading agreements are being made. China is acquiring very critical, scarce resources by providing Petrobras with the finance to acquire them. Petrobras has competence in deep sea drilling for oil. It has the acquired the technical know-how in the operations necessary to accomplish the task of extracting oil from sea. It is innovative and extremely competent in the use of technology to problem solve. It has also developed a tight value chain with low costs and high integration. In addition, it appears to have exceptional competencies in energy production from a variety of sources including extracting ethanol from crops.

(b)

(c)

(d)

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Chapter 8 Going Global
Contents
Introduction

Page
190

A.

Growth Options in a Global Perspective Joint Venture Merger with or Acquisition of Companies Organic Development Franchising and Licensing

190 190 191 191 192

B.

The Global Financial Environment Currency Exchange Rates and Exchange Rate Systems Financing Growth Options

193 193 194 197

E.

Globalisation and Culture What is Culture? Our Collective Programming Cultural Aspects of Globalisation Impact of Globalisation on Local Culture

198 198 199 202 205

F.

Limitations to Globalisation Global Transportation Infrastructure Demographics Natural Resources Technological Development The Anti-Global Lobby

205 205 205 206 206 206

Summary

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Answers to Activities

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INTRODUCTION
This chapter builds on the previous one and looks at the methods companies use to actually make global trade happen. We examine more closely the advantages and disadvantages of the options to achieve that growth, a topic that we looked at first in Chapter 3. We also revisit and expand the financial perspective of trading globally including the impact exchange rates have on the business. As companies expand into other nations, the subject of culture becomes an important factor to the success of the venture. If the organisation is unable to integrate its business practices and values with that of the new nation, then the firm is likely to make a loss or even fail to survive. Finally we will look at the potential limitations of globalisation and the opposition to the whole globalisation concept.

A. GROWTH OPTIONS IN A GLOBAL PERSPECTIVE
In Chapter 3 we looked at expansion options in outline. In this section, we will examine the opportunities and challenges that each option offers. Firms that wish to expand their operations into other countries and continents, by having a physical rather than a virtual presence, have four main options:     Joint Venture Merger and Acquisition Organic Growth Franchising and Licensing.

For very large companies, all of these options may well be used and the appropriate option will be chosen according to trading conditions in the particular location.

Joint Venture
A joint venture is defined as an entity formed between two or more parties to undertake economic activity together. The parties agree to create a new entity by both contributing equity, and they share in the revenues, expenses, and control of the enterprise. The venture can be for one specific project only, or may be a continuing business relationship. The advantages of joint ventures are seen as:   Investment risk shared by all partners Complementary resources and know how are combined.

Such arrangements may also be a necessary governmental condition for market entry into a particular country, as was the case with India in the past. The difficulties with joint ventures are perceived to be:     Identifying an appropriate partner and/or agreeing appropriate contractual terms Managing the relationship with the foreign partner Loss of competitive advantage through imitation that the other party might implement later Limits to the ability to integrate and co-ordinate activities across national boundaries.

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Merger with or Acquisition of Companies
First, we should distinguish between the two:  A merger is said to occur when the firms are of‟ comparable size and form a single new company. The shares of both companies are replaced by shares in the new company. When one company is actually purchased by another, this is very often called a merger, if the Chief Executive Officers agree it is in the best interest of both companies to state this. Acquisitions tend to take place when a stronger company with a larger market share buys another. The target company often knows it cannot survive. After acquisitions, only the buyer‟s shares continue to trade. A hostile merger is also regarded as an acquisition.

The rationale for mergers/acquisitions is shareholder driven – in other words, to improve shareholder return. The advantages of mergers/acquisitions are seen as being:     The new entity has full control of all resources and capabilities and potential for economies of scale Facilitation of integration and co-ordination of activities across national boundaries Rapid market entry Making first new investments allow development of „state of the art‟ facilities and can attract financial support from the host government. Substantial investment in and commitment to the host country can lead to economic and financial exposure Acquisition may result in problems of integration and co-ordination Substantial potential for cultural clash Entry time consuming and less predictable in cost especially if a first investment in new location.

Mergers/acquisitions are seen as being problematic since:    

Organic Development
This is internal development where strategies are developed by building on and developing the organisation‟s own capabilities –for example, a company may open a manufacturing plant in a new location, funding the whole venture itself. This strategy is usually suitable for a situation     Where partners or acquisitions are not suitable or available Where the company wishes to build on its own existing capabilities, particularly in respect of learning and competence development Where there are existing cultural influences within the company Where there is political support.

Organic growth can be problematic if there is likely to be political unease. Note that, foreign direct investment (FDI), whether through acquisition of a company in a new location or by organic growth, is likely to involve making „greenfield‟ investments by developing the facilities from base level.

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Franchising and Licensing
First, we should distinguish between the two:  A franchise is a right granted to an individual or group to market a company's goods or services within a certain territory or location. McDonald's, Subway and Domino's Pizza are well known examples. There are many different types of franchises including automotive, cleaning and maintenance, health and fitness, and financial services. Licensing can be defined as a written contract under which the owner of a copyright, know-how, patent, service mark, trademark or other intellectual property, allows a licensee to use, make, or sell copies of the original. Such agreements usually limit the scope or field of the licensee and specify whether the license is exclusive or non-exclusive, and whether the licensee will pay royalties or some other consideration in exchange. Licensing agreements are also used by franchisers to promote sales of goods and services. Licensing can be useful as a global growth option particularly to companies who do not see investment through acquisition or organic growth in a new country as justifiable – the actual investment is much reduced, as is financial and political risk. However, a problem with licensing can be lack of control over the way in which products are made or used elsewhere, or the cost involved in imposing that control.

Activity 1
Consider the following short summary of Coca Cola's strategy and then answer the questions that follow. Case Study 1: The Coca Cola Company Many of Coca Cola‟s bottling partners operate under licensing agreements which assures global coverage for the Company. Coca Cola also has some joint ventures with bottlers but rarely owns them bottlers outright In 2010 it acquired its North American bottling partners as a direct result of the same action by its main competitor Pepsico. This was a change of policy. In doing so, Coca Cola hoped to integrate capabilities and reduce costs as well as improving its value chain.

Questions (a) (b) Why do you think Coca Cola uses different growth strategies with its bottlers? Go to the Coca Cola website and find examples of the growth options that the company has used to expand.

See the suggested answers at the end of this chapter.

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B. THE GLOBAL FINANCIAL ENVIRONMENT
When one country sells goods to another it wishes to be paid in a form of money (currency), which it can readily use to purchase its own goods elsewhere, or which it can change into its own currency to pay its own workers and suppliers at home. You might think that it would all be a lot simpler if every country in the world used exactly the same currency, which would then be universal and which would not be identified with any one nation. The problem with any form of international currency is that there must also be some system of international control which all countries will accept. This immediately introduces political implications, which so far have proved impossible to reconcile. Consequently, the great mass of world trade has to be conducted in the normal national currencies of the world. Some of these are more acceptable than others, chiefly because some countries have stronger economies than others and some governments have firmer control over their national economic and financial systems than others.

Currency
Three classes of currency across the world are considered below: (a) The United States Dollar The US dollar is the most widely acceptable currency and it is used throughout the world. Many of the world's commodities and services are valued in dollars, most particularly oil. Dollars are also widely used in the internal trade of many countries whose own currencies are very weak because of severe domestic inflation. (b) Other Major Trading Currencies The currencies of many of the other leading trading nations of the world have a wide acceptability, though not as universal and general as the US dollar. When the dollar itself is under pressure and losing some of its exchange value, one or more of these currencies become a refuge for international finance. Among the main trading and reserve currencies in this group are the Euro, the Japanese Yen, the British Pound and the Swiss Franc. (c) Currencies with Limited Acceptability Some currencies may be acceptable within a particular region. There are also many currencies, especially those of African countries and those of North Korea and Myanmar/Burma, that have almost no circulation or acceptability outside their national boundaries (and often are not popular within the country either). Sometimes national governments discourage international exchange, involving its currency, as a means of keeping greater control and preventing the export of wealth. In other cases, the currency is too weak to support any external trade, or the official value in exchange for other currencies maintained by the national government is so unrealistic that no one who can possibly avoid it is willing to exchange foreign money at that rate. People generally feel happier to stay with a currency they know and understand. Trade may often be conducted by barter arrangements with some countries with weak currencies. For these agreements, some form of acceptable valuation is necessary. Again the basis of this tends to be the United States dollar, either directly or indirectly (for example, through oil).

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Exchange Rates and Exchange Rate Systems
Since various national currencies are used for global trade we must now examine a little more closely what is involved when one currency is exchanged for another. The exchange rate is the rate at which the national currency can be exchanged for the currencies of other countries. Therefore, there is not one rate but many, relating to all the different currencies in the world. The principal rate which is of interest to most countries is the one relating to the main currency in global trade, the US Dollar. For this reason, we will concentrate on the relationship between the US Dollar and the British Pound (GBP) or Sterling to illustrate the operation of exchange rates. If the exchange rate is $1.50 = £1, then £1 can be exchanged for $1.50 (ignoring dealing and other costs of exchange). Thus: £100 = $150. However, if the rate changes to $1.10, then £100 becomes worth only $110. Effect of Exchange Rate Changes Suppose there is a fall in the value of the pound in terms of US Dollars, so that in the space of a few months, the rate falls from $1.30 to $1.10. There is then an immediate effect on the prices at which traders are prepared to trade in international markets. Take the example of a manufacturer that is prepared to sell a motor vehicle, provided it receives £5,000:   At the rate of $1.30 (again ignoring transactions costs), the manufacturer could sell the car in the USA for $6,500 (£5,000  1.30). If the pound falls in value and is worth only $1.10, the manufacturer will accept $5,500 (£5,000  1.10) if it still wishes to receive £5,000 for the car.

This simple calculation shows us that a fall in the currency value makes exports cheaper in foreign prices. Cheaper goods are likely to be easier to sell and provided the increase in sales is proportionately more than the change in dollar price, exporters can hope to receive more revenue for their exports. Therefore, devaluation (lowering the value of a currency) may be used to help in correcting a balance of payments deficit. There will be more exports and they are cheaper for overseas consumers to purchase, but imports to the home country become more expensive – for example, suppose the vehicle manufacturer buys steel from another country and pays for it in US dollars: each $1,000 worth of steel, which used to cost £769.23 ($1,000/1.30), now costs £909.09 ($1,000/1.10). Most manufactured goods contain materials imported from other countries, so manufacturing costs inevitably rise following a fall in the exchange rate transactions, even if actual payments are made in a national currency. There will also be other effects on business:    A high proportion of British food and many consumer goods come from overseas and so they rise in price. Living costs are pushed up and workers seek wage increases to try to maintain their living standards. If they succeed, then labour costs rise alongside manufacturing costs, meaning that prices are also likely to rise, making the goods harder to sell abroad.

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Activity 2
Imagine you came to the UK last year for your holiday and you saw an iPad that you wanted to buy. Last year when £1 was equivalent to 1 Euro, you would have had to pay £600 for the iPad. This year the rate of exchange is £1 is equivalent to 1.20 euro Will you pay more euros or less for the iPad than last year? How many euros will you need? See the suggested answers at the end of this chapter.

The Formation of Exchange Rates The exchange rate represents the price of the national currency, and like any other price it is formed ultimately by the forces of supply and demand. Supply and demand result from the trade flows of imports and exports. To pay for imports priced in US Dollars, the United Kingdom has to earn dollars by selling British goods and services to other countries. The more Britain can export, then the more dollars the country earns. However, British firms want to receive their payments in pounds. To obtain pounds to pay for British goods and services, foreign firms have to sell their own currencies in the markets for foreign exchange and buy pounds. So the greater the demand for British products in world markets, the higher is the demand for pounds in the currency exchanges. Conversely, the higher the demand in Britain for foreign products, the more pounds have to be sold to obtain the foreign currencies needed to pay for them. It is evident, therefore, that one immediate cause of a change in currency exchange rates is the way the balance of payments is changing.  If the balance is in surplus, then revenue from exports is greater than that paid for imports and the supply of foreign pounds is high. So the pound is likely to rise in exchange value. A balance of payments deficit has exactly the reverse result; the exchange rate will decrease.

The weaker the balance of payments, the weaker the pound is likely to be. The views of traders and bankers about future movements in trade flows and currency exchange rates will also have an effect. For instance, traders often have to hold large sums of money for a few days or weeks, in anticipation of having to make large payments. They cannot afford to have money lying idle, so they lend it out in return for interest. They do not want to see the interest earned being lost through a fall in the exchange value of their money. This means that any suspicions that the pound is likely to fall will persuade the traders that their money is more safely kept in some other currency. This reduces the demand for pounds and increases the demand for foreign currencies. This type of behaviour also adds to the pressure resulting from a weak balance of payments. Exchange Rate Structures There are basically two types of exchange rate system – fixed and floating exchange rates. There may be variants on these, but the basic principles remain the same.

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(a)

Fixed Exchange Rates It is very rare to have an exchange rate structure that is rigidly fixed against some standard. Some movement within a band either side of a central rate is normal. Usually a number of countries agree to work to this kind of system. The more confident governments are that they can maintain the agreed rates, the narrower the band within which floating is permitted. A movement towards either the floor or the ceiling of the band requires action to correct the rate. The usual short-term action is to change interest rates to attract, or to discourage, capital movements. If the government is unable or unwilling to take action to restore the agreed exchange rate, or if its action is unsuccessful, then the rate will have to be changed. If member countries cannot agree on a satisfactory change the whole structure becomes unstable. The problem with any fixed exchange rate structure is reconciling the desired level of stability with sufficient flexibility to allow changes to take place as economic conditions change.

(b)

Floating Exchange Rates When the price of the currency in terms of every other currency is set by demand and supply in the market, the country is said to have a freely floating exchange rate. Under these conditions, there are no exchange controls and the government does not intervene in the market. If the demand increases and the supply remains the same, the exchange rate rises (appreciates); should the supply increase faster than demand, the rate falls (depreciates).  Demand If Britain's exports increase there will be more demand from importers to exchange their currencies into sterling. The pound will also be in demand if people want to invest more in the UK, either in deposits and shares or in physical assets.  Supply More sterling will be supplied if importers in Britain are buying more from overseas and require more foreign currency. UK investment abroad increases the supply of pounds. Just as in any other market, an increase in demand for pounds, with supply unchanged, will cause the price of sterling to rise or appreciate – more dollars have to be paid for each pound. Conversely an increase in supply, with demand remaining the same, would cause the currency to depreciate.

Government Intervention A government may intervene in the market to buy or sell its currency because it wants to hold down a rise in the rate, which would affect international competitiveness, or to support a rate which is falling, to keep foreign investments. One example of this is, in 2010, China was accused by the United States of artificially holding down its exchange rate so that it can export more. There have been attempts by the major industrial countries to influence the exchange rate of the US Dollar. Many commodities and raw materials, especially oil, are priced worldwide in

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dollars, so a rise in the value of the dollar for speculative reasons unconnected to trade could cause inflation. Even when all the major central banks act together, they cannot have a significant effect on the foreign exchange market. The sheer size of the market's daily dealings makes the reserves of the industrialised countries look small. Effect of Exchange Rates and other Financial Measures on Global Trade Fluctuation in exchange rates are a major issue in terms of costs and profit for companies that trade or invest internationally. For example, the exchange rate could move adversely or a country may impose exchange rate controls. In addition, there is the risk that countries may raise business taxes or interest rates to impose tighter financial controls. The risk associated with such changes in another country is known as "sovereign risk", and it can affect the financial position of companies quite dramatically. For example the 2009 Coca Cola Annual Report states “Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The Venezuelan government announced a currency devaluation and Venezuela was determined to be a hyperinflationary economy. Based on the carrying value of our assets and liabilities denominated in Venezuelan Bolivar as of December 31, 2009, we anticipate recognizing an initial remeasurement loss of approximately $100 million in the first quarter of 2010”.

Financing Growth Options
Firms have a variety of options for financing growth. The option they choose will depend to a certain extent on their size and present legal status. Taking the example of a private limited company that wishes to expand globally, there would be a number of choices: (a) Financing from their own funds This option allows the directors to have complete control, but means more risk for each of them should the venture prove not to be successful. They may have to take on personal liabilities to raise the capital. (b) Raise expansion capital by offering new shares in the private limited company This would allow the directors some choice in recruiting investor(s) who could add value to the business in terms of the skills they bring (or alternatively an investor who does not wish to play an active management role) without the existing ones losing major control. Finding the right investor may take too long or be difficult depending on the economic climate, etc. (c) Floating on stock market to raise capital This would enable the directors to raise capital without taking on personal risk if there is business failure – that is, the directors would not personally bankrupt or prevented from starting up another limited company. Also being a plc usually results in suppliers and customers having greater confidence as they are able to make credit checks and so on. The structure of the business would change and the present directors would become employees of the company and must pay Income tax and NI on their earnings, as they draw a salary and dividends after tax. In addition, all company assets would belong to

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the company and could be used only for company business. There will also be stricter accounting rules, with accounting costs becoming far higher. (d) Long term loans This option allows the management to remain in control while not stretching the finances of directors in the short term. A long term loan (up to 25 years) would be advisable for any major factory expansion and capital equipment, with shorter term loans (of 3-5 years) for items such new office furniture, computer equipment, vehicles, etc. This would allow the cost to be spread with interest rates controlled. The lending organisation is likely to ask for collateral as security against the loan. If the company defaults on payment the owners would lose the business. Large multinationals are likely to raise the finance needed using a combination of different options. Obtaining the most appropriate mix will be of great importance.    Short and long term loans Issuing debentures (debt) Using retained earnings.

Using retained earnings is a very positive option as it does not dilute the value of the shares belonging to existing shareholders or reduce their control. However, the amount will be limited by the company‟s previous profits and the firm may wish to invest more capital to make faster profits. Shareholders will expect the return on these funds to be equal at least to interest the firm could have made on the money in other investments since retained profits represent the deferred dividends of owners (shareholders). Selecting the currency in which to borrow is an important factor. Usually this will be the same as the currency in which the investment is to be made – risk is minimised by the liability being in the same currency as the income received from the project. Deciding whether to take a fixed or floating interest rate for the loan is another key decision. Under a floating interest rate, repayments are subject to increases in the interest rate which affects the repayments, but a fixed rate would eliminate that concern.

E. GLOBALISATION AND CULTURE
When companies go global they have to take into account the different norms and values of people from other nations. Unless this happens, the investment made is likely to yield slower returns. This could be through a lack of understanding of different tastes and preferences of consumers, lack of ability to integrate the company‟s working practices with an acquired company or to induct employees of greenfield businesses fully into what the firm requires.

What is Culture?
There are many aspects to culture – some are very explicit but others are more deep-rooted and difficult to identify. We now tend to think of culture as having two distinct meanings:   The achievements of civilised society, particularly in terms of the arts The way people think, feel and act within society or large social groups.

The second meaning is particularly important to organisations, both internally (as in "organisational culture") and how they relate to the external social environment within which they are located. This is obviously relevant to working in a global context

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Schein (1985) defined organisational culture as "a pattern of basic assumptions – invented, discovered, or developed by a given group as it learns to cope with its problems of external adaptation and internal integration – that has worked well enough to be considered valid and, therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to those problems". Geert defined culture in general as "the collective programming of the mind distinguishing the members of one group or category of people from another". The "category" can refer to nations, regions within or across nations, ethnicities, religions, occupations, organisations, or gender. According to Hostede a simpler definition is 'the unwritten rules of the social game'.

Our Collective Programming
The „collective programming‟ we have all acquired is a result of our socialisation through childhood and puberty. In that period we are heavily influenced by our families and friends and have an extremely high capacity to absorb information and to conform to the norms of our social environment. The physical environment in which we find ourselves also has an impact – rich or poor, safe or threatening, level of technology, degree of communication, etc. Culture at this level revolves around basic issues that have to do with group membership, authority, gender roles, morality, anxiety, emotions and drives. Culture affects our personal lives, our social lives and our professional lives at work. Culture is what enables a group to function smoothly, and this is highly important to organisations. We can see a number of different types of culture – or perhaps more correctly, different cultures – in each society, and organisations need to be aware of all these and their impact on the way in which they operate and the types of goods and services they produce.  National Culture There are approximately 200 nations globally. Some nations are culturally identical (monocultural), but others, especially large ones such as Brazil, China and India and Indonesia, are made up of culturally very different regions. Research has shown that national cultures usually differ significantly at the level unconscious, broad preferences for one state of affairs over others – that is, the values held by a majority of the population. These values are acquired in childhood and are deep-rooted, unconscious ones. This makes national culture extremely stable over time – it only changes slowly, over generations. The external signs of changes of culture such as symbols, heroes and rituals, do not make any impact on changing the underlying values. Thus, the differences between countries remain virtually the same over many centuries.  Organisational culture During our working lives we spend a lot of time working in organisations. We become accustomed to the particular norms and values of the organisation in which we work. Research shows that organisational cultures differ mostly at the level of practices – „the way things are done around here‟. These are more superficial and more easily learned and unlearned than the values that form the core of national cultures. When we change organisations we can adapt relatively easily to the practices of the new organisation.

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Since organisational cultures are rooted in practices, they are more susceptible to change; national cultures are deep rooted in values and hence present a more substantial challenge when it comes to change. The culture of an organisation also reflects aspects of its development and its external environment – for example: (a) The values and beliefs of the founder may still pervade the organisation's mission – for example, Anita Roddick's (Body Shop) commitment to the use of natural ingredients. The company's stage of development and, particularly for long established organisations, its administrative heritage – for example, Ford has a history of vertical integration and centralised control, whereas General Motors' heritage is of mergers and diversification The nature of the product or industry – for example, we can see a number of different features between the banking and technology industries as follows. Cultural feature Behaviours Banking Formal interactions Smart dress code Hierarchical Procedural reliability Financial expertise Conformity (to external regulation) Technology Informal interactions Casual dress Flat structures Innovation Intellectual capacity Flexibility

(b)

(c)

Management Values

Occupational culture When you enter a particular profession such as a doctor, engineer, teacher or accountant you undergo a period of mental programming. Occupational cultures have symbols, heroes and rituals in common with organisational cultures, but they also often imply holding certain values and convictions – as an engineer for example, you would learn to work with precision, to be especially careful about certain aspects of safety, dress in an accepted way and learn the specific technical language that enables you to communicate with other engineers. Occupational cultures in this respect take a position in between national and organisational cultures – for example, the culture of management as an occupation contains both national and organisational elements. Professional cultures also take into account: – – – – Level of education, including a distinction between generalists and specialists Degree of training Selection into an "elite" group, which may include having attended the „right‟ schools or training institutions Socialisation into the values and proper behaviours of the group.

In different nations, particular professions or training will be ranked as being most valuable, for example:

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Professions Most Rated by Nation Nation USA Britain Germany The Netherlands France  Profession/Training MBAs Accountants Engineers Sales Marketing

Gender culture Gender differences are not usually described in terms of cultures, but in each society there is usually a male culture that differs from a women's culture. Women and men are often technically able to perform the same jobs, but they do not respond to the same symbols, do not look up to the same heroes, and do not share the same rituals. The degree of gender differentiation in a country is also highly dependent on its national culture.

We can then imagine culture as resembling an onion. Figure 8.1: Rousseau’s Layers of Culture

Artefacts

Patterns of behaviour

Behavioural norms Values

Fundamental beliefs

The inner rings are the deepest feelings of culture – fundamental beliefs, values and behavioural norms. These relate to national culture. The outer rings are the more visible signs of culture – patterns of behaviour and artefacts. These relate to organisational and professional culture.

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Cultural Aspects of Globalisation
The aspects of culture mentioned above demonstrate the challenging task for companies who globalise, whether their growth is by joint venture, merger or acquisition, organic growth or licensing. We noted at the beginning of the last chapter, that global companies involve the movement of people across borders, and this necessarily means developing strategies to ensure that differences in national, organisational and occupational cultures do not stand in the way of maximising business performance. We can see the problems in terms of organisational culture through the example of Kraft's acquisition of Cadbury in 2010. When companies acquire other companies they often quote huge cost advantages, and Kraft stated that: „it could register pre-tax cost savings of around $675 million annually by the end of 2012.‟ However, within months, key staff were leaving the company because Kraft had failed to integrate the cultures of the two organisations. Kraft‟s culture was bureaucratic as every major decision had to be signed off at corporate headquarters, whereas former Cadbury employees had been „programmed‟ to work in a culture where they had autonomy. One of these managers was quoted as saying that a presentation she once made had to go through 20 drafts and be checked by eight people before it was acceptable: "that wouldn‟t have happened at Cadbury". Integration and Diversity The key, then, is to integrate cultures, but not at the expense of one over the other. Integration must embrace cultural diversity, so that whilst all employees understand and work within the organisation's own values and objectives, their own cultural identity is not denied. The most fundamental action is to have a strategy for integration and diversity. In tune with best practice, it is likely that this will be led by the central HR department in close collaboration with the senior management teams. Approaches to global integration which have been devised in this way include:      Inducting staff in new countries or acquired companies into the practices and processes of the organisation New and original staff working together on joint projects and learning from each other Recruiting staff on a global basis so that global teams are multicultural Conducting training and development in multicultural teams Providing employees with assignments in other countries so that they appreciate and learn from how other cultures work and also transfer new practices to the team in that location Having open feedback sessions, workshops, one to one meetings and internal surveys to gauge the progress of integration Using outside or inside change agents who work solely to assist in making the change happen.

 

The following case study of Coca Cola's approach illustrates this.

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Case Study 2: The Coca Cola Company Coca Cola demonstrate a strategic approach maximising opportunities from diversity and integration:  Coca Cola have role models who have been recognised as adding value to the Company‟s success and have progressed in their careers within the Company – for example, one Executive Vice President was originally based in Nigeria and the CEO is originally from the UK. Each of them had roles in other countries prior to taking on the senior position. This type of action reduces potential conflict between senior managers when making global decisions and projects an inclusive global approach. Coca Cola main offices are designed to be multicultural and multifunctional, providing the environment for cross cultural and cross functional learning. A global environment created in this way promotes cultural differences as a positive force for change through associates experiencing the value of a diversity of people. It helps to reduce conflict on the basis of cultural diversity, „That's why at our headquarters in Atlanta we have over 50 different nationalities represented at our corporate centre alone. It's why we have Latin Americans assigned to top level jobs in Asia.‟  The Company‟s fast track leadership training programme forces potential leaders to embrace change in a positive way, learning how to leverage their ‟cross cultural and cross functional‟ experience to develop the business. “We pick 20 to 30 high-potential managers from all over the world for special stretch assignments that benefit our business. We place them far outside their comfort zones and deep into interesting new roles.” An example is „one team, for instance, was sent to a Southeast Asian nation to develop a 5-year market-entry plan.‟  They have a clearly expressed local and global attitude – investing in each country and its employees, for example, through its partners and associates around the world. It invests in its bottlers (training, marketing, etc) and is able to change their approaches to business while listening to the local issues and making adjustments for them. Involving the workforce in ideas about change reduces conflict when change happens. Coca Cola has had an annual employee survey since 2007 and used this to involve employees as well as to obtain new ideas. This has proved a positive force for change. Use of outside consultants to provide a more objective view on how change can be implemented in a positive manner. As a result of a global strategic realignment, Coca-Cola Brazil was going through a major business model change. The company believed middlemanagement was a key for implementing the changes. The client identified behavioural problems with this group including lack of accountability and initiative as well as resistance to new ways of conducting business. Coca-Cola Brazil used consultants to resolve these issues and to develop and provide training modules to address these needs.

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Management For the global manager there are a range of challenges to overcome in organising and directing operations within an integrated but diverse cultural environment. (a) How to adopt not only the recognised managerial competences of the parent organisation, but demonstrate abilities as a champion of international strategy, crossborder coach, intercultural mediator and change agent. How to adapt to different professional cultures and maximise the opportunities available from diversity:    (c) What are the challenges and opportunities created by integrating different professional cultures? How do you attract and value people with diverse educational, professional and cultural backgrounds? How can a culturally diverse group be best managed and used as a resource to tap into?

(b)

How to use the appropriate key competencies at the organisational level to realise multicultural synergies and provide services which create stakeholder value:    Developing pathways to resources, especially through networking Mediating knowledge from anywhere Developing a learning support structure to facilitate organisational learning. Cultivate an intra- and inter-organisational bonding process Implement multi-task exchange processes Inter-cultural knowledge sharing Network locally and globally Encourage collaborative learning Communicate across linguistic and cultural boundaries Identify and restrict the undesirable effects of noise Embrace cross-cultural networking behaviour for creating productive interpersonal exchanges of ideas and experience.

(d)

How to communicate and integrate personnel and activities effectively:        

Branding Corporate and National Culture Some companies have promoted aspects of their national culture to underpin perceptions of their characteristics, irrespective of location:    LVMH (Louis Vuitton Moët Hennessy) – stressing French refinement and elegance. IKEA – with their low-cost, home-assembly, simple lines reflecting Scandinavian egalitarian and pragmatic values. BMW and Audi – who emphasise the values of German engineering.

On the other hand, other companies respond to the culture of their locations by adapting their corporate characteristics. For example, Disneyland Japan has a distinctive Japanese culture, emphasising Japanese values such as the drive towards perfection, courtesy, efficiency and cleanliness. This is partly a reflection of the way in which Disney licenses its operations into other countries, but also builds on its experience – when it first exported the Disneyland parks to France it suffered huge losses because it did not take into account the

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very different cultural values of the French and just built the American model and expected it to thrive.

Impact of Globalisation on Local Culture
The impact on local culture has been huge – to such an extent that Western products and ideas can be found almost anywhere in the world. Globalisation has resulted in the desire of individuals throughout the world to increase their standard of living and enjoy foreign products and ideas, adopt new technology and practices, and participate in a "world culture". Regional economies, societies and cultures have also become integrated through a global network of political ideals through communication, transportation and trade. There is a downside to this in the increasingly homogenised nature of goods and services, and the domination of Western cultural values and philosophies, resulting in a "swamping" of indigenous cultures and values. In some parts of the world, this has given rise to a sharp sense of real or perceived injustices in the access to, control and use of the world‟s resources.

Think Point
How has global culture impacted on the local culture in your country? To what extent is this positive and what have been the negative effects? Has there been any backlash against the threat to national culture?

F. LIMITATIONS TO GLOBALISATION
The expansion of globalisation in the future is likely to be limited by a number of factors including the following.

Global Transportation Infrastructure
The increasing globalisation of the world‟s economy has helped firms to reduce their costs dramatically, by allowing them to search the world for suppliers who can offer them the best goods at the most competitive prices. At the same time, it has also stretched companies‟ supply chains and with “just in time” manufacturing techniques, has made them much more vulnerable to problems created by any inefficiencies or breakdown in infrastructure around the world. The worldwide cost of developing and maintaining infrastructure to meet growing demand over the next 20 years has estimated at more than US$41 trillion. Apart from increasing trade flows, changing demographics are set to put further pressure on infrastructure. It is estimated that by 2030, 60% of the world‟s population will live in cities, straining existing road and railway networks to and probably beyond their limits. India, for example, is likely to need huge additional sums spent on improving and increasing its infrastructure, as its population density, already one of the world‟s highest, is forecast to grow by a further 22% by 2030.

Demographics
World population in 2015 will be 7.2 billion, up from 6.1 billion in the year 2000 and in most countries, people will live longer.

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Ninety-five percent of the increase will be in developing countries, nearly all in rapidly expanding urban areas. Increasing lifespan will have significantly divergent impacts. In the advanced economies and a growing number of emerging market countries, declining birth-rates and ageing will combine to increase health care and pension costs while reducing the relative size of the working population. This will strain the social contract and leave significant shortfalls in the size and capacity of the work force. There will be an increasing requirement for health care services and immigrant workers. In some developing countries, these same trends will combine to expand the size of the working population and reduce the youth „bulge‟, increasing the potential for economic growth and political stability. Aging will put a huge premium on skilled workers and will shift the “wealth of nations” to countries with younger, educated populations. The global hunt for already scarce talent will become even more of a preoccupation of companies and countries.

Natural Resources
Of all the categories of resource whose depletion is likely to bring an end to globalisation, the most likely to be limiting in the short term is energy. The linkage between energy availability, price and distribution is a major challenge. Water scarcities and allocation will pose significant challenges to governments in the Middle East, Sub-Saharan Africa, South Asia, and northern China. Regional tensions over water will be heightened. There has already been tension between Indian farmers and firms such as Coca Cola over water rights. Three billion individuals who will be living in water-stressed regions from North China to Africa heighten the implications for conflict. In addition to this exhaustion of resources, the growing public awareness of the potential damage to the environment and to the treatment of workers and communities in poorer countries of the world has become a limiting factor.

Technological Development
Technological advances are capable of reducing energy consumption for most applications. However, the process of testing, accepting and incorporating new technologies on a global scale is slow; this is especially true in the developed world, where the mass of existing technology creates inertia to further development that is difficult to overcome. It is also true in the Third World, where cultural barriers to technological change have their own inertia. Technological development is highly dependent on both energy and wealth. For example, nuclear power plants take years before they recover the energy investment of oil required to build them. Therefore, the lack of foresight to continue developing some technologies could result in a slowdown in global expansion.

The Anti-Global Lobby
There is a significant range of pressure groups, with little or no cohesion between them at present, campaigning against globalisation. The reasons for such anti-global movements include   Growing consumerism/materialism and the resulting loss of spiritual values. Individual languages and cultural practices are being abandoned for a global culture based on western tastes.

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The world‟s resources are being consumed by the richest nations and companies. If trade is an important indicator of globalisation, then the global economy is essentially concentrated on a few nations and a small number of elite within these nations. Only 10 countries account for 60% of global merchandise trade, with another 40 countries accounting for a further 30%. The remaining 150 odd nations of the world share just 10% of world trade. The returns are then further concentrated in the hands of a small percentage of the population, in both rich and poor nations. The growing power of multinational companies with turnover greater than the GDP of some countries. Such companies are accused of seeking to maximise profit at the expense of work safety conditions and standards, recruitment and reward standards, environmental conservation principles and the integrity of national legislative authority and independence. The loss of employment from developed countries as low technology, labour intensive productions shift to low wage countries. The opening of free markets may result in unrestricted competition affecting domestic industries which are not mature enough to compete. Environmental impact as ever increasing natural resources are used and human activities damage the environment – for example, the increase of carbon emissions from cars, planes and boats used to transport people and products around the globe.

  

An Oxfam International briefing paper, Harnessing Trade for Development, states that world trade rules have been developed by the rich and powerful on the basis of their narrow commercial interests and that trade rules should be judged on their contribution to poverty reduction, respect for human rights, and environmental sustainability.

Activity 4
Finally in this chapter, we present a summary of the development of the Georgio Armani fashion empire with which we can explore aspects of the development of global operations. Consider the following case study and then answer the questions that follow. Case Study 3: Armani – The Ultimate Fashion Brand Giorgio Armani, 74, is CEO of the Armani Group and sole shareholder of Giorgio Armani SpA (Armani), one of the world's leading fashion and lifestyle design houses, with 5,000 direct employees, 13 factories, and a direct network of 500 exclusive retail stores in 46 countries worldwide. The company is one of the few remaining independent, privately-owned companies in its sector. The company was founded in Milan in 1975 and later that year, the first ready-to-wear collection was presented. 1978 marked an important turning point in the company's history when it established a licensing agreement with GFT (Gruppo Finanziario Tessile – Textile Finance Group). GFT was the world's largest manufacturer of designer clothing – competing at the highest end of the fashion business, its success is rooted in its history, cutting edge technologies and well-organised labourforce. GFT had singlehandedly revolutionised the way artistic clothing was conceived, manufactured, marketed, and distributed. It was alert to social trends and

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needs, keeping it way ahead of its competitors. This licensing agreement resulted in Armani obtaining the opportunity to invest in a new headquarters including showrooms and press offices, and to expand the manufacturing side through GFT‟s expertise. In 1979, overseas expansion began by establishing the Giorgio Armani Corporation in the United States and by the end of the 70s Armani had emerged as one of the leading international fashion houses. In the early 80s the company established an important licence agreement with L'Oreal (formerly Helena Rubinstein) for fragrances and launched the Emporio Armani and Armani Jeans collections. In the second half of the 80s, Armani continued its overseas expansion by opening Giorgio Armani Japan through a joint venture with Japanese Itochu Corporation and the Seibu Department Store, followed by the signing of a licensing agreement for eyewear with Luxottica Group Spa. In 1999, a new Accessories Division was created including a first ecommerce presence with www.armaniexchange.com in the United States. As part of its strategy to maintain control over product quality and distribution, Armani initiated a series of share investments, which today include Intai Spa (100%), Antinea Srl (100%) and the manufacturing company Simint Spa (100%), the complete acquisition of which was finalised in 2001. In the five years from 1998 to 2003 the Armani Group spent Euro 600 million of internally generated funds on strategically important activities, including the evolution of its manufacturing base, the expansion and renovation of its retail network, the diversification of its product lines and enhancement of its headquarters facilities in Milan. In 2000, Giorgio Armani's, 25th anniversary year, the company launched its global website. In 2001, continuing with the Group's strategy to take greater control over all aspects of its manufacturing, distribution and retail activities and to further focus on the 'Made in Italy' content of its brands, a joint venture company with Vestimenta SpA (manufacturers and distributors of Italian tailored men‟s and women‟s apparel and one of the Armani Group's licensees since 1979) was formed for the production and distribution of the men's and women's Giorgio Armani top line. In 2002, the Group's retail investment programme continued at a fast pace with 16 store renovations and 30 new store openings in strategically important cities worldwide, including the second Armani multi-brand store covering 3,000 square metres in Hong Kong, which also signalled the launch of a strategic retail expansion programme for China. In 2002 Armani purchased IT based store systems for 28 of its US retail stores. These were used for store operations management, supporting critical store level activities including receiving, stock adjustments and transfers. The systems were deployed throughout the stores in a wireless environment, and deployed using handheld devices within the store. "Providing our customers with high levels of service is very important," said Stephen Culver, Chief Information Officer with Giorgio Armani, US. “The system has provided Armani with a strong store operations solution that enables real-time information to flow between the store and headquarters. With this information, we have been able to reduce inventory, improve labour management, and most importantly, improve customer service”.

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On the manufacturing front, two important acquisitions were completed in 2002: Deanna SpA for the production of high quality knitwear and Guardi, which controlled four specialist shoe makers, to support the further growth of the Group's shoe business. In 2005, A|X Armani Exchange purchased a web-based product lifecycle management and production tracking system, e-SPS, to streamline and integrate product development and global sourcing. This provided realtime visibility into merchandising, design and production activities from product concept to delivery, streamlining its entire supply chain process. At the end of October 2008, a global beauty website www.giorgioarmanibeauty.com was launched, demonstrating the company's commitment to embrace fashion and beauty within the online sphere. During the same year, a strategic marketing agreement was signed between Giorgio Armani and Samsung to develop high-end electronic and consumer products, including the launch of a Giorgio Armani mobile phone, the Armani/Samsung Television and the Emporio Armani Samsung mobile, "Night Effect ". From initial sales of $14,000 in its first year, 1975, the company grew to sales of $100m only a decade later. Today it has an annual turnover of close to $2bn.

Questions
(a) (i) (ii) (b) Describe instances where Armani has used mergers and acquisition, and licensing or joint venture, for growth. What do you notice about the use of these options so far as business operations are concerned? Support major business operations Continue its national and global competitive advantage.

Explain how Armani has used information technology to: (i) (ii)

See the suggested answers at the end of this chapter.

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SUMMARY
Firms have a range of choices for growing globally. The growth option they take will depend on the conditions in their location of choice. Joint ventures and acquisitions/mergers provide for the opportunity of easier entry into a new market through the existence of an established business there and also because resistance by the public and the government is likely to be lower. Organic growth is more risky financially, but the difficulties of integrating processes and systems are much reduced. This type of growth is more likely when the political and environmental factors are more stable. Licensing and franchising provide a method of obtaining global coverage with lower financial risk and may be a good initial way of entering a new market. Globalisation brings with it the challenge of financial management, where to borrow and in what currency. Treasury management is very important if large losses are to be avoided by swings in interest and exchange rates plus country devaluations. One of the main contributions to successful business performance is to ensure that cultural factors are taken into account and planned for. Recruitment, employment, training and employee feedback all need to be customised to the particular needs of the location and the national and professional culture of employees as well as to the organisational culture. Marketing too must adapt their communication channels and methods to maximise opportunities to connect with local populations effectively. Management techniques need to broaden to encompass all the necessary people and organisational skills specific to working with global teams. Globalisation is limited by factors such as lack of infrastructure, growing scarcity of resources such as energy and water, and opposition by pressure groups of various kinds. The power and influence of multinational companies and the narrow distribution of the wealth created have created wider gaps between rich and poor.

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ANSWERS TO ACTIVITIES
Activity 1 (a) Coca Cola uses different growth strategies with its bottlers depending on the location in which they are based. It decided to take full ownership of the North American bottlers because of the competitive threat from Pepsi. It needed to be in full control of the operation to ensure efficiency and drive down costs. In many other cases it uses licensing as this gives the company a wide global coverage without huge capital investment. It can still keep control as the bottlers have signed agreements regarding quality, delivery, price and so on. Joint ventures may be used to gain entry into certain countries where Coca Cola would have difficulty getting permission to trade. The joint venture also puts part of the risk of a new operation on the other organisation to ensure that the alliance succeeds. (b) There are many examples, including the following: Coca-Cola plans to invest more than $5 billion in bottling operations in Mexico and Brazil over the next five years. This appears to be organic growth as there is no mention of acquisitions, but some of the total amount could be split between several options. Coca Cola has a joint venture agreement with Illy Caffe SpA. It has invested huge sums in China both for organic growth and in a joint venture with a Chinese company, its bottling partner Cofco Coca-Cola, which is 65 per cent owned by a state-owned food company, and whose management has ties to the central government. In 2010, it was reported that its $2bn investment will exceed the company‟s total investment in China since 1979, which amounts to $1.6bn. Activity 2 The IPad will cost you more euros than last year because the exchange rate has changed and the £ is a stronger currency than the euro at this point. You will pay 600/1.2 = € 720. Activity 3 (a) (i) The case study identifies the following three acquisitions:    Simint Spa Deanna Spa Guardi

Examples of the instances where Armani has used licensing and joint venture are:        GFT – licensing agreement Helena Rubinstein – licensing agreement Samsung – licensing agreement Luxottica Group Spa – licensing agreement Vestimenta SpA – joint venture Itochu Corporation – joint venture Seibu Department Store – joint venture

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(ii)

Armani has used strategic alliances since the early period of his business. These have been very important to the foundation and the expansion of the business. Armani has used strategic alliances such as licensing as a means of expansion and globalisation through diversification using well known global brand names. For example he was able to diversify into fragrances by using a licensing agreement with Helena Rubinstein and into electronics by using a contractual agreement with Samsung. However Armani has expanded its manufacturing by acquisition and joint venture, usually with Italian companies in the supporting industries, such as shoes and knitwear which seems to align with the underlying "Made in Italy" theme while providing a means to grow and control the business expansion.

(b)

(i)

Armani seems to have been relatively alert in using state of the art information technology to support business systems. As early as 2002, its US stores were using wireless hand held devices to check stock levels and hence able to provide a more effective service to customers and check stock excesses or low points. Armani has also used technology to manage and improve its supply chain generally, from sourcing to life cycle management.

(ii)

Upgrades and relentless improvement are needed to retain competitive edge and Armani seems to have adopted electronic technology before many other organisations. The company has used technology extensively and in a variety of ways to retain competitive edge not only in the core brands, but in its diversification strategy. (The strategy of bringing together two leading names on one product to strengthen and continue the competitiveness of both brands can be seen with the collaboration with Samsung.) Examples are:    As early as 1999 the company had set up a US website with e-commerce facilities. New products such as sports shoes and mobile phones bearing the Armani Brand were developed Armani moved into the electronics market by developing and marketing its own branded phones and televisions with Samsung.

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Chapter 9 Introduction to the Socio-Cultural Business Environment
Contents
Introduction

Page
214

A.

Demographic Trends and Business Forecasting Global Demographics The Workforce of the Future

214 214 219

B.

Business Ethics Different Cultural Perspectives on Business Ethics Ethics and Management The Potential for Unethical Behaviour Corruption and Bribery Ethics and Conflicting Stakeholder Interests

225 225 229 232 232 235

C.

Corporate Social Responsibility Costs and Benefits of CSR How Pressure Groups Influence CSR Regulation and Review of CSR in Organisations

237 239 242 243

D.

Whistle-blowing and Corporate Responsibility The Cases For and Against Whistle-blowing Public Interest Disclosure Act 1998 Key Examples of Whistle-blowing

245 245 246 246

Summary

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Answers to Activities

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INTRODUCTION
This final chapter is concerned with the social and cultural changes taking place that will increasingly impact on how business is conducted in the future. In Chapter 8 we touched on culture and demographic changes, and we will now look at these factors in a little more detail. In the first section we focus on the implications of demographic trends for business and what these may mean for future economies, consumers and the workforce. In the second section of the chapter we compare business ethics in different areas of the world, how this affects planning and success in the global company and the underlying ethical principles of corporate social responsibility. Corporate responsibility and its interaction with company performance has become an issue of major importance to global organisations and the public in general. Firms are being forced to take responsibilities for conserving the scarce resources of the planet and taking more part in ensuring that all individuals have the basic needs for life. We look at the ways in which companies may gain competitive advantage and maintain market share whilst implementing corporate responsibility strategies. However, we shall note that the tension between the main aim of Anglo American companies of increasing shareholder value while caring for the planet and its people is an ongoing challenge.

A. DEMOGRAPHIC TRENDS AND BUSINESS
Forecasting Global Demographics
Forecasting future populations, their locations and age profiles is not an easy task. Despite all the advances in technology it is difficult to obtain accurate statistics, so making an estimation of demographics in twenty to thirty years is a challenge. In some countries, census information is not available or up to date. Figure 9.1: Forecast Population aged 20 – 60 years by Region, 2000-2100
0.65
China Russia

0.6 Proportion of population 0.55 0.5

Sub-Saharan Africa

Central Asia Latin America

0.45 0.4 0.35 2000 2020 2040 2060 2080 2100 2120
North America Eastern Europe Western Europe Japan/ Oceania

Source: www.redgreenandblue.com

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Even with the forecasts we have, many companies take no account of likely demographic changes even though the number of people in a country, their distribution within it, ethnic mix and age profile are vital to developing a robust business strategy. The current age structure of the world's population can be seen from the following table. Age Demographics by Gender Age Range % of Total 27.0 65.3 7.6 Male Female

0-14 15-64 65 and over

944,987,919 2,234,860,865 227,164,176

884,268,378 2,187,838,153 289,048,221 Source: CIA World Factbook, 2010

However, when we look at future projections, a rather different picture emerges. Global population growth is forecast to rise by 80 million people each year. This is further complicated by movements of people between areas of the world and between regions within countries, with increasing urbanisation being a particular feature. The age structure is also projected to change radically, with the advanced industrialised countries having an ageing population. The age structure of a population has a significant effect on the socio-economic issues that a nation faces. For example:    Countries with young populations (high percentage under age 15) need to invest more in schools. Countries with older populations (high percentage ages 65 and over) need to invest in services such as health care. Rapid growth of a young adult population may lead to mass employment, particularly if concentrated in particular areas (especially given the growth of urbanisation predicted) and this may lead to social and political unrest.

The urban population currently represents 50.5% of world total, and is growing at a rate of 1.85% annually (2010). The largest cities in the world already have enormous populations and it is unclear how they will cope with this level of future growth:      Tokyo (Japan) – 36,669,000 Delhi (India) – 22,157,000 Sao Paulo (Brazil) – 20,262,000 Shanghai (China) – 16,575,000 Karachi (Pakistan) – 13,125,000

The movement of people from disadvantaged locations to wealthier countries has always been a feature of demography. As the economic strength of different countries change in relation to each other, people will seek to better themselves by migrating to regions or countries offering more opportunities. In the 19th and 20th centuries the USA was one of the most popular destinations for migrants. The opening of the EU to Eastern European countries resulted in waves of immigrants to a United Kingdom already rich in immigrants from its former colonies. In the future, this trend may affect China and India, where populations will be ageing and they will require immigrant workers from the poorer nations to sustain their economies.

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Given these changes in the global population, the present problems of underemployment, pollution, waste disposal, epidemics, water shortages, famine, over fishing of oceans, deforestation, desertification and depletion of non-renewable resources will continue to grow. Businesses will have to take account of the impact of this on the way in which they operate, and governments will need to examine the extent, cost and types of interventions that will be required to provide the protection and services required where these cannot be guaranteed by the market.

Economic Growth, GDP and Wealth Distribution
The National Intelligence Unit, which manages information forecasting for the USA, forecast the changing economic order and potential issues that could result in Case Study 1. Case Study 1: - The Changing Economic Order Forecast to 2025 by National Intelligence Unit Although many of Latin America‟s major countries will have become middle income powers by 2025, others, particularly those such as Venezuela and Bolivia that have embraced populist policies for a protracted period, will lag behind and some, such as Haiti, will have become even poorer and less governable. Overall, Latin America will continue to lag behind Asia and other fastgrowing areas in terms of economic competitiveness. Asia, Africa, and Latin America will account for virtually all population growth over the next 20 years; less than 3% of the growth will occur in the West. Europe and Japan will continue to far outdistance the emerging powers of China and India in per capita wealth, but they will struggle to maintain robust growth rates because the size of their working-age populations will decrease. The US will be a partial exception to the ageing of populations in the developed world because it will experience higher birth rates and more immigration. The number of migrants seeking to move from disadvantaged to relatively privileged countries is likely to increase. The number of countries with youthful age structures in the current “arc of instability” is projected to decline by as much as 40%. Three of every four youth-bulge countries that remain will be located in Sub-Saharan Africa; nearly all of the remainder will be located in the core of the Middle East, scattered through southern and central Asia and in the Pacific Islands. Many other countries will fall further behind, economically. Sub-Saharan Africa will remain the region most vulnerable to economic disruption, population stresses, civil conflict and political instability. Despite increased global demand for commodities for which Sub-Saharan Africa will be a major supplier, local populations are unlikely to experience significant economic gain. China is poised to have more impact on the world over the next 20 years than any other country. If current trends persist, by 2025 China will have the world‟s second largest economy and will be a leading military power. It also could be the largest importer of natural resources and the biggest polluter. India probably will continue to enjoy relatively rapid economic growth and will strive for a multi polar world in which New Delhi is one of the poles.

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China and India must decide the extent to which they are willing and capable of playing increasing global roles and how each will relate to the other. Russia has the potential to be richer, more powerful, and more self-assured in 2025 if it invests in human capital, expands and diversifies its economy, and integrates with global markets. On the other hand, Russia could experience a significant decline if it fails to take these steps and oil and gas prices remain in the $50-70 per barrel range. No other countries are projected to rise to the level of China, India, or Russia, and none is likely to match their individual influence.

If we contrast the GDP of countries in the recent past with those forecast to 2050 there is a very different spread of share by nation. Figure 9.2(a): Share of World GDP, 1969-2009
40 35 30 25 Percent 20 15 10 5
1975 = 26.3%

EU15 USA
2009 = 26.7%

Asia/Oceania

Latin America Middle East + Africa

0 1970 1975 1980 1985 1990 1995 2000 2005

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Figure 9.2(b): Predicted GDP Growth Rates – BRIC, 2000-2050
8 7 6 GDP 5 4 3 2 1
2000-2005 2005-2010 2010-2015 2015-2020 2020-2025 2025-2030 2030-2035 2035-2040 2040-2045 2045-2050

China India

Brazil Russia

Source: Dreaming With BRICs: The Path to 2050, Goldman Sachs As the „emerging economies‟ further dominate the global economy, income structures will also change. Many western based multinationals have already forecast this and have stepped up their operations and started make enhancements to their product range to meet the differing tastes and preferences in these countries. Pepsico and Coca Cola are two companies that have invested vast sums to take advantage of the increasing disposable income in China, Brazil and Russia. Figure 9.3: Projected Changes in Household Incomes 2000-2020 Number of households with annual disposable income of $5,000 - $15,000 (Note: data for 2010 and 2020 are forecasts)
200 180 160 140 120 100 80 60 40 20 0
China India Indonesia Brazil Egypt Ukraine Vietnam Russia

Million

2000

2010

2020

Source: Euromonitor International, from national statistics

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Changing Economic Models In 2010 the Chinese government barred Coca Cola from acquiring of one of its largest beverage manufacturers, having been influenced by opposition from strong nationalists. China is described as using an economic model known as state capitalism. Although this term has various different meanings, it is usually described as a society wherein the productive forces are controlled and directed by the State in a capitalist manner. The State owns controlling shares of publicly listed firms and acts effectively as a capitalist company itself. For example the Chinese government has a majority ownership stake in China Eastern Airlines (61.64%), while some shares are publicly held. Another example is Coca-Cola‟s bottling relationships with partner Cofco Coca-Cola, which is 65 per cent owned by a state-owned food company and whose management has close ties to the central government.

The Workforce of the Future
Impact on Skill Levels for Future Business Successful business strategies rely on having accurate data about the labour force and its skills available. Even in 2010, there is often insufficient talent for multinational companies to secure their future success, and there is constant competition for the best graduates and skilled labour. Overseas locations provide a wealth of unskilled labour, but without sufficient numbers of employees with higher level skills, business growth will falter. As noted above, the advanced industrialised countries have an ageing population and therefore the skilled workers of the future are likely to be more concentrated in emerging countries with a lower average age population. Figure 9.4: Labour Force Growth in Age 15 – 64, 2000-2050
45% 30% 15% 0%

United States, 42%

China, -10%
-15% -30% -45%
2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Europe, -25% Korea, -30% Japan, -44%

Source: US Census Bureau, International Division The education of these future employees is crucial to those economies through the success of their businesses. UNESCO predicts that over the next 15 years, illiteracy rates of people 15 years and older will fall, but they will still be 17 times higher in poor and developing countries than those in OECD countries. Furthermore, illiteracy rates among women will be almost twice as high as those among men. At the time of writing, UNESCO notes that "close to 20% of all Brazilians who are 15 or older are unable to read or write their own names". In addition to the chronic

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lack of funds and unprepared teachers, there are science manuals that "have not been updated in 10 years, in some instances even 40 years". This type of information emphasises the present gap between skill levels in the advanced economic countries and some of the emerging ones. Some companies such as the Brazilian oil giant Petrobras are growing their own future workforce by concentrating on the personal development of their own employees at all levels. It has its own university and its degrees are validated by Ministry of Education as equivalent to those of Brazilian Universities. In 2008, Petrobras had 190,923 staff places taken up at its university, with the average training provided, per employee, being 103 hours (compared to 30 hours in USA and Asia).

Activity 1
(a) (b) (c) Which countries will be most affected by ageing populations in the next 20 years? How will this affect business operations and how will companies solve the issues? Why are multinational companies investing heavily in countries such as Brazil, China, India and Russia?

See the suggested answers at the end of this chapter.

Women in the Workplace The population statistics show that almost half the working population is female. In the past thirty years, women in the western economies have made up an increasingly significant part of the workforce. This pattern has been influenced by several factors:       The growth of household labour saving devices New laws and practices that make part time and flexible working hours possible, particularly improved leave arrangements for parents and carers Virtual working owing to growth of technology Global talent scarcity with firms competing for the most skilled employees Lower birth rates Changing values including the growth of consumerism.

The research from the NIU suggests that by 2020 women generally will have gained more rights and more freedom in terms of education and workforce equality, but that the gender gap will not have disappeared, even in advanced economies. It is also forecast that the pay differentials which exist today (see Figure 9.5) will persist into the future.

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Figure 9.5: Gap in Pay Levels Between Male and Females by Country Percentage gap between median men's and women's wages for all full-time workers (2006 or latest year available)
40.0 35.0 30.0 25.0 20.0

O.E.C.D. average = 17.6%
15.0 10.0 5.0 0.0 Korea Japan Germany Canada United Kingdom Switzerland United States Finland Portugal Czech Republic Spain Australia Netherlands Sweden Ireland Hungary France Greece Denmark Poland New Zealand Belgium

Several factors are likely to improve the status of women in the workforce. According to World Bank analysis, increases in the level of information and communication technology infrastructure tend to improve gender equality in education and employment. Currently, there are few women heads of state, but the involvement of more women in local and regional politics is rising and should improve the legislation and opportunities for growing numbers of women in the workplace in Europe. However, there are a number of issues that will slow equality in employment for women. In regions where there are high populations of young people coupled with a history of male domination, if there are limited public resources, competition for those resources will be huge, leading to an increased probability that females will not receive equal treatment. This will begin at the education stage – if schools cannot educate all, boys are likely to be given first priority. In countries where there is a preference for male children, girls risk infanticide and the female population is disproportionately low. Countries already unable to provide employment for male job seekers are not likely to improve employment opportunities for women. Certainly some MNCs have given special emphasis to developing women leaders as they recognise their link with women consumers in particular. The CEOs of Kraft, Pepsico and Xerox are among the prominent women business leaders, and Coca Cola has a women‟s development programme (although it is promoted and chaired by the male CEO).

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The Generational Challenge Since the 1960s the advances in wealth and the technology in the UK, USA and other advanced industrial economies, have influenced the ideas of successive generations about what they consider as acceptable work practices, terms and conditions and career opportunities. These developments pose challenges for managing business performance in future. The theory of „generations‟ was initially developed in the early 1990s by Neil Howe and William Strauss, both US sociologists. Generation theory views society as consisting of successive „generations‟, the three most recent of which are the:    „Baby Boomers‟ born between 1943 and 1963 „Generation „X‟ born between 1964 and 1981 „Generation „Y‟ born between 1982 and 2000.

„Milleniums‟ born 2001 onwards will be entering the workforce within 10 years and are expected to have yet another different perception of work and career. Each generation has its own unique „character‟ shaped by the economic, social and cultural forces current during its formative years. By examining these forces it is possible to understand what motivates each generation and gives it a unique outlook on life‟. (a) Baby Boomers grew up in the post World War Two era of rationing. They generally possess a "live to work" attitude, appreciate job stability and security, and enjoy making decisions and working with clear goals and responsibilities. A high proportion expected to stay in the same organisation for their entire career and to obtain promotion and salary rises steadily as a reward for their longer service. Many tend to be task oriented, preferring formal ways of communicating, such as face-to-face meetings, memos and emails. Generation X place great importance on work-life balance, are resourceful and independent, but collaborative and adaptable. Family life for this generation was much less secure that for the previous generations, with divorce, working mothers and parental job insecurity in the 1980s recession promoting traits of independence, resilience and adaptability. Other characteristics include:      Adapt well to digital technologies Thrive in multicultural settings Have a desire for some fun in the workplace Pragmatic approach to getting things done Build interpersonal relationships through different forms of communication – roundtable discussions, phone calls or emails. Many of them also started work in the early 1980s, when the economy was in a downturn. Hence they are not loyal to any company, only to the team they work with and the boss they work for. If a Generation X individual is unhappy, s/he looks for and accepts the best offer s/he can find at another organisation. Generation X takes employability seriously, but there is no planned career path. Rather, their career is more fluid – there is a career matrix and they can move laterally, stop and start.

(b)

The work profile for Generation X is given as follows. (i)

(ii) (iii)

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(iv)

At the same time, this generation expects immediate and ongoing feedback and is equally comfortable giving feedback to others. Generation X dislikes authority and rigid work requirements.

(c)

Generation Y grew up with more disposable income than previous generations as well as being able to spend more time in full-time education. Their characteristics include:      Most IT literate generation and very assertive Avoid commitments to employers and institutions Extremely brand conscious, possibly because brands have been such a constant feature of the Generation Y experience Better educated, more competent with technology and quicker to adapt than previous generations Refuse to conform to traditional standards and time honoured institutions without very good reason. They do not respond to formality, in particular bureaucratic hierarchies and traditions. Generation Ys want to be treated as equals with the rest of their older colleagues. They crave a flexible working lifestyle and are more interested in making their jobs accommodate their family and personal lives. They want jobs with flexibility, telecommuting options and the ability to go part time or leave the workforce temporarily when children are born. They seek the freedom to develop and advance themselves, and are not intimidated by authority or afraid to speak up. Generation Ys hold high expectations of their career and want their work to be challenging and meaningful – they do not expect to stay in any job for too long.

In the workplace: (i) (ii) (iii) (iv) (v) (vi)

(vii) They are quite prepared to walk away from organisations that are unable or unwilling to match their values and concerns. (viii) They are more aware of corporate social responsibilities and of the environment than Generation X or Baby Boomers. In the UK the Association of Graduate Recruiters found that 72% of final year students (Generation Y) said they would have to feel happy with an employer's ethical record before agreeing to work for them. Challenges for Employers Many employers have all three generations working in the same location. Their different aspirations, expectations and working practices are a challenge. (a) Recruitment Despite the recent rise in student numbers, many top firms are locked in a struggle to recruit and retain top graduate talent. This worsens each year, not because there are not enough applicants for each role, but that there appears to be a mismatch between what employers want and what graduates want to do, reflecting the features of the generations mentioned above. Companies recruiting Generation Y have to ensure that the package they offer is appropriate and so are their practices – culture, incentives, contacts and development opportunities.

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MNCs continuously compete for the same individuals and it will be a question of whether the company fits the requirements of the individual Generation Y rather than the other way round. (b) Management Once recruitment has taken place, management of Generation Y becomes the next challenge. Many older colleagues may prefer a traditional, less collaborative style of working, and employers find tensions building up between the generations with older workers being dismissive of younger workers' abilities and younger employees dismissive of the competence of their older co-workers. In 2010, the Chartered Management Institute (CMI) and the Chartered Institute of Personnel and Development (CIPD) examined how line managers and HR managers were adapting to an ageing workforce.  Only 14% of UK managers consider their organisation well prepared to cope with an ageing workforce and the fact that a third of UK workers will be aged over 50 by 2020. 93% of managers taking part in the study recognised that older workers bring valuable knowledge to organisations. Only 7% of organisations offer training to line managers on managing older workers, yet 47% of respondents think such training is needed. 59% think that young managers find it hard to manage older workers. The working population will be more diverse. Changing expectations of work and the impact of new technologies will require managers and leaders to develop a new range of skills that focus on emotional and spiritual intelligence, judgement and the ability to stimulate creative thinking to improve productivity. Personal responsibilities will increase and so will people‟s private needs. Attending to these needs will inevitably lead to blurring boundaries between work and life as people try to cope with numerous urgent demands. Work-life balance will be superseded by work-life integration. Talent markets will become more complex in that they will be more diverse in regard to age, generational issues and culture. Organisations will have to address the growing power of the employee and the need for personalised working patterns and benefits.

    

In another study, „Management in 2018‟, CMI's key findings included:

  

They also predicted that more organisations would be wholly virtual and that those organisations that maintain physical premises would be run by „by managers who create a sense of control and calm‟. Managers would need to focus on individual employees and their needs when developing work technologies and motivate people creatively. They would need to provide flexible, tailored support for work-life integration. Strengthening an organisation will require enhancing agility, clarity, flexibility, genuineness, innovativeness and openness. Finally, taking the notion of unforeseen events seriously, thinking these through diligently and investing in contingencies may prove to be business life saving in the long run.

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Think Point
In your country, do several different generations work together? What tensions may arise in the work place between different generations of employees, and how might management adapt its approach to deal with these?

It is likely that different generations work together in most countries. This has been a traditional feature of family businesses, but is becoming much more common in larger companies. The tensions are likely to vary with different national, organisational and occupational cultures. For example, in Asian countries, older people have traditionally been respected and perceived as people to learn from. Whether this will remain true in the future workplace is unclear. Management is likely to have been forced to adapt somewhat as western culture has affected young people. In particular, where skilled young workers have returned from studies in the US/UK they may have different ideas on how businesses should be run and these may conflict with existing cultural values. Has management had to start to listen to them and take into account some of their ideas?

B. BUSINESS ETHICS
The power and influence in business and society is greater than ever before. Business plays a large role in society by providing goods and services that the public wishes to purchase, provides employment and supports economic growth. When businesses act inappropriately, this can have a very harmful affect on individuals, communities and society in general. Stakeholders – including owners, employees, customers and suppliers, and the public at large –are increasingly demanding transparency in business operations, and are concerned that organisations treat them fairly. The subject of business ethics includes issues of conflict of interest, financial and accounting integrity, corruption, advertising standards, corporate and individual privacy and bioethics.

Different Cultural Perspectives on Business Ethics
Business ethics can be defined as: „the study of business situations, activities and decisions where issues of right and wrong are addressed‟. Right and wrong, in this definition, mean morally right or wrong. Morality is concerned with the norms, values and beliefs embedded in the social processes that define right or wrong to an individual or a community. Ethics, then, is the application of this sense of right or wrong (morality) to the rules of conduct of the individual or community. Another definition is: „how a company integrates core values into its policies practices and decision making‟. We can see that just between these two definitions there is a different emphasis on the meaning of ethics – the first is a more general one, addressing right and wrong in terms of what is socially acceptable, and the second demonstrates the perception related to the values that the company has defined for itself. The perception of morality varies from one nation to another, and from one community to another. However, most business texts focus on the Anglo American business and

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management models and theories. With the growing influence of other economies, it is imperative that we examine and compare these different perceptions of ethics and how they are demonstrated in the way operations and relationships are managed. For example, differences in legislation, cultures and practices between societies have made the application of ethical standards subject to what might be termed "ethical dilemmas". These occur when there are conflicts between what is a morally right action and the potential for the outcome of such action to be morally wrong – for example, child labour is perceived by western cultures to be morally wrong. but although to ban it may be morally correct, the child and his/her family may be left starving. Note, though, that ethical issues apply to all companies in all societies and are not only encountered by global companies, so they must be understood in terms of their cultural setting. There are three broad ethical models:    Anglo-American European Asian Pacific

Anglo-American Business Ethics In this model, the individual employee is expected to be responsible for ethical conduct within the business with the organisation providing guidelines for such behaviour, focusing on:     The primacy of increasing shareholder value Misconduct and morality in single decision situations Key issues such as privacy, workers‟ rights and salaries Whistle-blowing by individuals and groups as a control/monitoring mechanism.

The ethical guidelines for business conduct are usually given in corporate codes of conduct.

Activity 2
Here we present the Xerox Code of Conduct as an example of the Anglo-American model. Consider the following summary of its content and then answer the question that follows. Case Study 2: The Xerox Code of Conduct We are committed to conducting our business responsibly and in the best interests of our customers, employees, shareholders and the communities in which we work and live. We have had an employee Code of Conduct in place for nearly 40 years and all of our employees acknowledge their comprehensive understanding of it each year. Key topics include:    Conflicts of interest Legal and financial requirements and controls Employee and customer information privacy, including data protection and security, record retention and proper classifications of information Intellectual property

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            

Proper use of information systems and company assets Environment, health and safety Diversity and inclusion Harassment Use of alcohol and controlled substances Violence-free workplace Gifts and entertainment Guidelines for dealing with government customers Community and political activities Supplier guidelines Fair competition, antitrust, international trade and export control Bribery, improper payments, insider trading and money laundering Collusive bidding and kickbacks.

Question Describe, with examples, three ways in which this code of conduct illustrates the features of the Anglo American model. See the suggested answers at the end of this chapter.

The European Model of Business Ethics In the European model, the government, trade unions and corporate associations play a major role in defining business ethics. The ethical guidelines are in the form of a negotiated legal framework. The individual and the single company are not expected to be responsible for ethical decisions, but there is a collective responsible for the issues. These issues focus on social issues in organising the framework of the business and are less driven by shareholder value and the interlocking relations between companies and banks. The Asian Pacific Model of Business Ethics Here, the approach is that the senior managers of the company are held responsible for ethical conduct within the firm where the emphasis is on:        Accountability for mismanagement and corruption (corporate governance) Responsible organisation of business Businesses are owned and financed internally Greater managerial discretion giving rise to a more flexible approach to ethics Emphasis on personal virtues and collective responsibility Predominant focus on providing jobs that pay a living wage Production of products and services at affordable prices.

For example, in China it is unethical to make people redundant in an economic downturn and mismanagement of the business can result in arrest for corruption and even execution.

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In Asia the guidelines are left to managerial discretion and based on trust and implicit duty rather than formal governance arrangements. The Asian Pacific Approach is illustrated by the following extract from Tata‟s Code of Conduct.

Activity 3
Consider this first clause in Tata's Code of Conduct and then answer the questions that follow. Case Study 3: Tata Code of Conduct This comprehensive document serves as the ethical road map for Tata employees and companies, and provides the guidelines by which the group conducts its businesses. Clause: 1 National interest The Tata group is committed to benefit the economic development of the countries in which it operates. No Tata company shall undertake any project or activity to the detriment of the wider interests of the communities in which it operates. A Tata company‟s management practices and business conduct shall benefit the country, localities and communities in which it operates, to the extent possible and affordable and shall be in accordance with the laws of the land.

Questions (a) (b) Describe how this clause differs from that of Xerox given previously. Discuss why this is so. Now find the complete Code of Conduct at www.tata.com. (i) (ii) What do you notice about some of the 26 clauses? What do you think might be the reason for your answer to part (a)?

See the suggested answers at the end of this chapter.

Other Regions Africa and Latin America have a similar approach as both regions have traditional tribal and small family-based communities which tend to ensure that the individual is involved in collective decisions. Latin American ethics tend to be based around decisions made by the many small family owned firms where the key stakeholder is also the employee. Africa and some Latin America countries tend to have ethical guidelines set by Non Government Organisations (NGOs) often because the countries are under funded, lack education or highly corrupt as we will see in the next sections.

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Ethics and Management
Management ethics concerns the behaviour of those individuals in the organisation who have the power to make decisions. It is the legal duty of individual managers in UK not to pursue their own interests (or the interests of others) where these are not the interests of the organisation and its shareholders, or where these offend against the general moral norms of society. What standards of behaviour should managers observe? Although there may be a high degree of consensus in society as to what constitutes ethical behaviour (honesty, fairness, etc.) there are sometimes questions about how to apply these in practice, particularly where ethical obligations may conflict with each other. There are many ways of expressing what we understand by ethical behaviour. They are all concerned with highlighting societal expectations about how organisations and individual managers should act in their dealings with others. We could take the central elements of this to be: (a) Always to act within the law The obligation to act legally may too obvious to be an issue of ethics at all. However, there are many grey areas, for example:  Is minimal compliance with the letter of the law enough – for example, in safety or equalities issues – or does an ethical approach imply more proactive commitment? Is it unethical to pay bribes as the only means of securing an export order which will be in the interests of the firm's shareholders and workers? This is now illegal under UK law but is believed to be still practised (see below). Is it ethical to adopt off shore tax avoidance schemes which are not illegal, but which can result in firms paying very low UK taxes and thus failing to meet their social responsibilities to their home country? Conversely, in Anglo American terms, given the legal requirement for companies to be run for the benefit of shareholders, would it be proper for the managers not to take advantage of opportunities for tax avoidance, which is in the interests of shareholders?

There may be different interpretations of the law and what is illegal may only be determined in the courts after the event. The question of legality is often related to the concept of what may be reasonably foreseeable as the consequences of actions. (b) "Do unto others as you would be done by" The principle that you should treat others with respect, as you would expect to be treated yourself, gives rise to a number of expectations of behaviour in respect of interactions between:    the managements of different organisations individual managers and the organisation individual managers and their colleagues and subordinates.

There are number of ways in which this general principle may condition behaviour when it is put in the context of self interest: (i) Not to deprive others of the true facts about a situation, to which they are entitled, in order to pursue self interest or that of the organisation. This may be to cover up misdeeds or mistakes, or the misrepresentation of the financial position to shareholders (or to the government, for taxation reasons).

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(ii)

Not to use one's own power to exploit others in the pursuit of self interest or that of the organisation, or to use them for one's own gain. This includes: misrepresenting the views of others, such as in claiming the responsibility for others' work or making misleading claims in order to obtain sales. It also applies to cases of sexual harassment by managers of subordinates.

(c)

Not to pursue own interests at the organisation's expense Managers must not take advantage of their position in an organisation and the power and information which may come from that, to further their own interests. This clearly includes taking bribes and may extend to the acceptance of any personal favours associated with, for example, dealings with particular suppliers. It also includes using information which is confidential to the organisation to make personal gains such as through speculation in shares (insider dealing), unauthorised disclosure of information (for financial gain or otherwise) or the use of inside information to set up a rival business. (This obligation may also extend beyond the period of employment. Contracts of employment may forbid key personnel not to work for rival companies for a period after resigning, in order to protect the inside information which they possess. The fairness of such contracts can be challenged in the courts.) There are also concerns that senior managers and directors may act in their own interests rather than those of shareholders. Not only has the pay of top management risen far faster than pay levels generally (see Figure 9.6), but there are also allegations that the prospect of large bonus payments tempts managers to take risks which bring them immediate rewards, but which may be against the organisation's longer term interests. Figure 9.6: Comparison of CEO Pay with that of Other Employees and Other Indicators Cumulative percentage change in economic indicators, 1990-2005
450%
409.2%

400% 350% 300% 250% 200% 150%

Average CEO pay
326.6% 298.2%

260.8%

S&P 500 Index
106.7%

100% 50% 0% -50%

Corporate Profits Average Worker Pay 4.3% Minimum Wage
-9.3%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: www.financialsense.com

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As long as returns on investment are satisfactory, shareholders may take too relaxed a view towards managers' behaviour. This practice, particularly prominent in the USA, is not considered good corporate governance practice. Anglo American corporate governance guidelines suggest that a CEO should not also act as Chairman of the Board and set his/her own bonus levels. Role of Professionals in Organisational Ethics Professionalism can be seen as an important element in the consideration of management ethics, since most professional bodies are rigorous about adherence to what they define as acceptable standards of behaviour for a practitioner in that profession. Indeed, some professions, such as the legal and medical professions, have the power to remove an individual's licence to practice in extreme cases of malpractice. Therefore, professional ethics and standards may assume a dominant role in conditioning the behaviour of members of that profession. The Code of Conduct for Nurses and Midwives is an example: Case Study 4: The Code of Conduct for Nurses and Midwives Standards of conduct, performance and ethics for nurses and midwives The people in your care must be able to trust you with their health and wellbeing. To justify that trust, you must:     Make the care of people your first concern, treating them as individuals and respecting their dignity Work with others to protect and promote the health and wellbeing of those in your care, their families and carers, and the wider community Provide a high standard of practice and care at all times Be open and honest, act with integrity and uphold the reputation of your profession.

As a professional, you are personally accountable for actions and omissions in your practice and must always be able to justify your decisions.

Each of the above points can be read in more detail on the nurses‟ and midwives‟ website: www.nmc-uk.org. Similarly, the Chartered Management Institute has a code of practice for managers which can be found at www.managers.org.uk. One effect of this is that professionals may see loyalty to their profession as more important than loyalty to the goals of the organisation for which they work. Although the role and expertise of the professional must be acknowledged, there are many areas of professional judgement which can be fruitfully opened up to scrutiny – for example, accounting and financial management in terms of „creative accounting‟ and other practices which present a company's accounts in a more favourable light. However, challenging the dominance of the professions is not easy, since the necessary information and its interpretation require the specialist skills of the professional.

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The Potential for Unethical Behaviour
The forces driving towards unethical behaviour are:   (a) The pursuit of the organisation's goals, in particular, profitability The individual's goals, which may be many and varied. Level of competition The more intense the competition, the greater the pressure to act unethically in seeking a competitive advantage. This may also increase the pressure to achieve high performance, resulting in managers being tempted to 'take short cuts' to achieve financial targets or simply to misrepresent their achievements. (b) Organisational culture The more liberal the culture and the more autonomy of decision making and action it allows, the greater the opportunity for acting with self interest. Cultures which focus on outcomes rather than processes can imply that the ends justify the means. One of the purposes of the rule-bound bureaucratic structures typically found in public service is to prevent officials from having discretion to favour particular service users and so minimise the possibility of corruption. However, in such autocratic and bureaucratic cultures, there may be a tendency to cover up mistakes and obscure the truth of situations. (c) Degree of dependency between organisations and/or individuals Where one party relies on the other for supplies or approvals (as in the case of regulatory bodies), there is the potential for bribes and payoffs.

Three core factors that increase the temptation to act unethically can be identified:

Corruption and Bribery
Corruption is defined as a lack of integrity or honesty in the use of a position of trust for dishonest gain, especially susceptibility to bribery. It is considered to be one of the main global business issues and it is thought that more than $1 trillion is paid in bribes each year, amounting to approximately 3.3% of World GDP. The corruption perception index, produced by Transparency International, compares the levels of corruption in various countries. This is summarised in the following table. Figure 9.7: Corruption Indices Corruption Perception Index (CPI) 2005 From 0 = Highly Corrupt, to 10 = Highly Clean Out of 158 countries Low corruption 1 Iceland 2 Finland New Zealand 4 Denmark 5 Singapore 6 Sweden 7 Switzerland 8 Norway 9 Australia 10 Austria High corruption 151 Angola 152 Cote d'lvoire Equatorial Guinea Nigeria 155 Haiti Myanmar Turkmenistan 158 Bangladesh Chad

9.7 9.6 9.5 9.4 9.2 9.1 8.9 8.8 8.7

2.0 1.9

1.8

1.7

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Bribe Payers' Index (BPI) 2002 From 0 =High Level of Bribery, to 10 =Low level Out of 21 Countries Low propensity to bribe 1 Australia 8.5 2 Sweden 8.4 Switzerland 4 Austria 8.2 5 Canada 8.1 6 Netherlands 7.8 Belgium 8 United Kingdom 6.9 9 Singapore 6.3 Germany High propensity to bribe 15 Malaysia 4.3 Hong Kong 17 Italy 4.1 18 South Korea 3.9 19 Taiwan 3.8 20 China 3.5 21 Russia 3.2

Sources: Internet Center for Corruption Research and Transparency International The CPI Index refers to corruption in the public sector Contracts for public works present the biggest source of corruption. Arms and defence, energy, aerospace and banking are the industries in which the highest level of corruption takes place. Gifts received on overseas business trips are also potentially a form of bribery and many multinationals now forbid acceptance of these in their codes of conduct not only for employees but suppliers. However, in some cultures not accepting a gift may be considered an insult. Tata makes provision for this in its code as follows: Case Study 5: Tata Guidelines on Gifts and Donations A Tata company and its employees shall neither receive nor offer or make, directly or indirectly, any illegal payments, remuneration, gifts, donations or comparable benefits that are intended, or perceived, to obtain uncompetitive favours for the conduct of its business. The company shall cooperate with governmental authorities in efforts to eliminate all forms of bribery, fraud and corruption. However, a Tata company and its employees may, with full disclosure, accept and offer nominal gifts, provided such gifts are customarily given and/or are of a commemorative nature. Each company shall have a policy to clarify its rules and regulations on gifts and entertainment to be used for the guidance of its employees.

Why Does Corruption Take Place? We can identify five situations:   When procedures for allowing the market to bid for contracts in a transparent manner are replaced by executive authorisation, thus reducing competitiveness. Where this is careless or loose audit practice, allowing such behaviour to remain undisclosed.

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Where there is underfunding within the public sector – for example, underpaid public officials, lack of suitable financing of political parties, undersupply of public goods for education. Where social and cultural factors, including nepotism, support the practice. Not all countries view corruption and bribery as being unacceptable. Where there is a disparity between the resources available to the parties to a transaction. Abundant resources are an incentive for bribery, and developing countries are likely to have scarce resources. A link between GDP and corruption has been made and Figure 9.8. demonstrates the link with average pay levels. Figure 9.8: Corruption Levels Linked to Pay
120

 

Average Hourly Wage
107

Corruption Rating
100
Corruption Rating is from best (low rating) to worst (high rating)
82 70 80

108 106 102 100

80

Wages are from high (low rating) to low (high rating)

60

40
23 21 20 16 8 7 23

20

15

0 Australia Germany UK USA China India Indonesia Vietnam

Source: www.evolvingexcellence.com What are the Effects of Corruption? Four effects can be identified:     It reduces the taxes paid to governments, resulting in loss of public investment which would ultimately be used for the social good. It discourages foreign investment because of the additional cost incurred by paying the bribe, so it also reduces economic growth of some developing countries. Employees within companies lose their sense of professional integrity. The money is often linked to criminal activity.

Anti Corruption Measures Individual global firms issue guidelines to their stakeholders and have statements that urge those suspecting corruption has taken place to contact them (see also the section on whistle blowing below). There are also a number of national and international organisations working to reduce the levels of business corruption both globally and locally all over the world. Three prominent ones, and their key missions, are:

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(a)

Transparency International – an NGO based in London "leading the fight against corruption, TI brings people together in a powerful worldwide coalition to end the devastating impact of corruption on men, women and children around the world. TI‟s mission is to create change towards a world free of corruption."

(b)

The World Bank "Corruption sabotages policies and programmes that aim to reduce poverty, so attacking corruption is critical to the achievement of the Bank's overarching mission of poverty reduction. We believe that an effective anti-corruption strategy builds on five key elements:      Increasing political accountability strengthening civil society participation creating a competitive private sector institutional restraints on power improving public sector management.

To reduce the corrosive impact of corruption in a sustainable way, it is important to go beyond the symptoms to tackle the causes of corruption. Since 1996, the World Bank has supported more than 600 anticorruption programs and governance initiatives developed by its member countries." (c) International Chambers of Commerce (ICC) The ICC provides rules of conduct to combat extortion and bribery in international business. The ICC‟s Anti-corruption Commission encourages self-regulation by enterprises in confronting issues of extortion and bribery and provides business input into international initiatives to fight corruption.

Ethics and Conflicting Stakeholder Interests
Ethics operate at two basic levels –– those of the individual manager and the wider ethics of the whole organisation. Managers bring a set of values into their work situations and these operate in conjunction with the ethical culture of the organisation, usually revealed in general terms in their values and mission statements.. One of the key problems facing managements when pursuing higher ethical standards of decision making is the clash of interests between the various stakeholders of the organisation. The duty of managers to the owners of the enterprise (shareholders) is indisputable. If the owners do not receive a return on capital, they will withdraw the capital or close the business, cutting their losses if necessary. However, there are many entrepreneurs who support socially responsible policies (such as the late Anita Roddick, founder of the Body Shop) and these may also have to be taken into account. However, modern day businesses must take account of broader responsibilities: (a) Employees Irrespective of the kind of organisation, the interests of the employees must be considered. Employers have certain statutory obligations to safeguard the interests of workers (for example, a duty to promote safe working practices), but moral obligations also exist. These moral obligations will be influenced by prevailing social attitudes that may be as compelling as the legal obligations.

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(b)

Customers There are very few true monopolies, largely due to the abundance of substitute products and brands. Competition tends to preserve the objective of customer satisfaction in firms to a far greater degree than would otherwise be the case. The customer clearly desires low prices, conflicting with the profitability objective. Managerial decisions have to reconcile customers‟ interests with those of the organisation. The legal responsibilities of an organisation to its customers fall into two broad areas – to provide consumer choice and to ensure fair dealing. However, influential pressure groups have emerged in the area of consumerism in recent years which demand that businesses take account of customer concerns in the wider sense – for example, not trading with countries with oppressive human rights records, as was the case with campaigns against the Apartheid regime in South Africa.

(c)

Suppliers Most organisations depend upon an external source of supply and it is in their interests that this should be served by a fair and open market. This emphasises the mutual interdependence of commercial bodies, and fair and equal treatment of all potential external suppliers is therefore vital to their well being.

(d)

Society Current belief is that all organisations have an obligation to contribute to the well being of the country‟s economy and society as a whole. This may be thought of as an obligation of the government of the day, but expectations now extend to all types of organisations. Managers should demonstrate awareness of responsibilities to society in general. Despite deregulation and a general contraction of state involvement in enterprise, there are boundaries of tolerance shown by governments to certain practices. For example, many western Governments impose a greater financial burden on businesses whose activities result, directly or indirectly, in divergence between social costs and private costs – such as private motoring and smoking – with increases in tax making their products more expensive. The media, both within an organisation but more particularly within society as a whole, has an ever increasing role in helping society answer its ethical questions and reporting on alleged unethical behaviour by organisations.

(e)

Local communities Organisations often have a significant impact upon the local communities in which they trade – where products are grown, processed, distributed and sold. In employment terms, this extends employers' ethical relationship with residents to the broader travelto-work areas of their organisations.

To help decision making given these conflicting interests, two models have been developed. These attempt to provide a framework for an organisation to address ethical issues where there may otherwise be no guidelines upon which managers may draw in decision making.  The Ethical Decision Model (EDM) This approach takes the form of an analysis of what is at stake in the ethical issue being considered, taking the Anglo American model as the basis. In summary, management should pursue the principles of justice, integrity and decency while still building long-term value for the firm. The analysis emphasises consideration of how an issue affects the organisation and what the external constraints on ethical behaviour are. The findings of the analysis are

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applied to the ethics of each functional area of the organisation and are drawn together into an ethical audit. For example:  Ethical approaches to human resources include promoting employee health, safety and welfare, tackling racism, ageism and bullying in the workplace, counselling for social problems and career development, not making use of surveillance technology for spying on workers or reading their emails. Ethical approaches to customers include quality and service considerations, improved labelling to give customer information, fair treatment in all dealings. Ethical approaches to environment impact include pollution control, recycling waste paper, used bottles and cans from offices and works restaurants, conservation of natural resources and energy.

 

Ethics, Values and Responsibility (EVR) Congruence The concept of EVR congruence emphasises that all three elements have to be deployed in order to add value to the production process of turning raw materials into goods and services that meet customers‟ expectations. Thus, for example, it is not socially responsible to produce goods, no matter how efficiently, if it means harming the natural environment. EVR has implications for the quality of products and the quality of life of employees and all who come into contact with the organisation.

Activity 4
What does your organisation do to help managers make ethical decisions? Are there company guidelines for dealing with employees, customers and suppliers? For example, does it have written policies on not taking bribes from suppliers who want the company‟s business? Is there a policy about, describing its products and services accurately? What actions does it take to ensure managers treat employees fairly? What is the organisational culture in respect of ethical issues? For example, is stealing from the organisation tolerated? Do managers take credit for ideas that have come from other employees? Do you feel that the organisation has high or low ethical standards? To what extent to the standards of the organisation reflect those of the national culture?

C. CORPORATE SOCIAL RESPONSIBILITY
The concept of corporate social responsibility (CSR) is closely linked to ethics, but has a narrower focus in respect of the responsibilities of organisations to society. There are a number of different terms used to describe this – corporate responsibility, corporate citizenship, social enterprise, sustainability, triple-bottom line and corporate ethics – and a number of definitions, including:   "treating the stakeholders of the firm ethically or in a responsible manner" "the obligations of firms to society or more specifically to those affected by corporate policies and practices"

The Harvard Kennedy School states that "corporate social responsibility encompasses not only what companies do with their profits, but also how they make them. It goes beyond

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philanthropy and compliance, and addresses how companies manage their economic, social, and environmental impacts, as well as their relationships in all key spheres of influence: the workplace, the marketplace, the supply chain, the community and the public policy realm." Lascerre (2007) demonstrates the links between global firms and the range of stakeholders to which it interlinks and has ethical responsibilities. He calls this the "Ethical Web", as shown in Figure 9.9. Figure 9.9: The Global Ethical Web Host countries United Nations

European Union

Governments

International Institutions

IMF

Investors' countries

World Bank CSR

Financial Markets Shareholders SRI Funds

Global firms Corporate executives Front-line managers Public opinions Non-government organisations

Industry associations

Caux Amnesty International Greenpeace

Churches Press

TV

Academia

Transparency International

Corpwatch

However we define it, CSR is now an accepted part of the business environment and CSR policies form an integral part of business operations. CSR policy is disparate and organisations take different views on what it means – for example, Starbucks focus on employee issues while the Body Shop focuses on human rights. Other examples of key focuses include:      Child labour Recycling Use of scarce resources World social problems such as obesity Sustainable development and farming

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  

Treatment of employees, including their well being Emissions, including reducing the organisation's carbon footprint Paying a fair price to the producers of ingredients such as cocoa, coffee, milk, etc.

Just as organisations have different perceptions of what CSR issues are important the same is true of countries. Research has shown that:     Chinese CSR is focused on production of high quality, safe products South Africa is more concerned with contribution to social needs such as education and health US, Italy, France, Switzerland and much of South America concentrate on fair treatment of employees UK, Australia, Canada and Indonesia are most concerned with environmental aspects of CSR.

Costs and Benefits of CSR
Developing, implementing and promoting CSR policies is a cost to the business when its primary function is to maximise shareholder value. Adopting CSR policies requires resourcing such as personnel to design, implement, monitor and control the policies and keep them updated. New processes need to be adopted and, for manufacturers, this can entail significant Research and Development expense. Set against this, it is argued that, where public pressure about CSR issues is strong, consumers may abandon the firm and move their business to a competitor. However, the research on links between CSR, business performance and customer loyalty is far from complete and it is currently impossible to make a robust case for its contribution to shareholder value. Competitive Advantage Some organisations, have managed to find ways to promote their social responsibilities and making them work to their competitive advantage. The Coca Cola 2020 vision (see below), for example, focuses partly on preserving the planet and looking after its people while retaining its commitment to shareholder value as its number one priority. Both Coca Cola and Pepsico have modified their main beverage products to reduce sugar content to meet the growing pressure from the public and global health groups concerned about obesity levels. This has helped them to maintain their market position. They have both set up well-being sections on their websites. Case Study 6: - Coca Cola’s 2020 vision linked to CSR Our vision serves as the framework for our Roadmap and guides every aspect of our business by describing what we need to accomplish in order to continue achieving sustainable, quality growth.    People – Be a great place to work where people are inspired to be the best they can be. Portfolio – Bring to the world a portfolio of quality beverage brands that anticipate and satisfy people's desires and needs. Partners – Nurture a winning network of customers and suppliers, together we create mutual, enduring value.

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Planet – Be a responsible citizen that makes a difference by helping build and support sustainable communities. Profit – Maximize long-term return to shareowners while being mindful of our overall responsibilities. Productivity – Be a highly effective, lean and fast-moving organization.

Further examples of instances where CSR seems to be linked to competitive advantage include: (a) By finding ways to develop bottles from natural materials that lower its dependency on scarce resources and opening its own recycling operation, Coca-Cola has managed to reduce cost and improve its value chain which maximises shareholder value. Kraft Foods is another multinational company that has produced a range of lower fat and lighter range products to meet the needs of both health conscious consumers and the obesity lobby. Kraft through its Cadbury acquisition now contributes to the Fairtrade sustainability projects that assist farmers to obtain fair prices for their products and improve the quality and density of the crop. This not only ensures supply, but encourages consumers who are concerned with sustainability to buy Kraft products rather than those of its competitors. Hotel Chocolat set up its business around Fairtrade by producing its own cocoa and manufacturing its chocolate in St Lucia. It introduced sustainable cocoa farming and worked with agricultural experts from Reading University to produce better strains of crop. It has since developed the site further and opened Hotel Chocolat on the plantation owing to the customer loyalty it has built up at least partly as a result of its ethical approach to business and commitment to corporate responsibility. Case Study 7:- Hotel Chocolate CSR and Competitive Advantage In St Lucia, we are pursuing our passion for chocolate by becoming one of the world‟s few origin chocolatiers growing our own cocoa. The restoration of the historic Rabot Estate (pronounced ra-BOW) is continuing at pace, with new trees being planted and record quantities of cocoa being harvested. But we‟re also reaching out to the wider cocoa community in St Lucia through our Engaged Ethics Cocoa Programme. For 20 years cocoa farming in St Lucia has been in decline, something we‟ve started to change by guaranteeing to buy local cocoa at prices 40% above those previously achieved. Our early results are promising – with interest in cocoa on the up, we‟ve already helped create one hundred new jobs to date. Local farmers now have a secure income and feel confident enough to breathe new life into their farms through investment.

(b)

(c)

(d)

CSR and Talent Management In Section A we discussed the requirements of Generation Y when they seek an employer. They are much more likely to be attracted to an ethical employer that not only meets their standards as an employee, through career opportunities, excellent training and development and reward policies, but also demonstrates a robust CSR policy. The websites of many

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MNCs promote their policies for career seekers and they also do so on the social networking sites that Generation Y are likely to spend a considerable amount of their time. Negative Publicity There are numerous instances of companies being shown to be acting in violation of the standards expected of them by the public and their customers, and of their own stated CSR policies, primarily in less developed nations. This has attracted huge negative publicity in the western countries which are their home locations and has resulted, in some instances, in consumer boycotts. However, the effect does not appear to have any permanent effect on their market position. Examples include the following.  Unilever was accused by Greenpeace of destroying Indonesian rainforests for palm oil, which is a vital ingredient for its soap and margarines. It immediately reversed its position and stated that it would only buy palm oil from suppliers that could demonstrate they did not cut down forests. Research has shown that organisations that have been proven guilty of such actions are then quick to add a CSR initiative to their corporate goals. Primark sells low cost items since its manufacturing costs are kept low, but the company promotes itself as being ethical and socially responsible. However, it was discovered that child labour was being used and that some suppliers were employing workers paid as little as 9p an hour. In addition these individuals were working 90 hours a week in extremely poor conditions. There are many other cases where companies have declared themselves dedicated to corporate responsibility issues only to later be found operating unethical practices in distant locations. Coca-Cola was reported to be using 6 litres of precious water to make a litre of its famous beverages when that water is scarce and needed by local farmers to grow their crops for survival. At the same time the Company supported water conservation. The company has had trouble shaking off its negative corporate history and, despite all its recent actions on sustainability, has not convinced consumers of its sincerity. In the past 10 years it has had negative publicity about its treatment of workers in Columbia and China, and its role in fuelling child obesity. This has resulted in its products being banned on several university campuses in the USA. Another high profile example is Gap which was found still to be using child labour in 2007 despite a previous discovery being made in 2004. Case Study 8: - Gap's CSR Failures Gap and Corporate Irresponsibility Gap yesterday admitted to widespread problems – from unsafe machinery to child labour violations in the thousands of factories it uses around the world to produce clothing for its retail chains. Seeking to combat its image as a sweatshop operation, the company detailed the findings in its first social responsibility report. The full 42-page document was posted on its website. Gap said it has a team of more than ninety compliance officers who conducted about 8,500 factory visits last year. The company produces garments in 3,000 factories located in 50 countries. Gap said it cancelled supply deals with 136 plants last year because of various violations. Contracts were terminated with 42 plants in China, another 42 in south-east Asia, 31 on the Indian subcontinent and nine in Europe.

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In two factories at which contracts were terminated, Gap identified underage workers – though in both cases they were older than 14. The most frequent violations of Gap's code of conduct included factories not complying with local laws on annual leave, failure to pay the minimum wage, working weeks in excess of 60 hours, inaccurate record keeping and machinery lacking safety devices. On its website in 2007 the company stated that all individuals who work in garment factories deserve to be treated with dignity and are entitled to safe and fair working conditions and not since 2000, when a BBC Panorama investigation exposed the firm's working practices in Cambodia, have children been associated with the production of their brand. Behind the youngsters, huge piles of garments labelled Gap – complete with serial numbers for a new line that Gap concedes it has ordered for sale later in the year – lie completed in polythene sacks, with official packaging labels, all for export to Europe and the United States in time for Christmas. Jivaj, who is from West Bengal and looks around 12, told The Observer that some of the boys in the sweatshop had been badly beaten. "Our hours are hard and violence is used against us if we don't work hard enough. This is a big order for abroad, they keep telling us that. Last week, we spent four days working from dawn until about one o'clock in the morning the following day. I was so tired I felt sick", he whispers, tears streaming down his face. "If any of us cried we were hit with a rubber pipe. Some of the boys had oily cloths stuffed in our mouths as punishment." Manik, who is also working for free, claims – unconvincingly – to be 13. "I want to work here. I have somewhere to sleep," he says looking furtively behind him. "The boss tells me I am learning. It is my duty to stay here. I'm learning to be a man and work. Eventually, I will make money and buy a house for my mother." The discovery of the sweatshop has the potential to cause major embarrassment for Gap. Last week, a spokesman admitted that children appeared to have been caught up in the production process and rather than risk selling garments made by children it vowed it would withdraw tens of thousands of items identified by The Observer. Source :www.guardian.co.uk

How Pressure Groups Influence CSR
There are many pressure groups acting globally and nationally to encourage organisations to be more socially responsible in their use of physical and human resources and attention to reducing the poverty gap. Many have social networking sites where individuals can interact and give their views. Three of the most well known are:  Greenpeace – an environmental pressure group that campaigns for change about many environmental issues such as protecting forests, banning whaling and encouraging sustainable trade. Greenpeace campaigns for many things, but they all centre on the ability to sustain life in its diversity around the world. Coca Cola and others have started working with Greenpeace as an outward demonstration of their commitment to CSR. The promotion of such arrangements is, for the companies concerned, an important way of attracting and retaining customers.

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 

Friends of the Earth – campaigns for solutions to environmental problems; climate change, green economy and natural resources are a few of their areas of interest. Amnesty International – campaigns for the human rights of people around the globe. It states that "Our purpose is to protect people wherever justice, fairness, freedom and truth are denied. We work to bring change for people across the globe". They are concerned with rectifying business actions which threaten human rights, as in the Niger Delta in Nigeria, where they consider Shell's practices are stripping local people of their human rights.

Such high profile pressure groups have a strong influence on businesses and governments, and keep strong links with the press to ensure that issues are communicated globally.

Regulation and Review of CSR in Organisations
The financial goals of Anglo American organisations still take precedence over social concerns, and the vested interests of certain stakeholders remain likely to hold sway over wider social responsibilities. In addition, managers are not rewarded for improving social responsibility and there is evidence that employees are also unaware of what actions the organisation pursues regarding CSR. Given this situation, it would appear that CSR will only develop through external pressure. However, whilst most government and regulatory bodies have stressed the importance of corporate social responsibility, little has been done to embed it into the framework within which businesses operate.  The UN Global Compact (GC) is a voluntary corporate citizenship initiative that engages businesses with civil society and labour organisations, governments, academic institutions and other stakeholder groups. It is based on ten universal principles that address the areas of human rights, labour, environment, and anticorruption. The GC provides business participants with tools to create changes in their practices and they must submit Communications on Progress, which are reports on their sustainability efforts. Many multinationals are members of the GC. In the UK, CSR itself falls within the scope of the Department for Business, Innovation and Skills formed in June 2009, but there is no formal regulation issued about the subject. The government did set up the CSR Academy (now simply the CR Academy) to provide training, support and advice on aimed at developing CR professionals and action plans in organisations. The Companies Act 2006 defines directors‟ duties to include the likely consequences of any decision in the long term in the interests of the company‟s employees and to foster the company‟s business relationships with suppliers, customers and others. The EU is reported to be considering regulation, but although health and safety, discrimination and pollution are already regulated, there appears to be little case for enforcement of CSR on business enterprises.

Regulation is, in reality, based on the idea that government has a reasonable degree of certainty over what is right for all companies. However, there is little agreement about the concept of CSR in general or the way in which any particular approach might develop towards its enforcement, and especially any that takes account of the individuality of different companies and their search for a uniquely sustainable competitive advantage. Nevertheless, companies are taking the issue increasingly seriously. A KPMG report shows that 35% of a sample of companies they researched in 1999 published corporate responsibility reports, and that this rose to 52% in 2005. The same survey identified the drivers for CSR reporting as follows:   economic considerations – 74% ethical considerations – 53%

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   

innovation and learning – 53% employee motivation – 47% risk management and risk reduction – 47% access to capital or increased shareholder value – 39%.

A survey of professional investors reveals a similar trend. A total of 81% of those surveyed said corporate responsibility was currently a „„central‟‟ or „„important‟‟ consideration in their investment decisions, compared with 34% five years ago. This highlights an important shift from the directors‟ concerns solely being for the shareholder to an obligation to be mindful of the needs of all their stakeholders.

Activity 5
Fairtrade is used by some companies to show their commitment to corporate social responsibility and to sustainability of the world's resources. However, there is another view of Fairtrade as shown by the following article: "The core aim of Fairtrade is to improve the lot of small farmers - including their longterm income stability. Crop prices are notoriously volatile. Yet the likes of the educational development charity, Worldwrite, claims that an obsession with „small is beautiful' is a missed opportunity. By focusing on achieving a fair price for poor farmers, adherents fail to address issues of mechanisation and industrialisation – radical changes that might allow farmers in the developing world to stop doing back breaking work and break out of the poverty cycle. Equally, Fairtrade has been accused of promoting a state of dependence in the farmers it is meant to help. This view is articulated by the free market advocate, the Adam Smith Institute: "the (Fairtrade) movement effectively makes farmers 'prisoners to our market'. They become dependent on us continuing to pay premium prices for their goods." The fact that the certification itself is very tightly and centrally controlled in-house by the Fairtrade Labelling Organisation (FLO) seems to support that view. The certification process is also accused of being complex to set up - needing cooperatives of small farmers to come together for certification to be viable. These groups must be managed democratically, have transparent administration and be politically independent. Noble principles but ones that demand time, capacity and money to establish and the cost of the certification has to be borne by the members." (a) (b) (c) Research the key benefits of Fairtrade to growers as specified by the companies that support Fairtrade and describe them. How are these in conflict with the opinions given in the passage above. How does this conflict reflect the view that companies are not sincere about CSR, but are more interested in making bigger profits for their shareholders?

See the suggested answers at the end of this chapter.

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D. WHISTLE-BLOWING AND CORPORATE RESPONSIBILITY
Whistle-blowing may be defined as intervention by an employee to bring the wrongs (or perceived wrongs) of the employer to the attention of the owners of the company, the government, or the public at large. This is a controversial practice which has become the subject of much debate since the 1990s. Although most people agree on what is right or what is wrong, there are many different attitudes to whistle-blowing, particularly as to how far employees should go in speaking out and the degree to which that should be protected from the consequences of so doing. The issue is confused by the conflicting obligations on most workers by a duty of confidentiality imposed by the contract of employment, as well as common law and the wider ethical responsibility to the company and the public at large. So, should an employee keep quiet about a situation which he or she believes to be wrong, or should his or her conscience take over and 'blow the whistle'? This is usually a matter for individual judgment or conscience. As all employees are different, they will react in various ways as well as interpreting situations differently.

The Cases For and Against Whistle-blowing
The primary case for whistle-blowing insists that employees have a moral duty not just to their work and their immediate boss, but to the company and society as a whole. Thus, there is an obligation to report wrongdoing and it is matter of conscience. Other motivations and arguments include:   If a wrong is seen by a person, there may be other things happening, which are unacceptable – it might be the 'tip of the iceberg'. If unacceptable behaviour is allowed to persist without redress, others will believe they can get away with the same thing.

Note that, in certain situations, whistle-blowing is actually required by law – for example, where health and safety at work rules are being breached. On the other hand, if information is given to someone outside the organisation, this can be a breach of contract and render the whistle-blower liable to dismissal or even criminal action. It is common practice in many organisations for the terms and conditions of employment to bind the employee to secrecy, even after s/he leaves. Other arguments against disclosure include:   The belief that the employee should concentrate on doing her/his job and that the actions of others are nothing to do with him/her. Situations may be misinterpreted, or an employee can overrate the importance of the perceived misdemeanours of others, and what may be seen as a breach of company rules or policy may in fact be perfectly legitimate. Some employees are reluctant to 'blow the whistle' due to a 'snitching' mentality, where it is considered bad to tell tales on others.

To counter the threat to job security and the personal consequences of whistle-blowing, it can sometimes be done through a third party – for example, trade union representative can often handle what might be a difficult situation without exposing the individual to recriminations. Unions are becoming more aware of the need to act as moral policemen. In late 1997, one such organisation stated that it was going to compile a 'rogues' gallery' of employers and publicise their actions. Aimed primarily at identifying bad employment practices, this initiative

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would appear to be an open door through which potential whistle-blowers could move if they believe a case has to be answered.

Public Interest Disclosure Act 1998
In the UK, the Public Interest Disclosure Act 1998 is designed to give protection to individuals who disclose information which is perceived to be in the public interest. The stated intention of the Act was “to end the 'cover-up culture' that prevails in some organisations, where workers fear victimisation if they tell their bosses of a major problem”. The Act lists a number of protected disclosures which qualify the individual making the disclosure for protection under the Act. The disclosures can be summarised as: (a) (b) (c) (d) (e) (f) That a criminal act has been, is being, or is likely to be committed That a person has failed, is failing or is likely to fail to comply with any legal obligation That a miscarriage of justice has occurred, is occurring, or is likely to occur That the health and safety of any individual has been, is being, or is likely to be endangered That the environment has been, is being, or is likely to be damaged That information tending to show that any matter falling within the items above has been, is being, or is likely to be deliberately concealed.

Under the Act an individual who makes a protected disclosure has a right not to suffer detriment by the employer's resulting action. An employee dismissed as a result of making a protected disclosure can take a case to an employment tribunal. It is not only employees that the Act is designed to protect. Companies in the past have paid the price of ignoring employees who tried to point out wrongdoings. The Act has a deeper aim in encouraging businesses to behave ethically. In several previous public enquiries into rail and maritime disasters causing loss of life, it was shown that staff had tried to warn of dangers but had not felt able to raise the matter internally. If they had had the protection of the Act they might well have felt able to discuss the safety matters with their organisations and hence the disasters might not have happened.

Key Examples of Whistle-blowing
There have a large number of very high profile cases over many years, including the following:  Daniel Ellsberg – an employee of the US State Department who, in 1971, leaked secret details of the Vietnam War (known as the Pentagon Papers) to the New York Times, revealing deception by governments in their public statements over several years. He faced charges of espionage and the prospect of 115 years in prison, but all charges were subsequently dropped after evidence of government misconduct and illegal wiretapping were disclosed in the run up to the trial. Mordechai Vanunu – an employee of the secret Israeli nuclear weapons programme who revealed details to the British press in 1986. He was subsequently kidnapped by the Israeli secret service and spent over fifteen years in prison. Jeffrey Wigand – a former Vice President of Brown & Williamson Tobacco, who revealed on television in 1996 that the company knew exactly how addictive and lethal cigarettes were, yet knowingly increased the amount of nicotine in them. He was sued by the company, although the case was later dropped. The whole incident was the subject of the 1999 film The Insider. Karen Silkwood – a union activist and technician at the Kerr-McGee nuclear plant who alleged there were numerous violations of health and safety regulations at the plant in

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1974. She died under mysterious circumstances shortly after. Her story was also filmed, as Silkwood, in 1983.  Sherron Watkins and Cynthia Cooper – employees of Enron and Worldcom respectively, who revealed details of corrupt corporate financial practices at their companies in 2002.

One of the key examples in the UK was the Sarah Tisdale case. Case Study 9: Sarah Tisdall’s Disclosure One of the highest profile examples of whistle-blowing occurred in the UK Civil Service in 1983. A civil servant, Sarah Tisdall, discovered that government policy on nuclear missiles was at odds with its public pronouncements on the issue. Apparently driven by her own conscience to do what she believed to be right, she leaked documents to the press. The consequences of her action were dismissal from the Civil Service and prosecution for offences under the Official Secrets Act. She eventually served a custodial sentence when the case was proven against her.

In late 2010, the WikiLeaks website disclosed thousands of classified documents causing furore amongst governments, which then put pressure on internet providers to cut off access to the site. Excerpts are given in Case Study 10. Case Study 10: WikiLeaks Discloses Confidential Documents "WikiLeaks directed readers to a web address in Switzerland on Friday after two U.S. Internet providers ditched it in the space of two days and Paris tried to ban French servers from hosting its leaked data. The Internet publisher directed users to www.wikileaks.ch after the wikileaks.org site on which it had published classified U.S. government information vanished from view for about six hours. The United States is furious about WikiLeaks' publication of hundreds of confidential diplomatic cables that have given unvarnished and sometimes embarrassing insights into the foreign policy of the United States and its allies. WikiLeaks has released about a quarter-million confidential American diplomatic cables most sent during the last three years, which the website christened as Cablegate. The cables, which date from 1966 up until the end of February this year, contain confidential communications between 274 embassies in countries throughout the world and the State Department in Washington. The question is why, when America makes claims about its technological prowess, has not been able to devise a foolproof system to save it and its friends from embarrassment. After 9/11, America had changed its communication systems including the codes used, the question is how it was possible for WikiLeaks to decode the messages.

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Introduction to the Socio-Cultural Business Environment

Amazon denied it was under pressure from lawmakers, saying WikiLeaks had breached its terms by not owning the rights to the content it was publishing. But U.S. Senate Homeland Security Committee chairman Joe Lieberman questioned Amazon about its relationship with WikiLeaks on Tuesday and called on other companies that host websites to boycott WikiLeaks."

Those who have the experience of working in diplomatic missions know that internal reporting between embassy and the government is often frank and candid, but its veracity depends on the reliability of the diplomat and of those who provide the information. Against this backdrop, one would not know if all that has been quoted by WikiLeaks is correct. It has been portrayed as an effort to create strained relations between the US and other countries. However, WikiLeaks has caused ripples throughout the world, as the private insinuations from US diplomats about the leaders of other countries have hit the headlines. The leaking of confidential documents not only caused embarrassment for the individuals who made personal remarks about high level government officials, but also provided ammunition that could be used against the US by unfriendly governments. This was also one of the first whistle-blowing events involving the internet, and caused a number of apparently innocent companies such as Amazon to get into conflict with the US government. There is a potential threat that this could cause governments to look at ways of regulating and restricting the currently free circulation of information on the internet (at least in most countries).

Think Point
What are your own views on whistle-blowing? Would you do it, especially given the risks to yourself – both in terms of employment and potential for legal action? To what extent should whistle-blowers be protected

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SUMMARY
The world population will continue to grow over coming decades. However, industrialised countries are likely to have less population growth and an ageing workforce. The typical level of education and skills in the countries that have the fastest growing population are very low. Sub Saharan Africa is forecast to have exploding population growth. The level of disposable income will rise rapidly in many of the now emerging economies, providing MNCs with exceptional opportunities for growing their businesses and profit levels. The characteristics of the workforce are changing. The number of women in the workplace has increased owing to less demanding domestic tasks, higher levels of education and the possibility of work virtually. However, in some cultures the opportunities for women to work inside or outside the home environment will continue to be severely restricted. In western industrialised countries significant generational differences in expectation have arisen, which companies are trying to manage. The key characteristics of the newest generations of workers, known as Generation Y, are:        Technologically competent and connected 24 hours, 7 days a week Self-confident and opinionated Entrepreneurial, educated, bored by routine Environmentally and ethically focused Success-driven, goal orientated Diverse Lifestyle centred.

There are also changes in career expectations among Generation Y as a result of the economic and social environment in which they have grown up:       Long-term career development and multiple experiences within a single organisation Sense of purpose and meaning to the work Access to mentors and other company champions Work-life flexibility Tech-savvy work environment Primary loyalty is to networks before their employers.

Greater prominence given to these differences has resulted in challenges for managers and a need for new management approaches to capitalise on the differing talents and requirements of each generation so as to maximise the benefits for the firm. Business ethics concerns the idea of right and wrong transferred to the business setting. These ideas vary by cultures as do aspects of morality. There are three main models in which the content is focused in different ways and the responsibility for ensuring ethical practice varies. Managers often face ethical dilemmas in doing what is right morally, but which may affects others in a negative way. There are guidelines for managers to follow to ensure that they are behaving in as ethical a manner as possible. Corruption is one of the biggest unethical practices. This has been linked to different cultural approaches and to country GDP and average pay levels. Firms can follow ethical principles by ensuring that there is an ethical approach through the publication of and training about its code of conduct. Some firms have extended this code of

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conduct to their suppliers and will only contract with suppliers who comply with their standards. Corporate social responsibility has links to business ethics. However, there is no clear definition of the term which is consequently interpreted in different ways.  There is substantial evidence that Anglo American companies, in particular, adopt socially responsible practices that will assist them to achieve their corporate goals. Although in many cases, the recipient of the socially responsible practice do gain some benefits, the firm gains cost savings and innovative ideas which provide it with better performance and increase in market share. There have been a number of reported incidents of unethical practice by these same companies that promote themselves as socially responsible. Scepticism about the benefits of corporate responsibility is pronounced. Many managers do not see that there is any benefit to the firm, merely a cost. As managers targets are all focused on increasing shareholder value, there is no commitment to promoting socially responsible practices. Regulation and some legislation have been introduced to encourage better practice, but generally a firm makes the decision to demonstrate corporate responsibility on a voluntary basis. CSR is rarely integrated with strategic goals and often dealt with by PR people in the organisation. Recent research indicates that more organisations are publishing Corporate Responsibility strategies and joining together in voluntary groups such as the UN Global Compact which commits firms to report on standards within their organisation.

Whistle-blowing is a practice that is encouraged in Anglo American firms. This allows individuals to reveal company practices and information, which they regard as unethical. The original practice was an internal company one, but in recent years employees have revealed these „wrong doings‟ to the press. The recent scandals about MP‟s expenses in the UK are a further example of the growing pressure for transparency of practices in organisations.

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ANSWERS TO ACTIVITIES
Activity 1 (a) (b) The forecast is that UK, Japan, China, South Korea and Europe will all have ageing populations in the next 20 years and their working populations will fall. There will be too few skilled young people to take up jobs, and companies and countries are likely to depend on immigrant workers. Many young people from developing countries currently have low levels of literacy and poor access to education. Some companies such as Petrobras are educating their workforce to raise skill levels. They know that disposable income will increase in these countries which also have large populations. These two factors provide significant opportunities for growth of turnover and increases in shareholder value.

(c)

Activity 2 There are groups of clauses on workers‟ rights, whistle-blowing, personal conduct and morality – for example:    Workers‟ rights are referred to in diversity and inclusion, harassment, health and safety. Whistle-blowing is inferred in references to insider trading and harassment. Misconduct and morality are referred to in bribery and corruption, fair competition, money laundering.

Activity 3 (a) It describes a focus on the collective good of the country instead of on the individual or shareholder value. Tata expects all its employees to respect the culture they find themselves in and act in an ethical way towards those communities. The community and the way the company can help members of that community is put at the centre of its business approach. (b) (i) The detail of the individual clauses are very similar to those in the Xerox Code of Conduct – for example, it covers gifts and entertainment, shareholder value, ethical conduct. It seems to have been heavily influenced by the Anglo American ethics model, but it is interesting to note that the company is the subject of many clauses rather than the individual. In the Asian Pacific style of ethics, it is senior management who are held responsible for the ethics of the company. Tata is a global company and many or its operations take place in the Anglo American economy.

(ii)

Activity 5 (a) The Fairtrade website states that the benefits of fair-trade are:      That farmers receive a fair and stable price for their products. That extra income is provided for farmers and estate workers to improve their lives. That a greater respect for the environment is engendered. That small farmers have a stronger position in world markets. That there is a closer link between consumers and producers.

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(b)

There are two main issues of conflict brought up by the article:   The improvement in their lives does not extend to the development of the work practices which may make them more efficient producers. Rather than making their trading position stronger and helping the farmers to achieve independence and to be able to negotiate in the market themselves, Fairtrade makes them dependent on the buying firms to achieve a reasonable price for their crops.

(c)

The passage, when compared to the text on the Fairtrade website and that given by MNC websites, reflects well the potential insincerity of the companies claiming to act responsibly. Although the companies are paying higher prices, they also lock the farmers into producing for them. This gives the companies a potential competitive advantage of being able to acquire supplies when their competitors cannot, of those ingredients being of a higher quality (through assistance given to improve crops) and their production more sustainable. In other words, the companies can potentially guarantee their future crop resources while keeping the farmers dependent on them and appearing to be socially responsible.

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