My Revision Notes Edexcel A-Level Business 2nd Hodder

Pearson Edexcel
A-level
BUSINESS
SECOND EDITION
Andrew Hammond
h
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Edexcel A-level Business Second Edition
My Revision Planner
Theme 1 Marketing and people REVISED I TESTED I EXAM

I I READY
1 Meeting customer needs
10 The market
13 Market research
15 Market positioning
2 The market
19 Demand
21 Supply
22 Markets and equilibrium
24 Price elasticity of demand
26 Income elasticity of demand
3 Marketing mix and strategy

30 Product and service design
31 Branding and promotion
34 Pricing strategies
36 Distribution
38 Product life cycle and portfolio
43 Marketing strategy
4 Managing people
46 Approaches to staffing
49 Recruitment, selection and training
52 Organisational design
55 Motivation in theory
58 Motivation in practice
60 Leadership
5 Entrepreneurs and leaders

63 Role of an entrepreneur
66 Entrepreneurial motives and characteristics
67 Business objectives
69 Forms of business
72 Business choices
73 Moving from entrepreneur to leader
Theme 2 Managing business activities

6 Raising finance
78 Sources of finance: internal and external
82 Liability and finance
84 Planning and cash flow
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7 Financial planning
88 Sales forecasting
90 Sales, revenue and costs
92 Break-even
95 Budgets
8 Managing finance
99 Profit
102 Liquidity
104 Business failure
9 Resource management
107 Production, productivity and efficiency
110 Capacity utilisation
112 Stock control
115 Quality management
10 External influences
118 Economic influences
122 Legislation
125 The competitive environment
Theme 3 Business decisions and strategy

11 Business objectives and strategy
128 Corporate objectives
129 Corporate strategy
132 Ansoff’s Matrix
134 SWOT analysis
138 Impact of external influences
141 The competitive environment
12 Business growth
145 Growth
147 Organic growth
149 Mergers and takeovers
152 Reasons for staying small
13 Decision-making techniques
155 Quantitative sales forecasting
159 Investment appraisal
163 Decision trees
166 Critical path analysis
14 Influences on business decisions

171 Corporate influences
174 Corporate culture
177 Shareholders versus stakeholders
180 Business ethics

15 Assessing competitiveness
184 Interpretation of financial statements
189 Ratio analysis
193 Human resources
16 Managing change
198 Causes and effects of change
200 Key factors in change
202 Scenario planning
Theme 4 Global business

17 Globalisation
206 Growing economies
209 China versus India
211 Business potential in Africa
213 International trade and business growth
216 Factors contributing to increased globalisation
218 Protectionism
221 Trading blocs
18 Global markets and business expansion

225 Conditions that prompt trade
227 Assessment of a country as a market
230 Assessment of a country as a production location
233 Reasons for global mergers or joint ventures
235 Global competitiveness
19 Global marketing
240 Global marketing
243 Global niche markets
244 Cultural and social factors in global marketing
20 Global industries and companies (multinational corporations)

248 The impact of multinational corporations
250 Ethics in global business
253 Controlling multinational corporations
Glossary
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A-level Business Paper 1
+ Look at past papers. They are one of the best
ways to revise and practise your exam skills. Date:............................................................................
Write or prepare planned answers to the exam Time:...........................................................................
practice questions provided in this book. Check
your answers online and try out the extra quick Location:......................................................................
quizzes at www.hoddereducation.co.uk/
myrevisionnotesdownloads A-level Business Paper 2
+ Use the revision activities to try out different revision Date:............................................................................
methods. For example, you can make notes using Time:...........................................................................
mind maps, spider diagrams or flash cards.
Location:......................................................................
+ Track your progress using the revision planner and
give yourself a reward when you have achieved your
A-level Business Paper 3
target.
Date:............................................................................
Time:...........................................................................
Location:......................................................................

Introduction
Assessing A-level Business
Introduction
As an A-level Business student, it is important that you understand three key
things relating to your exams:
+ Assessment objectives
+ The command words used
+ The nature of the exam papers.
Assessment objectives
+ AOl - Demonstrate knowledge of terms, concepts, theories, methods and
models to show an understanding of how individuals and organisations
are affected by and respond to business issues.
+ AO2 - Apply knowledge and understanding to various business contexts
to show how individuals and organisations are affected by and respond
to issues.
+ AO3 - Analyse issues within business, showing an understanding of
the impact on individuals and organisations of external and internal
influences.
+ AO4 - Evaluate qualitative and quantitative evidence to make informed
judgements and propose evidence-based solutions to business issues.
Command words
+ Explain (4 marks) Requires a multi-stage definition which has been
linked to the context and includes analysis. If asked to explain a graph,
interpretation of what is shown is key. You must ensure that you show
understanding by making a point and then expanding on why that is so, or
what that means.
+ Calculate (4 marks) Assesses quantitative skills. ‘Calculate’ will require a
multi-stage calculation. These stages may include finding the right data,
recalling the correct formula, substituting the data into the formula and
performing the calculation.
+ Assess (8,10 or 12 marks) These questions expect a contextualised and
balanced answer with connectives. You are expected to consider factors
or events that are relevant to the question, ensure that you have included
contrasting arguments and then judge which are the most important or
relevant, justifying why.
+ Evaluate (20 marks) These questions need to build towards an informed
judgement and supported conclusion. You must review information then
bring it together to form a conclusion, drawing on evidence including
strengths, weaknesses, alternative actions, relevant data or information.
The A-level exam papers

The A-level is examined across three exam papers. Papers 1 and 2 each
contribute 35 per cent towards your final grade, while Paper 3 contributes 30
per cent. All three papers are marked out of 100 and last for two hours.
Paper 1 - 100 marks split into two sections

+ Section A and Section B - both based on stimulus material. Each section
consists of one data response question made up of several parts, including
one 20-mark evaluation question.
+ Questions on Paper 1 will test Theme 1 (Marketing and People) and Theme
4 (Global Business).

+ Section A and Section B - both based on stimulus material. Each section
consists of one data response question made up of several parts, including
one 20-mark evaluation question.
+ Questions on Paper 2 will test Theme 2 (Managing Business Activities) and
Theme 3 (Business Decisions and Strategy).

+ In November of the year before your exam, Edexcel will release the broad
context in which questions on this paper will be set. This will usually
involve telling you the industry from which the exam paper’s data will be
drawn, as well as identifying several aspects for you to research.
+ Section A - Based on stimulus material newly provided in the exam. This
section will focus on the broad pre-released context. One data response
question made up of a number of parts, including one extended open
response question. These are usually ‘assess’ or ‘evaluate’ questions only.
+ Section B - Based on further stimulus material newly provided in the
exam. This section will focus on a strand within the broad pre-released
context - in other words, one of the areas you were advised to research.
One data response question made up of several parts, including one
extended open-response question.
+ Questions on Paper 3 will draw from all four themes of your course.

1 Meeting customer needs
The market
Markets are where buyers and sellers meet in
order to exchange goods or services
A market exists where buyers and sellers meet in order to exchange goods
or services. Though some markets can be identified as having a physical
location, markets are best thought of as any occasion where a buyer and seller
can interact and can therefore be online, by post or in a shopping centre or
trade fair.
Mass markets and niche markets REVISED

□
Some businesses will produce products and services aimed at satisfying
A market segment is
the needs of a whole market, rather than any specific section of the market.
a subsection of a larger
Attempting to sell to the whole market is called mass marketing.
market in which consumers
Other businesses select a segment of the market and sell products specifically share similar needs and
to suit the needs of consumers in that segment. This process is called niche wants.
marketing. A niche market is a small
Table 1.1 Benefits of different marketing strategies segment of a larger market.
Benefits of mass marketing Benefits of niche marketing

Huge potential number of customers Meeting consumer needs more precisely
allows higher prices to be charged
Higher production levels allow Higher profit margins
economies of scale - lower production
costs
Can use mass media advertising Easier to enter for firms with limited financial
resources
There are notable differences between mass and niche markets as shown in
Table 1.2:
Table 1.2 Differences between mass and niche markets
Mass market Niche market

Characteristics Generic products which are broadly Specialist products and services are required.
similar in form and function Changes in consumer preferences can be rapid
and devastating to the market
Market size and share Huge markets in which large firms can Smaller markets mean successful firms may
operate successfully even though their achieve far higher shares of their niche than
market share may be low, e.g. Ferrero's mass market firms
5% share of the UK chocolate market
Brands Huge brands can develop with their Differentiation is more likely to be achieved
name/logo representing a key point of through product features and functions
differentiation

Exam tip
Choosing a mass or niche market approach is a strategic choice. In other words, this
choice will affect the whole business, from the approach to marketing through to
Meeting customer needs

decisions on scale of production and production methods and locations. Try to ensure
that when writing about a firm using mass or niche marketing you acknowledge the
impact of the choice of marketing strategy on other business decisions.
Now test yourself
1 State two benefits of mass marketing.

2 State two benefits of niche marketing.
Answers available online
Dynamic markets REVISED

□
7
No business can afford to stand still because markets are dynamic; they tend
to change over time. There are four major issues to consider:
Online retailing
Making links
Continued growth in online retailing has varied between different markets:
+ Clothing has grown tremendously but growth in online sales of books has This topic links to small
slowed to a virtual halt. business survival in
+ This unpredictability of growth adds to the unpredictability of dynamism competitive markets
in online retailing. (page 162). One of
+ History has shown us that retailers who fail to switch to online retailing the strategies a small
can fail completely as online rivals steal sales. business can use is
e-commerce-which
Above all, it is vital to ensure that your product or service is available to buy allows it to keep overheads
wherever consumers want to buy it. In some cases it is vital to have an online low and therefore prices
presence, or if consumers want to buy online and collect from their local competitive.
store, a click-and-collect service is needed.
How markets change

Markets change as a result of major external influences, as summarised by
the PESTLE acronym. PESTLE highlights the major
sources of external changes
Now test yourself * faced by businesses:
Political, Economic, Social,
Explain how small e-commerce retailers can charge a similar price to large high Technological, Legal and
street retail chains who receive bulk-buying discounts. Environmental.
4 Why might niche market businesses be especially vulnerable in dynamic markets?
Examples of market changes include the following:

+ Political: Britain’s departure from the European Union (Brexit) has led to
significant change in the process of importing and exporting.
+ Economic: The economic recession of 2008-09 led to major changes in UK
grocery retailing, as price-conscious shoppers opted for Aldi and Lidl.
+ Social: An increased desire for convenience has driven the rise in online
retailing.
+ Technological: Apps’ did not exist 15 years ago, prior to the advent of the
smartphone; by 2020 they were capable of turning century-old markets
on their head, such as the effects of Uber on taxi services or of AirBnB on
travel.
+ Legal: Growth in the market for vapes and e-cigarettes is being affected
by the introduction of new laws relating to who can buy these items, how
they can be advertised and where they can be consumed.
+ Environmental: The car industry is facing major changes in order to try to
minimise the damaging impact of exhaust fumes on the environment.

Making links
Many of these PESTLE factors are considered in Chapter 11 under the heading 'impact
of external influences' (page 147). It is there that you will cover why changes take place
in more detail - and, even more importantly, go on to consider how external changes
require strategic changes from businesses.
Innovation and market growth

+ A major cause of change within markets is innovation.
+ With competing firms continually trying to develop new products and
services that offer features that no rivals offer, consumer loyalties can
change dramatically.
+ Once one innovation has been successful, other companies may be forced
to try to adapt their offerings in order to keep pace with rivals.
+ Furthermore, many companies will try to come up with their own
innovations in order to try to benefit by leading change in the market.
Now test yourself Typical mistakes
5 How has technological change affected take-away food outlets? Too often exam answers
Another example of social change is an increase in the amount of 'retired' people imply that adapting
to change is a simple
still working. What benefits might B&Q experience from their policy of ensuring
that an appropriate number of their staff are 'older'? process for a business.
These responses fail to
Answers available online show an appreciation
of the impact on all four
business functions:
Adapting to change
marketing, people, finance
Market research and an understanding of general trends in the market are and operations. Required
vital to successfully adapting to change: changes may include
+ Identifying subtle changes in what consumers are looking for in their production methods, finding
products allows businesses to adapt their products to better suit these new suppliers, redeploying
needs. workers and adopting new
+ Changing earlier than rivals offers a major source of competitive advertising and distribution
advantage, whether it be removing sugar from food products or adding methods.
features to mobile phone handsets.
How competition affects the market REVISED

□
Competition is the feature of business that most stimulates change and
development. This is especially clear in the battle between Apple and
Samsung in the smartphone market. Neither can sit back for a moment.
That was clear when the market loved Apple’s new iPhone 11, knocking
Samsung off its top spot. Then, once again, Samsung needed to develop
upgrades to its S20 model to try to claw back its market leadership
position from Apple.
Increased levels of competition create various pressures for businesses:
+ The need to drive down costs.
+ The need to maintain competitive prices.
+ The need to develop innovative products and services.
+ The need to maintain high-quality products and services.
Now test yourself TESTED
What are the six major external forces that lead to change in markets?
State three benefits experienced by consumers as a result of increased
competition in a market.

The difference between risk and uncertainty REVISED
□
Operating a business in any market involves facing up to risk and coping with
uncertainties: Typical mistakes

+ The key difference lies in the predictability of events occurring.
Too many exam
+ A risk is quantifiable, so if statistics show that only 1 in 20 new consumer
answers use the terms
goods succeed, the risk involved in launching a new product can be
'risk' and 'uncertainty'
identified and quantified. interchangeably - they are
+ The factors causing the risk are the uncertainties - those factors that cause not the same thing.
a lack of certainty in future events - such as reactions of rivals, reactions of
consumers, reactions of retailers and such unexpected events as currency
movements and economic downturns.
Making links
7
Market research can help to reduce risk by eliminating some uncertainties (see below).
Recognising this can help to assess the usefulness of market research when tackling
exam questions. An answer explaining that research has reduced the uncertainty over
which product to launch leading to a reduction in risk will show good justification.
what marketing activity tends to be the key to successfully adapting to change in

markets?
Market research
Discovering information that helps a
business understand its market
Product and market orientation 1 REVISED
□
Product orientation is an approach to making decisions that considers
internal factors before worrying about changes in the market:
+ This means that product-orientated businesses can focus on their own
key strengths, which can lead to revolutionary new ideas that consumers
would never have dreamed of.
+ However, the danger is that the business fails to adapt its products in
line with what consumers are looking for, which could lead to huge
problems.
The opposite approach - market orientation - is more likely to lead to
marketing success since it places consumers’ views and behaviours at the Primary research is new
heart of decision-making within the business. research conducted for a
particular purpose.
Secondary research uses
Which type of business is likely to allocate a larger budget to market research - a pre-existing data that has
product-orientated or a market-orientated business? been gathered for another
purpose.
Primary and secondary research REVISED

□
Market research can use either secondary data or primary data, with primary
research being new research carried out for the first time, and secondary
research being research that uses data that has already been gathered for
some other purpose.

Primary versus secondary research
Table 1.3 Advantages and disadvantages of primary and secondary research
Primary research Secondary research

Typical mistakes
Advantages + Addresses the specific issues + Often free Primary research does
the business interested in + Provides a good market not have to be carried out
+ Data is up to date overview by individual businesses.
+ Can help to understand + Usually based on large-scale, They can hire a market
customer psychology reliably produced research research company to do
Disadvantages + Expensive, costing + information may be out of the research for them. If
thousands of pounds to do date it is new research it is still
properly + Not tailored to suit your primary. Primary means
+ Risk of bias from particular needs newly gathered, whereas
questionnaire and interviewer + Can be expensive to buy secondary uses data that
+ May need to compare published research reports has already been gathered
1
with other information to on markets for another purpose.
understand the meaning of
findings
Now test yourself Exam tip
is a product-orientated or market-orientated business more likely to come up with Generally most firmswill
brand new, revolutionary product ideas? use a combination of
12 What type of research uses data that has already been gathered for another purpose? secondary and primary
research, with secondary
3 What type of research gathers brand new data?
often conducted first to
Answers available online help design the primary
research needed without
Table 1.4 Different primary and secondary research methods incurring the high cost of
primary research first.
Secondary research methods Primary research methods
The internet Surveys
Trade press Retailer research
Government statistics Observation
Past internal sales figures Group or individual discussions
Quantitative research
Quantitative versus qualitative data is research conducted
The data gathered by market research may be quantitative or qualitative: on a large-enough scale
+ Quantitative data is factual, often numerate data that aims to be to provide statistically
statistically representative of the whole market. reliable data, usually aimed
+ Qualitative data contains opinion and is unlikely to have been gathered on at discovering factual
a large enough scale to give statistically reliable data. It is designed to give information about how
insight into why customers behave the way they do. customers behave.
Qualitative research is
unlikely to be carried out on
14 what type of research is aimed at delivering statistically reliable information? a large-enough scale to give
statistically valid data, but is
5 What type of research is aimed at finding out about customer attitudes in the hope
instead aimed at providing
of gaining insights into consumer behaviour?
insights as to why customers
Answers available online behave the way they do.
Limitations to market research REVISED

□
If all market research provided accurate and reliable data, then all businesses
would succeed. There are two major reasons why market research data may
be unreliable:
+ Sample size too small: This means that there is more chance that
respondents who do not reflect the overall views of the market are over-
represented in the sample.

+ Sample bias: The way that respondents are selected may cause certain
types of people to be over-represented in the sample. Their views may
skew the overall findings away from the views of the total population
being researched.
Exam tip
The research method may not be the major mistake made by a business whose
research seems to let them down. Analysing and then interpreting market research
data is the most common problem within the marketing process. The best marketing
decision-makers use surveys to provide insights - but they still take the key decisions
based as much on experience and intuition as on research.
Use of ICT to support market research REVISED

□
There are three main ways in which ICT can support market research:
Typical mistakes
+ Company websites can gather data on visitors to the website, which can
provide some information about online shoppers’ or browsers’ interests. Despite their name, a major
+ Social media can also offer information on consumer attitudes to a product purpose of loyalty schemes
or service, and even allow for an element of relationship-building between is to gather information on
the business and consumers. customers' buying habits.
+ Database technology, which has advanced so far in recent years, allows Therefore expect to use the
vast quantities of data relating to consumers to be trawled in order to concept of loyalty in answers
identify patterns that can help to explain how consumers actually behave, about market research as
with much of this data being generated by loyalty cards. well as in answers about
building customer loyalty.
Market segmentation ' REVISED

□
One main function of market research is to help to decide on useful ways Market segmentation
to segment markets. Splitting markets up helps to target specific groups means discovering useful
of consumers who share similar needs and wants, enabling a firm to meet ways to split up a market
these more closely. Market research can unearth insights that allow firms to into different groups of
identify segments that they can fulfil profitably. consumers who share
Benefits of segmenting a market include: similar characteristics,
wants and needs.
+ Products and services can be designed to suit specific customers.
+ Meeting customers’ needs precisely allows a higher price to be charged.
+ Promotional activity is easier to target.
Now test yourself
State two reasons why the results of market research may give misleading results.
17 List three ways that ICT can help with market research.
1: State three benefits of segmenting a market.
19 State three criteria by which a market may be segmented.
Market positioning__________________________________
Deciding how you want consumers to
perceive your product
Decisions over fine tuning the product being sold must follow earlier, strategic
decisions about what products to sell to which markets. This fine tuning is
the process of market positioning.

Making links Market positioning
means deciding exactly
The marketing mix (see Chapter 3) represents the toolkit a business can use to
what image you are trying
precisely position its product. Therefore you should be able to link the concept
to create for your product,

of market positioning to any answer where you are explaining a decision on the relative to its rivals.
marketing mix.
Market mapping REVISED

□
The two key judgements required in successful market mapping are:
+ choosing the right variables to place on each axis
+ placing rival brands in the correct places on the map, truly reflecting
consumer perceptions of those brands.
Healthy
1
M&S
sandwich
Older customer
Fish 'n' chips

McD
Less healthy
Figure 1.1 Market map of the UK fast food industry
With a market map produced, a business can identify the gaps in the market
more easily. So Figure 1.1 suggests that a gap selling healthy fast food to
younger customers may be a business opportunity.
Following this is a check to ensure that any gaps can be filled profitably. For
example: drawing a map of the UK car market can identify a gap for a truly
luxurious sports car selling for £10,000. Of course, the reason why this gap
exists is that no firm is capable of making the product at a cost that will give
them a profit at a price of £10,000.
With a gap identified, the firm must then decide how to use the marketing
tools at its disposal. Managers will want to create an image that matches the
product to the gap that has been identified.
Competitive advantage REVISED

□
Products without any competitive advantage over their rivals have been
proven time and again to have no long-term future. The two major generic
routes to finding a competitive advantage are to:
+ be the lowest cost producer, e.g. Ryanair in the European airline market
+ find a sustainable point of differentiation, e.g. KFC in the market for fast
food.
Producing your product more efficiently and thus more cheaply than any
rivals will ultimately allow a business to sell at a lower price than any other
firm, yet still make a profit. Generally, in any given market there is space for
one firm to fulfil this role of lowest cost producer.
The key to competitive advantage is that it should be sustainable in the long
term. A really strong brand name and image can achieve this, but only if the
whole business focuses on providing the products and service that match or
even enhance the brand.

Now test yourself Making links
20 what is market mapping designed to reveal? Sustainable competitive

advantage is the principle
21 What are the two main routes to competitive advantage?
is at the heart of Porter's
2 Explain the effects that the arrival of Aldi and Lidl have had on Tesco in the UK strategic matrix, which you
grocery market. will look at closely in Theme
Explain the main sources of competitive advantage for each of the following: 3 (see page 130). According
a) iPhone to Porter, no business
b) Nestle's KitKat can experience long-term
c) Nando's. success without sustaining
a competitive advantage.
How can being the most efficient producer of a product create long-term success?
Product differentiation r REVISED

□
Standing out from rivals can be achieved through actual, tangible differences
Typical mistake
between products or through manipulating consumer perceptions of your
product - a kind of psychological differentiation. Possibilities are shown in Be careful not to over-use
Table 1.5. the term 'unique selling
point'. Many product
Table 1.5 Tangible and psychological differences between products
features can differentiate
Actual product differentiation Perceived product differentiation a product without actually
being unique.
Design Branding
Different functions Advertising
Taste Sponsorship
Performance Celebrity endorsement
The purposes of product differentiation are: Product differentiation

means attempting to make
+ insulating the product from the actions of competitors
a product seem different,
+ allowing prices to be increased without a major fall in demand or sales.
in the minds of consumers,
to any other rival in the
Making links market.
As we will see later, in Chapter 2, differentiation is the key to reducing a product's
price elasticity. A product that stands out from its rivals will be perceived to have
fewer close substitutes, so customers will keep buying even when price is increased
as they do not believe there are any alternatives.
Adding value ' REVISED

□
Product differentiation generally helps to add value to products and services:
Added value is the
+ The ability to push prices higher without increasing the costs of producing
difference between the
a product will naturally add value.
cost of bought-in goods
+ Added value may come about through tangible, engineering methods,
and services and the selling
such as creating a great design or finding a way to produce in a far cheaper
price of a product.
manner, or it may be added through perception, generally through
promotional methods used by the business, such as advertising and
branding. Making links
+ L’Oreal’s long-standing slogan ‘Because I’m worth it’ is the company’s Effectively adding value
clever way of persuading customers that paying a higher price for L’Oreal boosts profit margins -
products is ‘worth it’, i.e. it adds value. most notably gross profit
margins - as the gap
between the selling price
and variable costs widens
(see Chapter 8).

5 what are the two main benefits of successful product differentiation?

26 How can advertising add value to a product?
Exam practice
The market for toys in the UK is highly seasonal. It is a e-commerce site through which Subbuteo products can be
market that has a strong record for innovation, especially bought directly may be harming sales growth.
in the development of electronic toys that use the latest
Questions
audio-visual technology, and can often throw up surprise
success stories. Over the past three years, the market has 1 Explain how the use of a familiar brand name can
grown. As well as new toy products, some old products help Hasbro relaunch Subbuteo products. [4]
are also making a return. In the niche market of sports 2 Assess the decision to relaunch Subbuteo
games, a global giant Hasbro has relaunched Subbuteo without an e-commerce site. [10]
table football in the UK. It decided to go ahead after
3 Assess the major influences on the market size
studying the results of some quantitative research among
of the toy market examined
boys. The game, which was first launched in the 1950s,
in the item. [12]
had been withdrawn from the market in 2007. With the
game beginning to appear in major toy retailers such as Answers and quick quiz 1 online at
Argos and John Lewis, the relaunch seems to be proving www.hoddereducation.co.uk/
a modest success. Nevertheless, many commentators myrevisionnotesdownloads
have suggested that the company's failure to launch an
Summary
+ Mass marketing and niche marketing are alternative + Market research methods can undermine the reliability
approaches to marketing that both offer benefits and of research results if sample sizes are small or samples
drawbacks. are poorly selected.
+ Markets are dynamic. They change, raising the + ICT can help gather and analyse market research data.
following issues for businesses: how markets change, + Market research can help to segment markets.
the rise of online markets, innovation in markets and + Market mapping helps to make decisions over where to
adapting to change in markets. try to position a product in the market.
+ Competition is a key driving force behind features + Successful market mapping requires good decisions
within markets such as prices, quality and innovation. on what to plot on the map's axes and where to place
+ Risk is quantifiable; uncertainty is unquantifiable and existing products.
unpredictable. + Having some kind of competitive advantage is crucial
+ Market research can allow businesses to understand for the success of any product.
the customers to whom they plan to sell, enabling + Competitive advantage can come from lowest costs or
better business decisions to be made. product differentiation.
+ Market research can gather fresh information (primary) + Differentiation may be tangible or perceived.
or be based on information already gathered (secondary). + Differentiation helps to lessen the effects of
+ Market research can be carried out on a large enough competitors' actions, allows firms greater price
scale to give statistically reliable results (quantitative) flexibility and helps to add value to products and
or can be small scale, in-depth and designed to give services.
insights (qualitative).
Exam skills
+ With so many exam questions ultimately asking + When looking to offer evaluation in longer written
about business success or even more often business answers, being able to see underlying causes of
problems, the concept covered within this section - of business success or failure shows the ability to sift
the need to meet customer needs - is a pretty simple through less important issues to get to the very heart
underlying factor determining success. of a business scenario.
+ Given that any business must sell customers something + Often, attributing a business's performance to the
they are willing to buy, the process of identifying, extent to which it has successfully met its customers'
understanding and then designing a product or service needs will show a level of depth of insight that will
to meet these needs is fundamental to success. effectively draw together the threads of your argument
to pick out what really matters.

2 The market
Demand
How much of a product consumers buy
Demand is such a fundamental concept in business that understanding the Demand is the term used
factors that affect demand is critical to running a successful business. The to describe the level of
main factors affecting demand are listed below. interest customers have in a
product.
Price ' REVISED

□
Higher prices lead to lower effective demand, since fewer customers can
Effective demand is
afford to pay. Price also affects consumers’ decisions on relative value of the
interest backed by the
product compared to alternatives - higher prices make alternatives seem
ability to pay.
better value. On the other hand, prices give off a signal about the product
being sold - so lower prices may damage consumer perceptions of quality.
Making links
Changing price affects demand - the concept of price elasticity (see page 24)
measures the extent to which demand is affected by changes in price.
Changes in prices of substitutes and

complements F REVISED
A clear relationship exists between demand for a product and the price of its
substitutes. If the price of a tin of Roses falls, demand for Quality Street will fall A substitute is a
as consumers switch to buying the cheaper substitute. The same relationship similar, rival product that
holds if the price of the substitute rises; demand for Quality Street will increase consumers may choose
as consumers switch away from Roses, the more expensive substitute. instead.
The relationship between demand for a product and the price of its A complement is a
complements works in the other direction: product whose use
+ Should the price of a complementary product rise, demand for the original accompanies another, so
product is likely to fall. petrol is a complementary
+ Often, complementary products can represent the ‘running costs’ of product to cars.
another product, such as petrol for cars or coffee capsules for coffee
machines.
+ If the price of the complementary product rises, demand for the original
will fall, and vice versa.
Now test yourself TESTED Typical mistake

Too many candidates under
if the price of petrol falls, what is likely to happen to demand for cars?
pressure confuse the terms
If the price of Adidas trainers increases, what is likely to happen to demand for complement and substitute
Nike trainers? - pause before choosing the
Answers available online appropriate term.

Changes in consumer incomes REVISED
+ As income levels rise, demand for most products (normal goods) rises in
line, as consumers have more income to spend. For luxury goods such as
2 The market
Porsche cars, demand will rise even faster than incomes.
+ Of course, incomes do not always rise. As economies go through recession,
incomes will fall, and for normal and luxury goods demand falls as
consumers try to save money.
+ However, some products, known as inferior goods, see demand rise when
incomes fall, as happened to Poundland in the recession-affected years
2008-13.
+ Inferior goods, as their name suggests, tend to be cheaper alternatives
to normal goods, which consumers can switch to in order to save money
when their incomes are falling.
+ As incomes rise again consumers will switch back to normal and luxury
goods, leading to a fall in demand for inferior goods.
Making links
The concept of income elasticity (see page 26) allows the measurement and prediction
of the impact of changing incomes on demand for products.
Fashions, tastes and preferences REVISED

□
Subject to change over time, factors such as attitudes to diet (for example,
no sugar or low fat) change unpredictably but can have a major impact upon
demand for products, either positive or negative.
Advertising and branding A

REVISED
□
Successful advertising can lead to major short-term increases in demand.
Consistent advertising linked to other marketing activity may help to build
a brand, protecting it from direct competition and making sales volumes
relatively stable.
Demographics REVISED
Changes in the make-up of populations, which form the basis of any market’s
demand, can affect demand for individual products. Major demographic
trends in the UK in recent years have seen a growing population of over-60s, a
rising birth rate and increased numbers of non-EU migrants. All these groups
provide opportunities for increased demand for carefully targeted products.
External shocks REVISED
Natural disasters, global issues like the coronavirus pandemic, changes in the
law, unexpected traffic problems or a major customer not renewing a contract
are all examples of events that can have a hugely damaging impact on
demand for small or large businesses. The major problem with many external
shocks is their unpredictability. They are outside the business’s control.
Seasonality REVISED
Seasonal factors affect demand for many products, whether they are related
to the weather and nature’s seasons or due to special events during the course
of a year, such as Christmas.

3 List seven factors that could affect demand for a product.

4 Give two examples of external shocks that could damage demand for a local
independent coffee shop.
Supply
How much of a product firms are willing to
produce
Along with demand, the amount that businesses are willing and able to
supply will have a major impact on the price of all products:
+ The general rule governing the amount firms are willing to supply is that
the more profit they can make by supplying a product, the more they are
willing to supply.
+ This is because firms making choices over how to use the resources they
have available are assumed to put those resources to whatever use will
maximise profit for them.
Changes in costs of production REVISED
If the cost of making a product changes, the amount that a business is willing
to supply will adjust accordingly:
+ If production costs rise, the amount supplied will fall.
+ If production costs fall, the amount supplied will rise.
This is because as costs rise and fall, the amount of profit the firm can make
changes. Firms will always supply more if they can make more profit and less
if profits are lower.
The most common cause of changed production costs is changes in the costs
of the resources used to make a product, including materials and labour.
Making links
Economic influences, particularly exchange rates (see page 119), but also weather
conditions affecting food harvests, are likely to lead to changes in the costs of
resources.
Introduction of new technology REVISED

□
New technology used in production, such as industrial robots, tends to reduce
the costs of production:
+ The introduction of new technology should lead to an increase in supply.
Not only are firms willing to supply more with lower production costs offering
higher profits, but also new production technology may increase capacity,
meaning that there is more output available.
Now test yourself
Explain the relationship between costs of production and supply.

How might the invention of a new, more efficient production robot affect the
supply of cars?

Indirect taxes REVISED
Indirect taxes act just like another component of the cost of producing a indirect taxes are taxes
product or service. Therefore: that the government
2 The market
imposes on goods and
+ An increase in indirect tax rates will increase costs and therefore reduce
services, for example VAT.
supply.
+ A decrease in indirect tax rates will cut total costs and therefore increase
supply.
Government subsidies REVISED

□
These are the opposite of taxes. When the government wants to encourage
the supply of a product, such as wind-powered energy, it may offer subsidies
to businesses producing this product. This cuts the cost of production faced
by the business, meaning that subsidies will increase supply.
External shocks r REVISED

□
Unexpected events, such as economic crises, poor harvests of agricultural
commodities or natural disasters, can have the impact of reducing the total
quantity of an item that is available. This would lead to an increase in the
Revision activity
price of the item, meaning that production costs rise for firms, thus reducing
the amount they are willing to supply. Produce a mind map, with
'Supply' in the centre, which
summarises the major
□ factors affecting supply and
then how that factor affects
Give an example of an external shock that may reduce the supply of wheat. supply. So, you will have
Explain two reasons why governments might offer subsidies to firms supplying one branch for each factor
wind turbines. and each branch will break
off to explain how changes
what would be the effect of a reduction in the rate of vat on supply?
in that factor might increase
Answers available online or decrease supply.
Markets and equilibrium

What happens when demand (customers)
and supply (producers) meet
The interaction of supply and demand 1 REVISED
□
In commodity markets, price is determined simply by the interaction of
Commodity markets are
supply and demand. Simply stated: markets for undifferentiated
+ If demand is higher than supply, the price of the product will rise, until products, generally raw
demand falls back to the level of supply. materials such as gold,
+ If supply is higher than demand, price will fall, stimulating more demand crude oil or rice.
to ensure that all that is supplied is sold.
Equilibrium describes a
What is happening is that price adjusts until demand and supply are in situation in a market where
equilibrium. This is the natural state for all markets in which price is supply and demand are
determined simply by demand and supply. balanced, making the price
stable.
Making links
The section on pricing strategies on pages 34 and 35 of Chapter 3 explores how
producers decide what price to charge when selling non-commodity products.

what name is given to products that cannot be differentiated?

Supply and demand diagrams REVISED

□
Drawing a demand curve simply involves plotting a series of points showing
how much of a product would be demanded at a range of different price
levels. In a similar way, a supply curve can be plotted, showing how much of a
product businesses are willing to supply at a range of price levels.
Table 2.1 shows the demand and supply of sacks of coffee beans at a range of
prices.
Table 2.1 Demand and supply of sacks of coffee beans
Price ($ per sack) Demand (million sacks) Supply (million sacks)
RM
K‘jM
This information can be used to plot both a demand curve and a supply curve
on a diagram that will show the market for coffee beans (Figure 2.1).
Quantity (millions)
Figure 2.1 Equilibrium in the market for coffee beans
11 Why does a demand curve slope downwards from left to right?

2 Why does a supply curve slope upwards from left to right?
As Figure 2.1 clearly shows, the current equilibrium price is at $250 per sack,
i.e. the place at which the level of demand and supply are the same.
If there is a significant change in the factors that determine the demand or
supply of coffee, the lines will change. Possible reasons for these changes
are examined through pages 19 to 22. These will cause leftward or rightward
shifts in the demand and supply curves. They will need to be redrawn and are
likely to generate a new equilibrium price. Table 2.2 summarises the effect on
price of shifts in the curves.
Table 2.2 Effect on price of shifts in the demand/supply curves
If this changes Price will move

Demand curve moves to the right (rises) up
Demand curve moves to the left (falls) down
Supply curve moves to the left (falls) up
Supply curve moves to the right (rises) down

13 What name is given to the point at which demand and supply curves cross?
14 State two factors that may cause a demand curve to shift.
2 The market
15 State two factors that may cause a supply curve to shift.
Price elasticity of demand

What happens if a business changes its
selling price
Price elasticity of demand measures the responsiveness of demand for a
product to a change in its price.
Calculation r REVISED
□
Price elasticity of demand can be calculated by measuring the percentage
change in demand that follows a change in price:
% change in demand
Price elasticity of demand =----------------------------
% change in price
Exam tip Typical mistake
The two percentage changes should always be in opposite directions. The price Always use percentage
elasticity will therefore always be a negative figure. To calculate a percentage change, change figures. Do not
take the change between the two figures for, say, price, divide by the original price simply use the absolute
and multiply by 100. For example, a change in price from £80 to £100 is a 25 per cent changes in price (£s) or
change ((£20/£80) x 100 = 25%). demand (units sold).
Interpreting price elasticity

Table 2.3 Differences between price elasticity and inelasticity
F REVISED
□
If price elasticity is between 0 and -1 If price elasticity is a negative number greater than 1
Product is price inelastic Product is price elastic
Changes in price have a proportionately smaller effect on Changes in price have a proportionately larger effect on
demand/sales demand/sales
Exam tip
Check to see if the examiner's text tells you the price elasticity of the product/
business, use it if it does. However, you can also infer price elasticity by assessing the
extent to which the product is differentiated; see the section on page 25 on factors
affecting price elasticity.
If a business increased its price from £2.50 to £2.75, what is the percentage change
in price?
17 If that change in price led to a fall in sales from 1,500,000 units to 1,200,000, what
is the percentage change in demand?
Using your answers to questions 16 and 17, calculate the price elasticity of the
product.

Price elasticity and revenue REVISED
□
Depending on a product’s price elasticity it is possible to make definitive
statements about the effect of price changes on its revenue (Table 2.4).
Table 2.4 Effects of price change on revenue
If the product is: Change in price: Effect on revenue: Explanation:

Price elastic Increasing price Fall in revenue Because a small increase in price leads to a large fall
in demand
Price elastic Decreasing price increases revenue Because a small cut in price leads to a large
increase in demand
Price inelastic increasing price increases revenue Because an increase in price leads to only a small
fall in demand
Price inelastic Decreasing price Fall in revenue Because a price cut will only cause a small increase
in demand
This predictability gives the opportunity to generate clear advice to offer

in answer to questions asking for recommendations about a product’s
selling price.
Making links Exam tip

This stresses why the concept of price elasticity links clearly with decisions on pricing Using price elasticity
strategies (see page 34) - the predictability of the relationship between price and sales as a way of justifying
helps businesses to make more informed decisions. a recommendation on
whether a business should
increase or decrease price
Now test yourself TESTED allows you to develop a
sophisticated argument that
9 Would a well-known popular branded product be likely to be price elastic or uses theory well.
inelastic?
0 To increase revenue on a price elastic product, should price be increased or
decreased?
Factors influencing price elasticity REVISED

□
The major factors affecting price elasticity all boil down to whether the
product seems different from its rivals. They are:
+ degree of product differentiation
+ availability of direct substitutes
+ branding and brand loyalty.
Ultimately, the issue is whether customers go into a shop seeking out Marmite
or Heinz Tomato Ketchup, or whether they’ll scan the shelves making price
comparisons to decide which condiment to buy. If price is a central factor in
the decision, price elasticity will be high (‘elastic’). If it’s got to be Nike, price
elasticity will be low (‘inelastic’).
REVISED
□
Price elasticity is a useful concept for managers for two major reasons:
+ Price elasticity can help in forecasting sales, by considering the likely
impact of planned future price changes.
+ Knowledge of price elasticity can help to decide on the best pricing
strategy for increasing revenue, as shown in Table 2.4 above.
However, it is important to consider that price elasticity values tend to change
over time:

+ In a competitive market many firms’ actions will affect the extent to which Exam tip
one product stands out from its rivals Qust think how many chocolate bars
there are). Most businesses prefer
+ This unpredictability can undermine the usefulness of price elasticity by to have price inelastic
2 The market
making it hard to really know the current price elasticity until after the products because they are
price has been changed and the effect on demand measured. able to increase their price
if necessary as a result of
□ perhaps in an increase in
costs. This helps to explain
21 What three factors determine price elasticity? why so much marketing
What are the two major uses of price elasticity for marketing managers? activity can be traced back
to attempts to make the
23 What is the major limitation to the use of price elasticity?
product stand out from
Answers available online its rivals, reducing price
elasticity.
Income elasticity of demand

• How do changes in average incomes affect a
• business’s sales? Real income is the amount
• -------------------------------------------------------------------------- by which average incomes
• Income elasticity of demand measures the responsiveness of demand for a have adjusted for inflation -
• product to a change in real incomes. the amount by which prices
have risen. For example:
Making links average household incomes
up 3% in the past year;
Changes in the state of an economy, as explored in Chapter 10, would prompt inflation at 1.2%-so real
decision-makers to use knowledge of their products' income elasticities to help with incomes are up by 3% -
sales forecasting. 1.2% = 1.8%.
• Calculating income elasticity REVISED
Income elasticity of demand can be calculated by measuring the percentage

change in demand that follows a change in real incomes:
% change in demand
Income elasticity of demand =---------------------------------------
% change in real incomes
Typical mistake
Unlike calculations of price elasticity, the result of an income elasticity calculation
can either be positive or negative. It is important to make sure you pay attention to
whether the changes in demand and income are positive or negative and carefully
note the sign of your answer. This will determine how the product is categorised.
Now test yourself
24 If average earnings rise by 4 per cent and prices rise by 2.5 per cent, what is the
Typical mistake
change in real income?
5 if a 3 per cent fall in real income leads to a 6 per cent rise in demand for potatoes, Always use percentage
what is their income elasticity? change figures. Do not
simply use the absolute
6 What are the two main factors affecting the income elasticity of a product?
changes in income (£s) or
Answers available online demand (units sold).

Interpreting income elasticity REVISED
□
When categorising products and services according to their income elasticity
there are three possible types:
+ Inferior goods: These will have a negative income elasticity.
+ Normal goods: These are products with a positive income elasticity
between 0 and 1.
+ Luxury goods: These goods and services have a positive income elasticity
that is greater than 1.
Table 2.5 Effect of changes in income on different types of product
Type of Change in real Change in demand Explanation

product incomes
inferior good increase Decrease Consumers stop buying cheaper substitutes and
trade up now they have more money
Decrease increase Consumers switch to these products to save money
as their incomes fall
Normal good increase increase at the same rate as increasingly affluent consumers are now able to buy
real income or a little slower a little more of this type of product
Decrease Decrease at the same rate as As consumers tighten their belts they will cut back a
real income or a little slower little on these products
Luxury good Increase increase at a faster rate than As consumers' incomes rise these luxuries are the
real incomes ones that most of their extra income will be spent on
Decrease Decrease at a faster rate These will be the first products to disappear from
than real incomes consumers' shopping baskets when they feel the
need to tighten their belts
Factors affecting income elasticity 1 REVISED

□
Necessity or indulgence?
+ The indulgences - those things we can easily live without, but love to treat
ourselves to when we can afford to - will be those that are most sensitive
to changes in income.
+ Necessities are those more basic items that we would always expect to
buy, even when times are tight, therefore they are not as sensitive to
changes in real incomes; although we may try to cut back on the amount
of pasta we buy when times are tight, we will continue to buy it.
Who buys the product?

The super-rich will still be able to afford to buy luxuries even during a
recession, so demand for Bugatti cars may well be unaffected, whereas
demand for Porsche sports cars may fall, as those who are ‘merely rich’ need
to cut back on some of their luxuries.
Significance of income elasticity REVISED

□
Sales forecasting
Knowledge of the likely reaction of a product to a change in real incomes
allows a business to forecast sales if they have reliable economic forecasts
available. Of course, the reliability of economic forecasts is not always strong.

Typical mistake
Income elasticities change overtime. As a result, a company can never be 100 per
cent confident that what happened to sales last time real incomes changed will
2 The market
be repeated. Add to this the fact that most economic forecasts tend to be a little
inaccurate (at best) and writing about using elasticity to forecast sales should be
accompanied by words such as 'may' or 'could' instead of 'will'.
Financial planning
If income elasticity gives sales forecasts, then this information can be Making links
factored into budgets and financial plans. If a recession is forecast, a firm
producing luxuries can plan ways to reduce costs in advance of a probable Keep in mind the chance
sharp fall in sales. to link the concept of
income elasticity to financial
planning techniques
Product portfolio management (Chapter 7) - more effective
+ Having a product portfolio consisting entirely of luxuries or inferior goods planning can come from the
increases the danger of changes in real income having a critical impact use of income elasticity.
on sales.
+ Firms intending to spread their risk will look to ensure that their product
portfolios contain products with a range of income elasticities.
+ Though this may sound easy, it can be hard for a business selling a luxury
good to prevent damage to their image if they release an inferior version.
Now test yourself TESTED 4

State two reasons why sales forecasts based on income elasticity may prove
inaccurate.
Exam practice
The UK market for milk

Demand and supply of milk in the UK at different price levels
Price (pence per litre) Demand (billion litres) Supply (billion litres)
The estimated income elasticity of milk in the UK is +0.1.

Questions
1 On one diagram, draw a demand and supply curve for milk in the UK using
the data in the table above. [4]
2 Using the data in the table for demand at a price of 44p per litre and
45p per litre, calculate the price elasticity of demand for milk. [4]
3 Calculate the impact on demand for milk in the UK if incomes fell by
5 per cent in a year, if the price was 42p per litre. [4]
4 Explain two possible factors affecting supply of milk in the UK. [8]
Answers and quick quiz 2 online

Summary
+ in addition to price there are seven other major factors + Demand and supply curves shift due to a range of
that could affect demand for a product. They are: different causes.
+ changes in the prices of substitutes and + Shifts in demand or supply cause changes in the
complementary goods equilibrium price in a market.
+ changes in consumer incomes + Price elasticity measures the responsiveness of
+ fashions, tastes and preferences demand to a change in price.
+ advertising and branding + All price elasticities are negative values.
+ demographics + Price inelastic products have an elasticity between 0
+ external shocks and -1.
+ seasonality. + Price elastic products are those with a price elasticity
+ Decisions on how much to supply are governed by how greater than -1.
much profit a business can make. + Price elasticity depends on the extent to which a
+ Changes that would increase the amount of profit product stands out from its rivals.
a firm can make lead to an increased willingness to + increasing the price of a price inelastic product will lead
supply and vice versa. to an increase in revenue.
+ The major factors affecting supply in most markets % change in demand
are: changes in the costs of production, introduction of + Income elasticity of demand =----------------------------
% change in real income
new technology, indirect taxes, government subsidies,
+ According to their income elasticity, products are
external shocks.
classified as luxury goods, normal goods or inferior
+ in markets with undifferentiated products, price is
goods.
determined by the interaction of demand and supply.
+ income elasticity depends on whether the product
+ A demand curve shows the amount of the product that
is an indulgence or a necessity and on who buys the
would be demanded at a range of price levels.
product.
+ A supply curve shows the amount of a product that
+ income elasticity information can be used to forecast
firms would be willing to supply at different price levels.
sales, aid financial planning and design a balanced
+ The point where the two curves cross is the equilibrium
product portfolio.
position, i.e. the point at which the price will be stable
in the short term.
Exam skills
+ Reflecting on this second chapter, the market, income elasticities of demand when assessing a future
illustrates that one of the real difficulties in running a strategy for a product.
business, and in being able to craft effective business The very best exam answers are those that are able
exam answers, is being able to recognise the way in to strip out what issues are relevant for a question,
which more than one factor will impact on a business but then show the examiner that the student can build
scenario. a logical argument by drawing these issues together
+ in very simple terms, we have seen that the interplay and painting a verbal picture of how they are related,
between demand and supply in a market are the especially demonstrating that they understand cause
fundamental drivers of price. and effect.
+ There will be even greater complexity at play in many
scenarios - as shown by the need to consider price and

The marketing mix is the collective term for the four major marketing
decisions that a firm must make when trying to build a coherent plan, or
strategy, for how its product will be marketed. Each of the Ps (product, place,
promotion and price) should work in harmony to generate a coherent, credible
image for the product.
Product and service design

Deciding exactly what a business should sell
Design is everywhere. Any product that has been made has been designed,
including products that are used to make other products.
Services are also designed, perhaps in a less obvious way and using slightly
different principles from, say, designing a sports car. The process by which
services are purchased also has to be planned and therefore designed -
perhaps designing an easy-to-use, attractive-looking app for ordering that
pizza. So, the principles of the design mix still apply.
The design mix REVISED

□
Function Economic
(and quality) manufacture
Figure 3.1 The design mix
+ Aesthetics is the word used to describe the look, taste, texture or feel of
an item.
+ Function relates to whether the item actually does what it is expected
to do and the extent to which it surpasses expectations of quality of
performance.
+ Economic manufacture considers the ease and economy with which the item
can actually be made on the scale required.
+ Design is a compromise. Product and service designers must consider each
of the points of the triangle in Figure 3.1.
+ However, for many firms, one aspect will take priority over the other two,
so own-label drinks manufacturers will be far more concerned about
designing a product that can be manufactured very cheaply than about
a quality or aesthetics.
+ Not all businesses will head for the edges. As can be seen, BMW tries to
W strike a fine balance between all three aspects of the mix.

1 What are the three points of the design mix?

What type of business may be most concerned with economy of manufacture?
Benefits of good design 1 REVISED

□
+ Can add value.
+ Can provide a point of differentiation.
+ Can reduce manufacturing costs, boosting profit margins.
+ Improves brand image.
+ May boost brand loyalty.
Changes in the design mix to reflect social

trends REVISED
□
Environmental concerns
As acceptance grows of the need to be aware of the environmental impact
of business activity, product design has increasingly focused on three key
environmental concerns:
+ Sustainability: This is the need to ensure that materials and components
Sustainability means
used are sustainably sourced. making something using
+ Design for waste minimisation or reuse: This describes a growing materials that will still be
awareness of the need to design products from the outset with the end available in the future,
of their lives in mind. Designers are trying to ensure that the parts of a perhaps because one tree is
product that cannot be reused and must be thrown away are reduced to as planted for every one that is
close to zero as possible. cut down.
+ Recycling: Even those parts of products that cannot be reused may be able
to be recycled for another use. Many designers are now looking to ensure
recyclability of products and components wherever possible.
Ethical sourcing
Media coverage over recent years has begun to examine the sources of
components and finished goods used by businesses. Reports of child labour
being used to make clothing, or unethical fishing methods used to catch tuna,
have encouraged designers to ensure that the components or ingredients
used in their products come from ethical sources wherever possible.
Now test yourself
3 State three possible benefits to a business of great design.

4 List three environmental concerns increasingly considered in product design.
5 How can design help to ensure ethical sourcing?
Branding and promotion

Methods of convincing consumers to buy Promotion describes
products methods used by the
business to communicate
Both branding and promotion are methods of communicating, explicitly or information and persuade
implicitly, information about a product or service to consumers. consumers to purchase a
product.

Types of promotion REVISED
These are best categorised into two groups: those that are aimed at boosting
sales in the long term and those that are simply expected to generate a short Public relations describes
term effect. attempts by a business
to create publicity that is
reported as news, such as
Long-term methods staging a glitzy launch party
+ Persuasive advertising for a new product.
+ Public relations
Exam tip
Short-term methods
Think carefully when
+ Buy one get one free (BOGOF)
answering a question about
+ Seasonal price-cutting promotions
an appropriate form of
promotion. Ask yourself
Now test yourself
about the goals of the
6 State two forms of promotion that may provide a short-term boost in sales but business: a short-term
undermine a firm's brand image. boost in sales? Or are they
willing to invest in long-term
How can a business benefit financially from the use of long-term brand-building
sales growth?
advertising in glossy magazines?
Types of branding ' REVISED

□
The benefits of branding
Added value Ability to charge premium prices Reduced price elasticity of demand
Individual brand
These are single product brands, such as Marmite or Penguin (biscuits). The A brand is a recognisable
firm that manufactures these brands may make little or no attempt to push name or logo that helps to
their company name, focusing instead on the single brand to provide focus. differentiate a product or
Which company makes Penguins? And which makes Marmite? business.
Brand family
This is a brand name that is used across a range of related products, with
Cadbury being a prime example. The benefit of this is the ability to use the
umbrella brand name to encourage sales of each product within the family
through association with others. A strong brand family also makes it much
easier to get retail distribution when launching new products.
Corporate brand
Using the company name as a brand, in the way that Nestle does, can
convince consumers that all products across the entire range share similar
benefits (or drawbacks!). Even for Nestle, though, there may be individual
products that seem stronger without the corporate brand logo, such as
Nespresso (a Nestle innovation that keeps quiet about the brand connection).
Making links
Decisions on what type of branding to use will be influenced by the company's
product portfolio (see page 41 - is there a benefit to using a brand family or corporate
brand when trying to enter a new, highly competitive market?

Ways to build a brand
+ Advertising: This works best as a way of reinforcing the messages the
A unique selling point
company wants to send about its brand. (USP) is a particular feature
+ Unique selling point (USP): This may well provide the key stimulus that of a product or service that
launches a brand, and although the unique feature may be copied in time, no rival provides.
the brand may already be well established before this happens.
+ Sponsorship: This is a way of brand building by association. Sponsoring
an event, a sports team or even a TV programme can help to create
attachments in consumers’ minds that build the brand’s personality: for
example, Red Bull sponsoring extreme sports.
+ Digital media: From using social media to build relationships with
customers to using Google Adwords to pop up every time a particular
search is carried out, digital media offer a range of methods to help build a
brand, some of which have not even been developed yet.
Making links
Branding is a classic way to differentiate a product from its rivals. This differentiation
builds customer loyalty and enables prices to be pushed up - helping a business to
enjoy a healthier gross profit margin (see Chapter 8).
Changes in branding and promotion to

reflect social trends REVISED
□
Viral marketing
Traditionally, businesses loved creating ‘word of mouth’ promotion, where
happy customers recommended a business to their friends and family - the
good reputation of the business was spread like a virus.
In a digital world, word of mouth became supercharged, with social media
offering a faster and wider way to spread good (and bad) recommendations
about a product.
Social media
Social media, just like traditional media (TV, newspapers), are seen by
many businesses as another place where they can display their promotional
messages, through an Instagram or Snapchat account, on a Facebook page or
a Twitter feed.
Emotional branding
+ In some ways all branding is attempting to create some kind of emotional
response to the brand from customers.
+ However, some branding is more overtly emotional than others; think
about the sense of fun created by Ben and Jerry’s.
+ With the advent of digital media, especially social media, the relationship
between a brand and a consumer can reach new emotional levels, with
consumers following certain brands for daily updates on their brand of
choice.
Now test yourself j
Give one disadvantage that can arise from creating a corporate brand.
9 List three methods that can effectively be used to build a brand.
10 Explain why viral marketing has become more significant in the last 20 years.

Deciding on a general approach to how to

price products
When making decisions on how to decide price for a product, a business is
likely to devise a general approach to pricing, such as Apple pricing high to
‘confirm’ the brand’s superiority and to complement other aspects of the
marketing mix. Short-term changes in price may occasionally be prompted by
external events, but in the medium to long term a company’s pricing strategy
shapes decisions on the actual price to charge.
Types of pricing strategy REVISED

□
For NEW products
Price skimming
This involves launching a brand new product at a high price while the product
is unique.
Penetration
This involves launching a new product at a very low price to entice customers
to try it.
Exam tip
The decision over pricing strategy for new products must be determined by the level
of competition. A new product that has no clear rivals is likely to use skimming, but a
product with many close competitors cannot use skimming, as nobody would be likely
to buy. Before deciding on a sensible pricing strategy, ask how unique the product is.
Table 3.1 Advantages and disadvantages of price skimming and price penetration
Price skimming Price penetration

Advantages + High prices help to create a desirable image + Low price encourages lower risk product
for the product sampling
+ Early adopters will pay the high price in return + Low price boosts sale volumes - cutting
for exclusivity production costs
+ High prices generate rapid profits - helping to + High volumes may persuade retailers to buy the
recover the costs of innovation quickly product - boosting distribution
+ Encourages customers to develop the habit of
buying the product
Disadvantages + Will deter some customers with price seen as + Product's image may be immediately cast as
a 'rip-off' 'cheap'
+ Early buyers may be frustrated once price + Upmarket retailers may be unwilling to stock
starts to fall the product
+ image may suffer when price begins to fall + Likely to create price sensitivity among
customers - a higher price elasticity
Now test yourself
11 Why would a firm launching a copycat product into a competitive market be wrong
to choose price skimming as a pricing strategy?
2 Why might a luxury brand avoid penetration pricing for new products?

For EXISTING products
Cost-plus
This involves deciding price by adding a desired percentage onto total costs
per unit.
To calculate price charged: unit cost + (% mark-up)
+ Benefit: This should guarantee a profit is made on each unit sold.
+ Drawback: Ignoring the market may mean an unrealistic price is
generated.
+ Appropriate: When the firm is a market leader with little need to worry
about competition.
Now test yourself ,
13 A bakery makes 600 hot cross buns for Easter Saturday. Each bun has 4p of
ingredients, 3p of labour and will go into a ip bag. The energy cost for the 600
buns is £24 and the mark-up is 200 per cent on unit cost. Using cost-plus pricing,
what is the selling price per bun?
Predatory
A strategy that sets price low enough to force a competitor out of business -
often only on a local basis where competitors are smaller, local firms.
+ Benefit: Once a rival has been forced to close, prices can be pushed up
higher, increasing margins.
+ Drawback: If it can be proven to be specifically designed only to drive rivals
out of business, predatory pricing is illegal.
+ Appropriate: When a firm is clearly more financially powerful than smaller
rivals.
Competitive
A competitive pricing strategy means charging a price at the market average
or at a discount to the average price in the market.
+ Benefit: This should ensure that price will not put customers off buying the
product.
+ Drawback: Firms that use a competitive pricing strategy have little control
over the price they charge and thus the revenue they generate.
+ Appropriate: When a company is trying to take on more powerful rivals.
Psychological
Less of a strategy and more of a tactic used to make fine-tuned decisions on
the price to charge, prices are set just below major psychological levels, such
as £9.99 instead of £10, or £9995 instead of £10,000.
+ Advantage: This can help nudge customers into making a purchase by
helping them to believe they are not quite spending £10 or £10,000.
+ Drawback: It may have little effect on many planned purchases and may in
fact mildly annoy consumers.
+ Appropriate: When selling impulse purchases or ‘little treats’.
Factors that determine the most appropriate

pricing strategy r REVISED
□
+ Level of product differentiation: Highly differentiated products will have
more control over pricing, potentially allowing them to use cost-plus
pricing.
+ Price elasticity of demand: Inelastic demand means that firms can adjust
prices however they wish without seeing major impacts on demand,
whereas a producer of a price elastic product will always face pressure
to reduce prices in order to boost demand, and may be unable to even

contemplate an increase in price. This pushes them into a competitive
pricing strategy.
+ Level of competition: The higher the level of competition, the less scope a
firm has for moving away from a purely competitive strategy.
+ Strength of brand: Strong brands differentiate products, reducing their
price elasticity. This all adds up to the ability to take control over their own
pricing, probably allowing a cost-plus approach.
+ Stage in the product life cycle: During the introduction phase there’s a key
decision to make - penetration or skimming; pricing will often change,
perhaps being pushed up as the product moves through growth and into
maturity.
+ Costs and the need to make a profit: As price has a direct impact on
revenue, a business has to consider its costs when deciding price. Pricing
below unit costs will lead to loss-making, which is unsustainable in the
long term. However, a balance must be struck between pushing price
above costs to maximise profit and ensuring that the price is relatively
competitive.
Changes in pricing to reflect social trends REVISED

□
+ Online sales: pricing online may be more sensitive than on the high street
because online consumers find it easier to compare prices than those
trudging around different stores. Pricing levels may be lower as running an
online business generates lower fixed costs than ‘bricks and mortar’ stores
that have rents to cover in prime locations.
+ Price comparison sites appear to encourage firms to price competitively
so their products and services show up as best value on these sites. In
fact, though, many of these sites are simply sales outlets for producers;
consumers should beware of assuming they are being told about the best
deals available.
Now test yourself
14 To calculate price using cost-plus pricing, a percentage mark-up is added on to what?

5 What type of market share are firms using competitive pricing likely to have?
Why does the absence of a strong brand name on a product suggest competitive
pricing is a sensible choice?
Distribution
Decisions on which outlets should be used to
enable customers to buy the product
Place, or distribution, is a vital part of the marketing mix, because if
consumers cannot get access to the product, they will not be able to buy it.
Typical mistake
Too many answers show naivety in implying that any manufacturing business can get
their product into any retailer. Especially for small businesses, securing distribution
for their product can be one of their biggest challenges, in the UK, a huge proportion
of grocery items are sold through four supermarket chains. If a manufacturer can
convince one of the big four to sell their product, that may be the key to success.
However, with limited space available on supermarket shelves, the level of competition
for that space is huge.

Distribution channels REVISED
□
Traditional physical channel

Direct to retailer
Kellogg's Sainsbury's Consumer

\______________ / \_____________________ /
Be your own retailer
Apple Apple stores Consumer
Direct online
Online retailer
Small producer
of made-to- Consumer
order gifts
\.
Figure 3.2 Examples of distribution channels
Now test yourself TESTED The route a product takes

from producer to consumer
17 Briefly explain why getting the 'Place' element of the marketing mix wrong can is called the distribution
destroy a product's chances of success. channel.
Answers available online intermediaries are
businesses between the
producer and the consumer
Traditional physical channel in a distribution channel,
Many producers sell their products to wholesalers who act as suppliers to such as retailers.
smaller retailers. This channel pushes selling prices up, as wholesalers and
retailers will both add their own markup. However, this channel helps smaller
firms to achieve a wide distribution across many outlets.
Direct to retailer
Larger producers can ignore wholesalers and sell their products in bulk to
major retail chains, saving on the wholesalers’ markup but exposing them to
tough negotiations with retail chains on price and credit terms.
Be your own retailer

Producers that want to exert complete control over how their products are
sold can set up their own retail outlets. Apple stores are designed to showcase
Apple products in the best possible environment to show their strengths, but
this of course means Apple incurs significant costs running these stores.

Direct online
Producers can set up their own websites - often at significant cost - to allow
consumers to buy products directly from them. This means the producer
keeps the full price paid but excludes the possibility of selling to consumers

who are uncomfortable buying online.
Online retail
For smaller producers unable to afford the expense of building slick
e-commerce platforms, existing sites, most notably eBay, offer the chance
to sell online to a wide audience without the same investment, but with the
disadvantage of eBay’s fee.
Changes in distribution to reflect social

trends REVISED
□
Online
Direct channels of distribution are not new. Mail order and catalogues have
been around for over 50 years. The difference that direct online distribution
makes is in the power of websites to offer a wide and varied range of
products, with the scope to update the products on a daily basis. In addition,
online distribution offers small firms the chance to reach a global audience in
a way that other channels simply could not offer.
From product to service

Some services will never be distributed online, or in any other way than the
provider and the customer meeting face to face. Haircuts, clubbing or staying
in a hotel will always involve personal interaction, even if the way you book
changes over time. From booking face to face at a travel agent, to booking
a holiday by phone, time moves on and now online holiday booking sites
dominate the industry.
Now test yourself
Explain the role of wholesalers in a traditional channel of distribution.

Identify one benefit and one drawback to a producer of opening its own retail outlets.
2C How has the growth of e-commerce helped small producers?
Product life cycle and portfolio

Managing which different products are sold
by a business over time
The product life cycle REVISED
The product life cycle is a pattern of sales over time that most products
tend to follow. The life cycle model has four phases following the launch of
a product:
+ Introduction
+ Growth
+ Maturity
+ Decline
Sometimes an additional phase - development - is identified as happening
before the product is launched.

Each phase is characterised by what is happening to sales of the product
(Table 3.2).
Table 3.2 Sales during a product's life cycle
Introduction Sales are low and rise only slowly

Growth Sales begin to rise much more quickly
Maturity Growth in sales now slows and sales stabilise at their highest level
Decline Sales of the product begin to fall, until the product is phased out or
an extension strategy is launched
Now test yourself I I
21 List the four stages of the product life cycle.

22 what is the stage of the life cycle sometimes called before a product is launched?
The key decision-making benefit of the product life cycle model is to help
make effective marketing decisions. Typically, the following issues and
decisions characterise the different stages of the life cycle (Table 3.3).
Table 3.3 Examples of how the marketing mix may vary at different stages of the product life cycle
Development introduction Growth Maturity Decline

Sales Zero Low increasing Growth is slowing Falling
Costs per High investment High; sales are Falling as Falling as sales are Low as
unit in product relatively low overheads are still growing development costs
development but launch costs spread over more have been covered
but only a few are high and units and promotional
prototypes and overheads are costs are being cut
test products being spread over very
produced few units
Product Prototypes Likely to be basic May be modified Depends - may Focus on most
given initial focus on core profitable items
customer products and
feedback; range remove poor
may be increased sellers; may extend
brand to new items
Promotion As development Mainly to raise Building loyalty May focus on Probably no
is nearly finished, awareness highlighting the spending at all
it may be used to differences with
alert customers of competitors'
the launch products
Distribution Early discussions May be limited as increasing as May focus on key Lower budgets to
with retailers will distributors wait more distributors outlets and more keep costs down
help in finalising to see customers' willing to stock profitable channels
the product reactions and product is
packaging rolled out to more
markets
Price Not needed Depends on pricing Depends on May have to Likely to discount
approach, e.g. demand conditions drop to maintain to maintain sales
high if skimming and strategy, e.g. competitiveness
is adopted; low with skimming
if penetration is strategy, the
adopted to gain price may now be
market share lowered to target
more segments

Issues with the product life cycle
Decision-makers using the product life cycle model to help them select
appropriate marketing activities have a problem. Though the model seems to
predict the future, sometimes the decisions made by the marketing bosses
can actually move a product from one phase of the life cycle to the next.
For example:
+ The manager of an existing brand in maturity expects the product to go
into decline.
+ If the latest sales figures show a dip in sales, the manager may decide this
shows the decline phase has begun.
+ They may therefore slash the amount spent on promoting the product as
the life cycle model suggests is appropriate for products in decline.
+ This itself may lead to a sustained reduction in sales and may actually
hasten the decline of the product.
This chain of events shows how the life cycle model itself may encourage
managers to make decisions that speed a product through the life cycle faster
than might naturally occur otherwise.
Explain why managers still use the product life cycle to make decisions despite its
limitations.
Extension strategies r REVISED

□
Of course, many businesses faced with a product nearing the end of its
maturity stage or even entering the decline stage may be keen to squeeze
more life out of their product. Changes can be made to the product’s An extension strategy
marketing mix that provide not just a quick burst of sales but a medium- to is a medium- to long-term
long-term effect on sales - preventing decline or even boosting sales. plan for extending the life
The two major adjustments that can lead to successful extension strategies cycle of a product.
are shown in Table 3.4.
Table 3.4 Changes that can lead to successful extension strategies
Changes to the product + Adding extra functions or features Typical mistake

+ Changing ingredients/materials
+ Launching slightly different variants on the product - Do not always assume that
shapes/sizes, etc. every extension strategy
will be a success. There
Changes to promotion + Targeting a different market segment
is often a reason why the
(not simply a new + Finding new uses for the product
product is starting to fade.
advertising campaign) + Increasing use of the product among existing
customers
Exam tip
An extension strategy is an attempt to solve a business problem. As with all problem
solving, the best solutions will always address the specific causes of the problem.
Recognising whether this is happening in a case study offers excellent scope for
evaluation.
New product development r REVISED

□
Developing new products is the key to long-term success for most businesses.
Unfortunately, the process is both expensive and time-consuming. In
addition, it is fraught with possibilities of failure. The processes involved in
developing a new product or service may include:

Figure 3.3 Activities involved in new product development
A general rule of thumb suggests that only one in five new products actually
becomes commercially successful.
The major issues that are likely to determine the success of a new product are:
+ understanding the needs and wants of the market Making links
+ the creativity with which solutions to problems can be found Devising and implementing
+ finding and committing the resources (money and people) needed for the an extension strategy may
new product development to succeed. well involve adjusting a
product's design mix (see
Now test yourself pages 30-31) often through
an aesthetic change, but
Explain why successful new product development is vital to ensure healthy profit perhaps through adjusting
margins in the long term. the function element.
The product portfolio

Large businesses normally sell a range (or portfolio)
of different products. A company such as Unilever
sells a wide range of products, see Figure 3.4
With such a wide range of different brands and
products to manage, it is important that Unilever
marketing managers continually develop new
products and kill off those products whose sales
are falling, and consequently draining resources
that could be better used on other products within
their portfolio. In order to manage their portfolio
of brands successfully, marketing managers will
analyse their product portfolio regularly, often
using a tool called the Boston Matrix.
Figure 3.4 Highlights of Unilever's product portfolio

The Boston Matrix REVISED
High

Cash Rising
B Star
Market
growth
(%) Low
Dog Problem
child
" Low
Market
share
(%)
Figure 3.5 The Boston Matrix
The matrix assesses each product within a firm’s product portfolio. The two
key variables considered are market share and growth of the market in which
the product is being sold. Once these two figures have been discovered, each
product in the portfolio can be plotted on the axes shown in Figure 3.5.
Each quadrant of the diagram above is labelled with a memorable tag:
+ Problem child + Cash cow
+ Rising star + Dog
Typical characteristics of each type of product are shown in Table 3.5.
Table 3.5 Typical characteristics of the Boston Matrix categories
Problem child These products may be successful in the future but currently have low market share. Their potential,
however, is based on the fact that they are being sold in rapidly growing markets offering the chance
of rapid sales growth if supported by the right marketing.
Rising star These are products in exciting and rapidly growing markets that currently hold a high share and are
the future money-makers for the firm. Although these products will need a lot of money spent on
them at the moment - fighting off all the competitors attracted to these high growth markets - if
high market share can be maintained, future profitability is likely.
Cash cow These are products in stable markets that hold a high market share, and can therefore generate
relatively high sales with relatively low marketing expenditure. As a result, they are likely to generate
significant profits that the business can use to help further develop other products within its
portfolio.
Dog These products have a low market share of a low growth market and are thus generally unattractive
members of the portfolio. They are the most likely candidates to be killed off.
The four key strategic choices that portfolio analysis tends to generate are as
follows:
+ Building: Trying to boost sales of a product with a bright future but shaky
current position (usually problem children).
+ Holding: Spending enough money to maintain market share (usually rising
stars).
+ Milking: Typically associated with cash cows, this strategy involves taking
the profits generated by a product without spending heavily on that
product.
+ Divesting: The process of getting rid of products within the portfolio. This
will often happen to dogs, but may occur with problem children for whom
there seems to be too much to do to boost market share profitably.

Now test yourself TESTED Making links
5 What are the three main influences on the success of the new product Careful examination of
development process? a company's product
6 What four labels are given to the four quarters of the Boston Matrix? portfolio, probably using the
Boston Matrix (see page 42)
Answers available online will form an important part
of a SWOT analysis (see
Chapter 11).
Marketing strategy
What overall approach should a business
take to its marketing activity?
Successful marketing strategy is likely to be characterised in three ways: Marketing strategy is
+ Strategy is about the future: Success in most markets relies on predicting the term used to describe
the future market conditions and ensuring that the plan devised for the general approach
marketing the business’s products suits the market conditions that will to marketing used by a
develop during the life of the strategy. business.
+ Strategy must be achievable: Not only must a strategy use only the
resources the firm can call upon to deliver its marketing plans, but also the
plans themselves must address the real conditions operating within the
market, for example operating within an economic downturn.
+ Strategy is company specific: There is usually only space in a market for
one business following a particular strategy, so one firm may be able to
trade successfully on being the cheapest, while another will need to find a
key point of differentiation if consumers are to recognise their product as
offering any significant difference compared to its rivals.
Choosing marketing strategies r REVISED
Mass market strategies

A basic choice faced by a business is whether to attempt to sell a standard
product to almost all consumers in a market - a mass market strategy - or
whether to concentrate their efforts on selling specialised products to smaller
subsections of the market - a niche market strategy.
Table 3.6 Benefits of mass market and niche market strategies
Benefits of successful mass market strategy Benefits of successful niche market strategy
High distribution levels Able to meet consumer needs more precisely
Greater control over advertising and promotion Able to charge a higher price than mass market products
A degree of influence over pricing within the market Less direct competition
Successful mass marketing:

+ probably relies on one major balancing act - the need to differentiate the
product from all rivals without making it less appealing to any particular
group of consumers.
+ can be a very tricky balance as many methods of product differentiation
will reduce the appeal of the product to some groups of consumers.
+ might include differentiation through quality, for example - excluding
consumers unwilling to pay the associated higher price.
Niche market strategies

+ Although marketing to small subsections of the market is a fertile area for
small specialist businesses to achieve success, some larger firms do use a
niche marketing approach.

+ Often, the key to successful niche marketing is a depth of understanding of Making links
the product and consumer tastes that takes many years to build up.
+ As a result, entering a niche market tends to be something that cannot be Mass markets and
rushed - a patient approach is needed to ensure that consumers’ needs are niche markets were first

met appropriately. considered at the beginning
of Chapter 1. The choice
Now test yourself between aiming at a
mass market or a niche
7 What are the three general characteristics of successful marketing strategy? market is one of the two
21 State two benefits of successful mass marketing. axes on Porter's generic
strategy grid, considered in
29 State two benefits of successful niche marketing.
Chapter 12.
Business to consumer (B2C) strategies

+ With business to consumer marketing, getting and keeping the right image
for the product or service is vital.
+ Of course, all aspects of the marketing mix contribute towards creating
the image, so continually revisiting the marketing mix to ensure that
consumers are getting the overall product they want is vital.
+ The goal of any business to consumer marketing strategy must be
developing customer loyalty among an ever-growing base of customers.
Business to business (B2B) strategies

+ Business to business marketing is, of course, underpinned by the same
principles as business to consumer marketing - that of developing
customer loyalty.
+ What differs tends to be the key characteristics of a product or service
that business customers are looking for.
+ What is missing in business to business transactions is emotion,
something that can often play a key role in business to consumer
marketing. Instead, what matters most to business is price and reliability.
Figure 3.6 helps to summarise the key differences and shared end-goal of Figure 3.6 Logic chain: B2B
business to consumer and business to business marketing. versus B2C
Consumer behaviour - developing

customer loyalty REVISED
□
Customer loyalty can be thought of as being even deeper than simply
generating repeat purchases:
+ Really successful marketing does build some kind of emotional attachment
between consumers and the brand.
+ Critical here is not just ensuring that each aspect of the marketing mix is
‘right’, but also that the different aspects of the mix genuinely combine to
create a clear image for the product.
+ Then, if that image really is one that appeals to consumers in the market,
that emotional bond can be created - the kind of bond that sees an almost
religious devotion to products such as Apple electronics, Cadbury’s Dairy
Milk or BMW cars.
Briefly explain the reasons why successful business to business marketing differs
from successful business to consumer marketing.

Exam practice
A major multinational producer of household products The company's marketing managers are devising their
has identified the following features of six of their major marketing strategy for the next three years and face a
brands: number of decisions.
Product Market share Market growth Questions

Brand A High High 1 Which brand is a cash cow? [2]
Brand B Low High 2 what pricing strategies are most likely to have been
used for the newly launched Brand E? [2]
Brand C High LOW
3 Using the Boston Matrix, advise the company
Brand D LOW High
on the strategies they might adopt in managing
Brand E Low High their portfolio over the next three years. [10]
Brand F Low LOW
Summary
+ Design can be a key tool in positioning a product within + The main factors determining the right pricing strategy
the market. all relate to the level of product differentiation (brand,
+ Design involves balancing aesthetics, function and competition, price elasticity).
economy of manufacture. + other factors affecting the choice of pricing strategy
+ Good design brings a range of benefits to firms. include costs and the stage in the product life cycle.
+ in many businesses, design is influenced by + Distribution is crucial because it involves ensuring that
environmental and ethical concerns. consumers can buy the product where they want to
+ Different forms of promotion tend to have either a long buy it.
er a short-term impact. + Gaining distribution in retailers cannot be taken for
+ Promotions aimed at a short-term sales boost may granted.
damage brand image. + There are five main channels of distribution available to
+ Branding is a key form of product differentiation. producers.
+ Brands may be created for an individual product, for a + Intermediaries can help spread products to a wider
range of products or for a whole business. range of consumers but add to the final selling price of
+ Promotional methods that are effective at helping to the product.
build a brand include advertising, a USP, sponsorship + The internet has opened significant opportunities in
and use of digital media. changing the way products are distributed.
+ Recent developments in promotion and brand building + The product life cycle consists of four stages once the
have included viral marketing, use of social media and product has been launched.
increased use of emotional branding. + The stage of the product life cycle is likely to affect the
+ Pricing strategies set out the broad approach a firm will marketing mix used for a product.
take to setting price. + New product development is often unsuccessful.
+ Two alternative strategies are available for firms + Firms use the Boston Matrix to analyse their product
launching new products: skimming and penetration. portfolio.
+ Four strategies (cost-plus, competitive, predatory + Mass marketing and niche marketing offer different
and psychological) are used by firms selling existing benefits.
products. + Business to consumer and business to business
marketing need to be addressed in different ways.
Exam skills
+ This is a heavy section, with plenty of specialist + It is sometimes easy to get lost in the desire to develop
terminology used to describe different pricing your skills of analysis and evaluation, overlooking the
strategies, approaches to branding and even a model fact that accurate and thorough subject knowledge -
like the Boston Matrix which has its own, unique most often demonstrated in correct use of
terminology. terminology - underpins these 'higher level skills'.
+ in order to produce excellent answers to exam + Without accurate knowledge you may be in danger
questions, choosing and using correct terminology of simply misunderstanding a term in a question -
is vital. The best students will use the term 'price ending up not answering the question set at all and
skimming' where others will simply refer to launching a scoring zero.
product with a high price.

4 Managing people
Approaches to staffing_____________________________
What is the company’s attitude to its
employees?
Staff as an asset versus staff as a cost REVISED
□
Some senior managers see the people that work for the firm as a source A zero-hours contract is
of potential competitive advantage. Others take a different approach, an employment contract
seeing staff as just another cost to be minimised. Key features of these two that has a minimum of
contrasting approaches are shown in Table 4.1. zero hours a week. So the
employee is not guaranteed
Table 4.1 Different ways of treating staff
any work or income and is
Treating staff as an asset Treating staff as a cost only told of their'working
Permanent contracts Flexible contracts, perhaps zero hours week' a few days in
advance.
Develop staff skills with training Minimal training offered
Pay staff a salary Low pay, often at an hourly rate Staff turnover is also
called labour turnover and
Builds loyalty from staff Often leads to a high staff turnover rate
is the proportion of staff
who leave a business during
While it suits some businesses to keep their costs as low as possible,
a year.
others will adopt a strategy of providing high-quality service, which would
encourage them to treat staff more as an asset to be nurtured, developed and
retained.
Making links
As staff costs are usually fixed costs, the approach a business takes to its staff will
affect its break-even point (see page 92) - less spent on staff lowers the break-even
point, allowing the business to survive more easily if sales fall.
Why may a permanent contract lead to higher-quality work than a zero hours
contract?
Flexible workforce REVISED

□
Flexibility refers to the ability of a business to adapt its operations to changes
in patterns of demand. The way that staff are employed and managed can
have a major impact on the flexibility of a business.
Why is it useful
A rapidly changing external environment means that patterns of demand can
change rapidly, meaning that supply must change in response. Key drivers of
these changes include:
+ changes in the weather
+ increased competition
+ personalisation of products and services.
A lack of demand may mean employee time cannot be used productively.
Three hairdressers in a salon cannot style hair if there are no customers at

the salon. These represent a cost that is not matched by the generation of
revenue. Meanwhile, if increased demand for certain products or services
cannot be met due to staff shortages, potential customers may well go to
more flexible competitors.
How to achieve it
There are a number of actions that a business can take to ensure that its
human resources can be deployed as flexibly as necessary. Four key methods
are explained below.
Multi-skilling
+ Using training to ensure that staff can perform a range of different roles
within the business brings greater workforce flexibility.
+ Instead of performing just a single role, employees who are multi-skilled
can cover for absent colleagues and also switch to roles that need to be
filled when patterns in demand change.
+ Multi-skilling also tends to bring motivational benefits, as staff may enjoy
the variety of work offered and may feel valued by the business as they
receive greater training and skill development.
Table 4.2 Advantages and drawbacks of multi-skilling
Advantages of a multi-skilled staff Possible drawbacks of multi-skilled

staff
+ Productivity rises as staff are used + Loss of production as employees
more fully switch between jobs
+ Reduced disruption from staff absence + Increased training budget required
+ More motivated staff + Staff may feel more is being asked
of them
Part-time and temporary

+ Around a third of the UK’s workforce are employed in part-time jobs.
+ For some people, part-time hours allow them to fit work in alongside other
commitments.
+ This can help to bring people into the workplace who may offer excellent
skills and experience but are unable to commit to full-time work.
+ Temporary staff are employed on short-term contracts, meaning that if the
employer no longer needs them, the contract is not renewed.
Flexible hours and home-working

+ For companies that treat their employees as an asset, staff may be allowed
to choose when they work a set number of hours.
+ Another way of increasing the flexibility of a job’s requirements is to allow
employees to work at home, or from home. This gives the staff greater
flexibility to manage their time around other commitments.
+ Developments in technology have made greater flexibility in location
possible, with mobile phones and video messaging services such as Zoom
allowing face-to-face, immediate communication between people in
different locations.
+ Enforced home-working during 2020’s pandemic really highlighted both
the benefits and drawbacks of working from home.
+ Flexibility for the employer may come from the use of zero-hours
contracts. These are especially common in industries such as retailing and Outsourcing means
hospitality. contracting another
business to perform certain
Outsourcing business functions, allowing
Another method to increase capacity during times of high demand is to use significant increases in
other businesses to perform business functions. This is called outsourcing. capacity when needed.

Table 4.3 Benefits and drawbacks of outsourcing
Benefits of outsourcing Drawbacks of outsourcing

+ Ongoing fixed costs can be kept at a low level within the + The company to whom work is outsourced needs to
business make its own profit, adding to costs
+ Sudden surges in demand can be met quickly + Outsourcing arrangements may take time to work out
+ Companies to whom work is outsourced can offer + The company to whom work is outsourced may not
high-quality services reach the required quality standards
which method of creating a flexible workforce a best-suited to each of the

following situations?
a) A company needing staff to keep working during a pandemic
b) A school where the number of students studying each subject varies
significantly from year to year
c) A farm that needs fruit to be picked each summer
I) A business that needs to temporarily boost output to cope with short-term
panic-buying of its product in stores
Hint: use each of the following methods once: multi-skilling, temporary contracts,
home-working, outsourcing.
Dismissal versus redundancy REVISED

□
+ Getting rid of staff can happen for a number of reasons, but these boil
Exam tip
down to either a reduction in demand or incompetence or disruption
from staff. Although redundancies are
+ In the first case, staff will be made redundant. Although making an effective way of reducing
redundancies will reduce ongoing costs, the law requires businesses to costs in the long term, the
compensate those made redundant according to how long they have need to make redundancy
worked for the business. payments to staff means
+ Dismissal occurs either when an employee, having been fairly warned, that in the short term there
is deemed ‘not up to the job’ or when they have committed a major will be a significant cash
breach of their terms of employment - perhaps theft or some other outflow. This means that
dishonesty. In the case of an employee being fairly dismissed, no making redundancies is not
payments are made. a good way to resolve a
cash flow problem.
Employer/employee relations r REVISED

□
There are times when an employer needs to discuss and agree certain
changes with their entire workforce or at least groups of employees. This
process of discussion and agreement is what is referred to when the term
‘employer/employee relations’ is used.
Collective bargaining
Collective bargaining occurs when an employer deals with one or a few
representatives for the whole workforce when discussing problems, or
negotiating pay rises or changes to working conditions. Most commonly,
employees are represented by a trade union which will have a local
representative who carries out bargaining with the employer on behalf of all
the members. This approach is beneficial because:
+ Employers only need to negotiate with one or two people on behalf of the
whole workforce, thus saving time.
+ Employees benefit because acting together gives them more power in their
relationship with the employer.

Individual approach
+ This approach is, as its name suggests, the opposite of collective
bargaining.
+ It allows employees to be treated on an individual basis, with stars singled
out for better treatment.
+ However, it is far more time-consuming for the employer.
+ Perhaps most importantly, the employer is in a stronger position if
an employee is unable to call upon threats of strike action from their
colleagues if they are unhappy with the deal being offered.
3 State three ways of creating a more flexible workforce.

4 what effect does redundancy have on the cash flow of a business?
5 What is the name given to the process of agreeing changes to pay and working
conditions with a trade union acting on behalf of its members?
Recruitment, selection and

training________________________________
Taking on new staff and developing the skills
of all staff
Recruitment REVISED
□
The need to recruit could be triggered by: Making links
+ existing staff leaving
Recruitment and training
+ growth of the business
may be prompted by new
+ new activities needing new skills.
product development (see
Once a firm has identified the need to recruit it will begin the recruitment page 40), or a product
and selection process as shown in Figure 4.1. reaching the growth stage
of its product life cycle (see
Determine the number and type page 38).
of employees required
Conduct job analysis for each vacancy to identify

the various duties and responsibilities involved
Create a job description and person specification
Advertise the vacancy (internally and/or externally)

to attract suitable applicants
Draw up a shortlist of the most suitable

applicants for interview
Decide on the most suitable candidate(s) using

appropriate selection method(s)
Appoint the successful candidate and inform those

who have been unsuccessful
.9
Figure 4.1 Stages in the recruitment process

This process allows a systematic approach to recruiting the right person to fill
Internal recruitment
the vacancy, by carefully identifying what the vacant job involves, what skills means filling a job vacancy
will be required to do that job and attempting to attract a number of suitable with somebody who already
applicants from which to choose. works for the business.
Initially the recruitment process is designed to attract potential applicants. External recruitment
Then the selection part of the process begins in order to reduce the field of means filling a job vacancy
applicants to the best person for the job. The decision on whether to recruit with somebody who does
internally or externally will depend on the: not currently work for the
+ cost of the recruitment method business.
+ size of the recruitment budget
+ location and characteristics of the likely candidates.
Table 4.4 Advantages and disadvantages of internal recruitment
Advantages of internal recruitment Disadvantages of internal recruitment

Quicker and cheaper than external recruitment Limits the number of potential applicants
Chance of promotion may help boost morale within a Fails to bring in new ideas from outside the business
business that frequently recruits internally
The skills and attitudes of internal candidates will already be Creates a vacancy elsewhere in the business that will still
known by the business need to be filled externally
Selection i
REVISED
Once applications for a vacancy have been received, the business must now
narrow down the field so that they are left with the best candidate for the
vacancy. The selection process may require candidates to undergo a number
of different procedures. The most common are outlined in Table 4.5.
Table 4.5 Common methods of selection for job vacancies
Method of selection Explanation Analysis

interviews Still the most common method, interviews Bias or prejudice on behalf of the interviewer
can take place face to face or by telephone. may skew the results of interviews,
They offer the chance to hold a conversation, undermining the usefulness of this method
allowing follow-up questions and some being used on its own
freedom of which areas to probe
Testing and profiling Attempting to bring objectivity to the selection Purely objective selection methods can mean
process, aptitude tests can uncover just how screening out great candidates who do not fit
high a candidate's skill levels are in certain the 'traditional profile’ of the job
tasks. Meanwhile, profiling helps to identify
the personality type of each candidate
Assessment centres Candidates may be invited to attend an This method tends to be more expensive than
assessment centre, where a range of others and is more likely to be used for more
selection methods, from role plays to group senior positions
tasks and interviews can be combined to
better assess their abilities and performance
in a simulated environment
Now test yourself
Why can interviews be an unreliable method of selection?


Training REVISED
Seen by Herzberg as the most powerful tool at a manager’s disposal, training

Training is designed
allows employees to develop new skills, thus boosting the range of tasks they to enhance employees'
are capable of performing. existing skills or develop
new skills.
Making links
induction training is
Training links effectively to theories of motivation (see page 55), with induction training the term that specifically
in particular helping to satisfy employees' safety needs, while training to develop describes initial training
employees' abilities helps their esteem needs and helps to meet Herzberg's motivators. when an employee begins
a job that is designed to
The benefits and costs of training for a business are shown in Table 4.6. familiarise them with the
workplace and the business.
Table 4.6 Benefits and costs of training for a business
Benefits Costs Typical mistake

Higher skill levels can boost productivity Providing training can carry a large
Do not be tempted to use
and innovation financial cost
the term induction training
A wider range of skills can enhance the While training is being provided, the to describe all training that
business's flexibility normal operations of the business can be offers employees new skills.
disrupted It relates only to the training
Motivates staff, who feel they have been Better-trained staff are more attractive to provided at the beginning
invested in by the business other businesses who may try to poach of a member of staff's
them employment.
On-the-job versus off-the-job training

Figure 4.2 shows the advantages and disadvantages of on-the-job training.
Choosing to use off-the-job training prevents the two disadvantages but
means the business can miss out on the advantages offered by on-the-job
training.
Advantages Disadvantages
Figure 4.2 Advantages and disadvantages of on-the-job training
Now test yourself
State two reasons why on-the-job training may be more effective than off-the-job
training.
State two reasons why off-the-job training may be more effective than on-the-job
training.

Organisational design
How to organise people
Structure ' REVISED
□
+ As organisations begin to grow, thought must be given to the way in which
Business functions are
the different people and jobs are to be structured.
the main departments
+ This helps in ensuring that the work is co-ordinated effectively and the working within a business.
organisation is following its correct strategic path. The traditional business
+ Organisations use a hierarchical system, with the main decisions taken functions are marketing,
at the top and those lower down the structure putting those decisions finance, human resource
into practice. These structures are usually split vertically into business management and
functions. operations management.
+ Vertical paths through the organisation, through which communication
A line manager is a single
passes, are referred to as chains of command.
boss for each member of
+ Other aspects of traditional organisational structures include the need
staff, from whom orders
for each member of staff to have a single boss - a line manager. This
must be taken, advice can
helps to ensure that each employee knows who to take orders from, who
be sought and to whom
to approach for advice and to whom they must be answerable for any actions must be explained
mistakes. where necessary.
Span of control is the

Spans of control term used to describe the
+ Each manager should not be expected to supervise too many members of number of subordinates
staff otherwise they would not be able to perform their role effectively. directly answerable to one
+ Therefore it is important to design an organisation where individual manager.
managers’ spans of control are not too wide.
Delegation means passing
+ Limiting spans of control means that for larger organisations, many levels decision-making power
of hierarchy are needed. down the organisational
+ Therefore, management levels can run from functional managers (such as structure to a lower level.
the marketing manager) through other senior management roles (brand
manager) to regional managers, location managers and then supervisors Centralised structure
and team leaders. describes an organisational
+ At each layer, different levels of power and responsibility are found - the structure where most major
decisions are taken at the
nearer the top, the more power and responsibility (and pay).
very top of the organisation
by the most senior
Typical mistake managers.
Delegation does not mean simply telling someone to do something - that is simply Decentralised structure
issuing orders. For delegation to take place, some actual decision-making power over is the opposite of a
how to do a job must be passed down to a subordinate. centralised structure and
is where decision-making
Subtle differences can be found between organisations, especially when is passed lower down the
relating to where key decisions are made: organisation structure
+ In a centralised organisational structure, to aid co-ordination most through the process of
delegation.
significant decisions will be made at the very top of the structure.
+ In other organisations, perhaps those where local conditions vary greatly,
it makes more sense to allow local managers to make decisions for their
branch.
Figure 4.3 helps to explain the potential benefits of both centralised and
decentralised decision-making.

The
structure is:
Centralised Decentralised
Decisions made
Decisions made
locally, doser to
at the top
customers
... restricting ... giving local

autonomy for managers more
local managers responsibility
... probably
... but giving
making them
consistency to
(and staff) more
customers motivated
Figure 4.3 Centralised versus decentralised organisations
1 Who makes major decisions in a centralised structure?

Making links
If a business operates on a global scale, its approach to marketing should determine
its structure, with a domestic or ethnocentric approach suiting a centralised structure,
and a decentralised structure needed if the business takes an international or
polycentric approach. This issue is covered in detail in Chapter 20.
Types of structure REVISED

□
A further fundamental difference in organisational structure concerns the
basic shape of the structure.
Tall
A tall structure is one with many layers and narrow spans of control. Table
4.7 summarises the advantages and disadvantages of a tall structure with
narrow spans of control.
Table 4.7 Advantages and disadvantages of a tall structure with narrow spans
of control
Advantages Disadvantages
Allows close supervision of staff Staff may feel over-supervised and not
trusted by their management
Communication within the immediate team Communications as a whole may be poor
(boss and immediate subordinates) is likely with so many layers for messages to pass
to be excellent through
Many layers of hierarchy means plenty of With narrow spans, there may be little
opportunities for promotion to the next level scope for staff to use their own initiative

Flat
A flat structure has fewer levels within the hierarchy, but wider spans of
control:
+ This forces increased delegation by managers who are unable to closely
supervise far higher numbers of subordinates.
+ This can result in more mistakes. It can also lead to far greater motivation
from staff, who are expected to use their own initiative.
+ A flat structure also has the benefit of reducing the number of layers
between the top of the structure and the very lowest level. This may make
it easier for senior managers to develop an understanding of the real day-
to-day challenges faced by staff dealing with customers, for example. This
can increase the ability of the firm to respond to changes in customers’
tastes, boosting competitiveness.
Matrix
A matrix structure differs from traditional structures in one very significant
way. Instead of only having one line manager, staff may have two, or even
more. Though a traditional functional structure is likely to exist, cross
functional project teams are formed, with staff from different departments
working together on a project, under the leadership of the project leader.
Table 4.8 Advantages and disadvantages of a matrix structure
Advantages of a matrix structure Disadvantages of a matrix structure

Working together allows expertise from Each project team member will have at
each department to be immediately least two bosses
available, preventing possible delays in
projects
The focus of the project team should be Two bosses means it can be unclear
on success of the project, rather than whose orders should take priority
making their functional department more
important than others
Learning from the views of colleagues in Getting staff from different functional
other departments helps to develop each areas to agree can be difficult
team member
Now test yourself
In what type of structure may staff have more than one line manager?
13 Why does a flat structure encourage delegation?
14 How does a tall structure offer more scope for promotion?
Impact of structure on motivation and

efficiency r REVISED
□
It is remarkable how many ways structure can affect efficiency and
motivation and therefore costs and profit. Effects on efficiency and therefore
unit costs include:
+ poor communication leading to mistakes
+ duplication of tasks
+ tasks being overlooked and not done
+ departments failing to work together effectively.
Meanwhile, structure can affect motivation by encouraging or preventing the
following:
+ scope to show initiative
+ delegation

+ responsibility Exam tip
+ gathering of all information required to perform a job
+ opportunities for promotion. Whenever relevant, look to
build chains of logic that
Now test yourself TESTED interweave organisational
structure, motivation theory,
Look ahead to the next section which deals with motivation in theory. Link up each productivity (efficiency) and
of the five bullet points about motivation above to the work of at least one theorist unit costs.
to understand how you can use motivation theory alongside organisational
structure when building a chain of argument in an exam answer.
Motivation in theory
Theories of why people work
The desire to understand what motivates people to work is driven by the
commercial need to fully use the human resources at the firm’s disposal. For
over a century, academics have been trying to put together viable theories
that help to explain what motivates people to work. The four key theorists are
explained below.
F.W. Taylor (scientific management) REVISED
Frederick Winslow Taylor’s approach to motivation can be summarised

simply as ‘money motivates’. His theory suggests that people only work in
order to maximise their own income. This means that to get people to work
harder, money should be used as an incentive (or removal of money as a
threat). This approach to motivation was accompanied by Taylor’s beliefs
about how work as a whole should be organised, as summarised below:
+ Observe workers at work.
+ Identify the most efficient workers and how they do the job.
+ Break the task down into small, simple, repetitive parts.
+ Devise equipment specifically designed to speed up the process.
+ Set out clear-cut instructions for what each employee must do.
+ Design a payment system that rewards each worker each time they
complete their task.
F.W. Taylor’s work is still visible in many jobs today, where commission or Making links
piece-rate pay are used to incentivise more work being completed. However,
Taylor’s ideas of how a business should be organised became extremely At the heart of Taylor's ideas
unpopular with workers. They felt treated like pieces of machinery and is the concept of efficiency
denied the opportunity to use their minds at work. They were also resentful in how a business manages
of the level of control that the work process and payment method gave its resources (see page 109).
employers.
Elton Mayo (human relations theory) 1 REVISED

□
+ Mayo’s work stemmed from a range of experiments he conducted into the
effectiveness of‘Taylorism’.
+ As he carried out more and more workplace-based experiments, Mayo
discovered that there were more factors affecting workplace performance
than money.
+ Mayo’s findings centred on the importance of interpersonal relations as a
factor affecting productivity, thus the name ‘human relations theory’.
The factors Mayo identified are summarised below:
+ Workers gain satisfaction from a certain level of freedom and control over
their working environment.
+ Workers who feel they belong to a team tend to work more effectively.

+ Group norms (what people in a team expect of each other) tend to have a
strong influence over workers’ behaviour and productivity.
+ Communication between workers and between managers and workers
improves morale.
+ Managers taking an active personal interest in their employees has a
beneficial impact on workers’ performance.
L____
Explain how Taylor's belief in why people work ties in with paying people for each
unit they produce.
Explain how this means a firm should be able to meet staff pay and make a profit.
What did Taylor say was the only thing that motivated people to work?
19 What did Mayo discover also played a part in motivation?
Maslow (hierarchy of needs) REVISED

□
Self
actualisation
Esteem needs
Social needs
Safety needs
Physical needs
Figure 4.4 Maslow's hierarchy of needs
Abraham Maslow’s hierarchy of needs, shown in Figure 4.4, summarises his

beliefs about what explains human behaviour, both in general and in the
workplace:
+ He believed that all humans have five sets of needs.
+ These can be arranged in a hierarchy, with the most basic needs for life at
the bottom and the higher-level needs at the top.
+ Meeting each level of needs is a priority until they are met, when a person
will focus on the next unsatisfied level of needs.
+ Businesses use the hierarchy to understand how to motivate their staff
using a range of techniques. The hope is to move people up the hierarchy
to the higher-level needs which tend to generate the best level of
workplace performance.
Table 4.9 shows how each level of need has workplace implications.
Table 4.9 Maslow's hierarchy of needs: implications for business
Maslow's level of human need Business implications

Physical needs, e.g. food, shelter, warmth Pay levels and working conditions
Safety needs, e.g. security, a safe structured environment, Job security, a clear job role/description, clear lines of
stability, freedom from anxiety accountability (only one boss)
Social needs, e.g. belonging, friendship, contact Team working, communication, social facilities
Esteem needs, e.g. strength, self-respect, confidence, Status, recognition for achievement, power, trust
status and recognition
Self-actualisation, e.g. self-fulfilment; 'to become everything Scope to develop new skills and meet new challenges, and
that one is capable of becoming', wrote Maslow to develop one's full potential

Frederick Herzberg (two-factor theory) REVISED
Herzberg’s theory relies on accepting his definition of motivation - of doing

something because you want to do it. He distinguished this from movement,
which he defined as doing something to get a reward or avoid a punishment.
Herzberg was clear:
+ Motivated workers give their best performance all the time, are willing to
embrace change and are great at solving problems.
+ Workers who do things to gain rewards or avoid threats will only do so
while the reward is available or the threat remains.
+ Even worse, workers are likely to get stuck into a single way of doing things
and therefore resist change.
Herzberg’s two-factor theory suggests that factors affecting people at work
can be grouped into ‘motivators’ and ‘hygiene factors’. He identifies five
common features of instances when workers are genuinely motivated.
Providing the opportunity for staff to experience these can lead to job
satisfaction. Herzberg’s motivators are:
Typical mistake
Suggesting that Herzberg
claimed that pay and
bonuses motivate staff is
wrong. Herzberg was clear
Figure 4.5 Herzberg's motivators that money is a hygiene
factor and while offering
All of these needs relate to the work an employee is actually asked to do. bonuses can generate
The other set of needs all relate to the context, or environment, in which an movement (better than
employee is expected to do their job. These needs, which Herzberg called average work), it does not
hygiene factors, must be met to prevent an employee feeling dissatisfied: motivate.
+ company policy and administration (the rules and paperwork involved in
working for the business)
Herzberg used the term job
+ supervision enrichment to describe
+ pay designing jobs that include
+ interpersonal relations (with peers, bosses or subordinates) the motivators. These
+ working conditions. include: a complete unit of
These hygiene needs do not motivate staff, however they must be satisfied work, direct feedback on
to prevent dissatisfaction. Herzberg argued it is impossible to motivate a performance and the ability
dissatisfied worker. Three possible scenarios are explained in Table 4.10. to communicate directly with
any other member of staff.
Table 4.10
Hygiene needs met, no motivators Worker will give movement (not their best - only enough to gain reward or
avoid threat)
Motivators met, but hygiene not satisfied Employee will be resentful of their job and, no matter how interesting the
work is, will perform poorly - and look for another job
Hygiene needs and motivators met Employees can focus on their job and will do it to the best of their ability

20 List Maslow's five levels of needs.

1 State two examples of Herzberg's hygiene factors and three of his motivators.
Explain in your own words the difference between motivation and movement,
giving an example from your school/college life.
Motivation in practice
How to get people to work harder
Financial rewards REVISED
□
Table 4.11 Summary of financial rewards
Type of reward Explanation Advantage Disadvantage

Piecework Paying each member of staff This encourages speed, as It is likely to lead to quality
a set amount of money each the quickest staff earn the problems as staff rush to
time they repeat a task most money complete as many tasks as
possible
Commission Paying staff, whose role This incentivises staff to sell It may lead to mis-selling as
involves selling, a certain as much as they can staff try to sell more expensive
percentage of the revenue they products or services to maximise
generate, usually on top of a their commission, causing
low basic salary or hourly rate customer dissatisfaction
Bonus Paying a lump sum as an This can provide an excellent Large bonuses can distort staff
additional reward to members way of offering staff a valued behaviour, emphasising the need
of staff if a target is hit, extra thank you to reach the bonus target by
typically once a year whatever means possible
Profit-sharing Allocating a certain proportion This aligns staff goals with Hard-working staff may resent
of annual profits to be shared business goals others who receive the same
as a bonus among staff profit-share bonus without putting
in the same amount of effort
Performance-related This involves rewarding staff This allows individuals' Employees may feel the process
pay whose performance exceeds performances to be clearly used to decide on the award of
a certain level where work rewarded financially PRP is unfair or biased against
performance is hard to them
quantify. The decision whether
to award a bonus usually
depends on some form of
appraisal system

The use of financial methods of motivation can be a strong force in shaping an For any financial method,
organisation's culture (see page xx). Financial rewards really shape people's Taylor's theory - that money
behaviours, so behaviour that stimulates a financial reward will quickly form a part of motivates-can be used
the normal and acceptable way of behaving in the business. to justify why the method
should work.
Now test yourself
3 Which motivation methods are designed to align a worker's personal financial

rewards with the company's financial success?

Non-financial techniques REVISED
Table 4.12 Summary of non-financial motivational techniques
Explanation Why it should Possible problems Empowerment is a slightly

motivate stronger form of delegation
Delegation Passing decision Allows staff to meet Staff must have the in which the subordinate is
making power to Maslow's esteem skills and experience given some decision-making
staff over how to and self-actualisation to make good power over what tasks need
perform a task needs, as well as decisions to be done, not simply told
being a motivator for when to do them.
Herzberg Consultation means
Empowerment Passing even more Allows staff to meet The need for asking the views of staff
power to staff, to Maslow's esteem appropriate skills affected as part of a
the extent where and self-actualisation and experience is decision-making process,
they may be given needs, as well as even greater than although the manager
authority to decide being a motivator for that needed for retains the power to make
what job needs doing Herzberg successful delegation the decision.
Consultation Seeking staff's May help to meet Many decisions will Job enlargement is the
opinions before esteem needs on appear to go against term used to describe any
making a decision Maslow's hierarchy the views of many increase in the scope of
staff-consultation a job and this describes
may be seen as a both job rotation and job
meaningless process enrichment.
Team-working Allowing staff to work Allows staff to meet The performance
in a group rather than Maslow's social of more productive
individually needs; recognises individuals may be
Mayo's belief that dragged down to a
human relations team average level
are necessary to
motivate staff
Flexible working Allows staff to adjust Helps to ensure Co-ordinating the
where and/or when Maslow's lower level workforce can be
they work to suit their needs are met, and harder to achieve
lifestyle can be a key factor in
meeting Herzberg's
hygiene needs
Job enrichment Giving staff added Meets Herzberg's Some staff may view
responsibilities motivators and extra responsibility
and challenge by Maslow's top two as an unwanted
widening the scope levels of need burden
of their job
Job rotation Moves staff between Helps to prevent Prevents the
different tasks of boredom - little potential productivity
Exam tip
the same level of theoretical benefits that come
complexity justification from specialising in Wherever possible, use a
one task motivation theorist when
Job Gives staff more, Can make in reality, most staff explaining a method of
enlargement similar tasks of employees feel a recognise they are motivation. Explain how the
the same level of sense of esteem simply being asked theory suggests the method
complexity to do more for no would actually help to
extra reward improve motivation of staff.

24 State three motivation methods that F.w. Taylor would advocate.

5 State three motivation methods that Herzberg would advise a business to use.
6 What motivation method could be used if workers are struggling to meet their
social needs at work?
Explain why delegation may need to be accompanied by training.
Leadership
Leaders and managers REVISED
□
The roles of manager and leader are different, although in many businesses,
A manager is a person
especially smaller firms, the same person may be expected to fulfil both
fulfilling a role whose major
roles. Peter Drucker’s quotation ‘Managers do things right; leaders do the right
job is to oversee putting
thing’ sums up the difference nicely.
plans into action, getting the
details right and ensuring
Typical mistake that the resources allocated
Although some leaders are charismatic characters, with outgoing personalities that are used correctly.
subordinates love to follow, many highly successful leaders may go unnoticed - not all The role of a leader is to
great leaders lead by example. identify key issues to be
addressed, set objectives
Table 4.13 Responses of leaders and managers to different circumstances and decide what should
be done to address those
Circumstances What managers do What leaders do issues and who should do it.
Key staff are leaving Recruit new staff with Rethink the design and
___________ >
care responsibilities within the job
An important customer Get staff to smooth Take personal responsibility for the
is threatening to go things over as best they customer's disappointment and
elsewhere can sort the problem out
A downturn means Hire an hr specialist Call a staff meeting, explain what
redundancies are company to handle the is happening and deal with the
necessary whole process whole thing personally
A very promising new Take control of the Delegate the project to a bright
product idea has been development and young manager, providing extra
proposed assemble a large project resources when needed
team
Making links
This difference between managers and leaders echoes the topic at the end of
Chapter 5 which examines how entrepreneurs - who may be great managers - may
struggle to adapt to performing as leaders once their organisation grows.
Explain why the leader and manager are likely to be the same person in a small
business.

Types of leadership style REVISED
□
Different leaders deal with their staff in different ways. You need to
understand four types of leadership style:
+ Autocratic: Autocratic leaders issue instructions and expect these to be
obeyed. They know exactly what they want done and pay little attention to
what workers have to say. Communication will be one-way, top down, with
the manager not expecting or responding to feedback.
+ Paternalistic: Paternalistic leaders see themselves in the role of a
traditional father-figure - the head of the family. They care about the best
interests of staff/family and listen to their views. But the leader makes the
decisions, albeit decisions believed to be in the best interests of staff.
+ Democratic: Democratic managers expect their staff to be involved in
decision-making. They will delegate authority to subordinates, believing
that this is the best way to get the job done. Some democratic managers
will agree clear objectives with staff, then let them get on with doing the
job in order to achieve the objectives. Making links
+ Laissez-faire: Literally meaning ‘leave to do’, laissez-faire managers leave The first row of Table 4.14
staff alone to get on with things, generally without even providing a clear shows clear links between
sense of direction. This will often be the result of the manager being either motivation theories and
too busy or too lazy to provide focus and structure. However, for a new leadership styles (see
business needing ideas and creativity, leaving talented creative staff alone page xx).
can provide a fertile ground for innovation.
Table 4.14 Assumptions and approaches of three types of leader
Democratic Paternalistic Autocratic

Style derived from Belief in Maslow's higher- Mayo's work on human A Taylorite view of staff
order needs or in Herzberg's relations and Maslow's
motivators lower- and middle-order
needs
Approach to staff Delegation of authority Consultation with staff Orders must be obeyed
Approach to staff Salary, perhaps plus Salary plus extensive fringe Payment by results, e.g.
remuneration employee shareholdings benefits piece rate
Approach to human Recruitment and training Emphasis on training and Recruitment and training
resource management based on attitudes and appraisal for personal based on skills; appraisal
teamwork development linked to pay
Now test yourself
29 Name the leadership style being explained:

The leader seeks and listens to the views of staff, delegating with a clear sense
of purpose.
b) The manager cares about the welfare of staff and considers this when making
decisions.
The manager expects their instructions to be followed and keeps all decision
making power.
The manager leaves staff to get on with their work without any clear direction.

Exam practice
HMRC - the UK organisation responsible for collecting taxes - attracted news
headlines as a result of its decision to outsource the cleaning of its offices. This
meant that cleaners, formerly employed by HMRC, might lose their pension benefits
and legal entitlement to sick pay. The company to which the cleaning work was
outsourced used staff employed on zero-hours contracts. This shifted the risk
involved in employing staff away from HMRC to the subcontractor. In turn, the
subcontractor shifts risk to the people they employ. The zero-hours contracts mean
the subcontractor does not have to pay staff when there's no work, therefore avoiding
unnecessary costs.
Questions
1 What is meant by a zero-hours contract? [2]
2 what is meant by outsourcing? [2]
3 Using a motivation theory of your choice, explain why HMRC's new cleaners,
employed by the subcontractor, are likely to do a poorer job than cleaners who
were previously employed by hmrc. [6]
4 Assess whether HMRC made the right decision about how to have its offices
cleaned. [10]
Summary
+ Different employers may view their staff either as a + Key issues affecting the shape of organisational
critical asset to the business's success or simply as a structure are spans of control and levels of hierarchy.
cost to be minimised. + Organisational structure can have major impacts on
+ Having a flexible workforce makes it easier to run a efficiency and motivation.
business successfully. + Methods of motivating staff can fall into two categories:
+ Employer-employee relations can be based on either financial and non-financial methods.
collective or individual bargaining. + The five financial methods are: piecework, commission,
+ The need to recruit staff could be triggered by existing bonus, profit-sharing and performance-related pay.
staff leaving, growth of the business or new activities + Non-financial methods are: delegation, empowerment,
being performed by the business. consultation, team-working, flexible working, job
+ Staff may be recruited internally or externally. rotation and job enrichment.
+ Selection methods including interviews, testing and + Clear links can be drawn from the motivation theorists'
profiling, and assessment centres are used to decide work to explain why these methods should work.
which applicants to employ. + The roles of leader and manager are significantly
+ Training staff has both benefits and costs. different.
+ initial training is called induction training. + Different leaders treat their staff in different ways. This
+ Training can be carried out on the job or off the job. is called their leadership style.
+ Organisational structures can be classified as tall, flat + The main leadership styles to focus on are: autocratic,
or matrix. paternalistic, democratic and laissez-faire.
Exam skills
+ This section of the course introduces the notion that + Thinking yourself into the mind of a believer in
different people think differently about how businesses Herzberg's theory will enable you to offer advice to a
should be run. business that would differ hugely from that offered by a
+ Whether it is how to structure an organisation or how Taylorite observer.
best to keep staff motivated, different perspectives + Look to use these alternative perspectives on
on 'the best way' give rise to the type of tensions that managing people as a way of creating argument and
business examiners love to set up in their questions. counter-argument within your answers.
+ Taking different perspectives can often be a highly
effective way to build two contrasting arguments when
tackling a question that requires a judgement.

Role of an entrepreneur
What do the founders of a business need
to do?
Businesses could not exist without entrepreneurs. They are the individuals
who spot business opportunities and then act in order to exploit the
opportunity. Entrepreneurs must fulfil a number of roles within their
businesses, as outlined below.
Creating and setting up a business REVISED

□
Generating a business idea
At the very heart of any entrepreneur’s success is a good idea, probably based
on an understanding of consumers. The main sources of business ideas are:
+ Observation: Watching what other businesses are doing or how consumers
behave may give an idea that can be copied elsewhere. Or it may suggest
an idea that can be adjusted to work even more successfully.
+ Brain-storming: This is the process of simply listing possible ideas without
any selection involved; this will come later.
+ Thinking ahead: This is spotting trends that will lead to changes in
the future that will offer business opportunities, for example noting a
government initiative to boost the number of apprenticeships and setting
up a website specialising in advertising apprenticeships.
+ Personal or business experience: Noticing that certain needs are not met
through personal experience or within a workplace.
+ Innovations: Scientific breakthroughs or major overhauls of an existing
type of product may generate viable business ideas.
Spotting an opportunity
An idea will only become a viable business if a market exists for it. The ability
to identify chances to turn ideas into saleable products or services relies on
spotting an opportunity. Typical sources of opportunity tend to be centred on
changes occurring in the wider world:
+ Changes in technology: Increased computing power in mobile handsets
broadens the range of possible apps that could be produced to meet a need
for consumers to control something on the move.
+ Changes in society: Trends in the way people behave, such as increased
part-time work opportunities for the semi-retired, can represent an
opportunity for a recruitment agency for retired workers.
+ Changes in the economy: Differing rates of national or regional economic Making links
growth may offer opportunities to be exploited.
+ Changes in the housing market: New housing developments may bring The external factors that
associated opportunities to service providers if local populations grow, or can hinder successful
become wealthier. entrepreneurship are
developed further in
Techniques such as market research (see below) or market mapping can be Chapter 10.
used to examine the market.
Market research
Entrepreneurs are likely to have to conduct any market research on a very
small budget. Small, low-cost studies can still help, though. They may throw
up an important opportunity.
Cheap market research methods could include:
+ Walking around a local town: This will give the opportunity to see if there
are any obvious gaps (what, no Thai restaurant?) in addition to being able
to see which types of business seem to be most popular with locals.
+ Spending time with other entrepreneurs: Entrepreneurs in other parts of
the country may be willing to share their insights and experience, helping
to boost an entrepreneur’s understanding of consumers’ behaviour.
+ Discussions with friends: This could be dangerous, as friends may not
want to dampen an entrepreneur’s enthusiasm; however, they can act as a
focus group that could throw up new insights.
+ Producing a market map, as detailed in Chapter 2 (see page 16).
Now test yourself
State two ways that walking around the local town may help to identify a business
opportunity.
Why should all potential entrepreneurs be alert to changes in the outside world?
Running and expanding a business REVISED

□
Habits of successful entrepreneurs in the way they
run their businesses
+ They measure performance in an unbiased way: if there are problems
these must be identified rather than ignored.
+ They have an eye for detail: it is unlikely that anybody other than the
entrepreneur will be as worried about getting the little things right.
+ They have the ability to step back from the day-to-day issues: only by
thinking strategically will a new business be able to secure a long-term
future.
+ They love what they are doing: without this, the motivation needed to do
the three things above will drain away.
Problems with business expansion

Some businesses are not suited to expansion, as the idea and opportunities
remain small-scale or localised. For other entrepreneurs, expansion may be
vital to prevent others from developing an idea more successfully. The three
major problems to avoid as an entrepreneur considering expansion are:
+ Over-estimating demand: what works in one place may not work
elsewhere.
+ Failing to raise sufficient finance: it is a lack of cash that ultimately leads
to all business failure. Without having made sure that the business has
enough finance to support operating on a larger scale, the danger of
running out of cash becomes acute.
+ Not recruiting enough or the right people: as entrepreneurs expand their
business they will find their limited time more stretched, with more
to oversee (perhaps causing too much stress). It is therefore vital that
when they recruit they get the right staff who understand the business
philosophy and have the skills needed.
Making links
We can see here that expanding a business needs careful management of each
functional area. Specifically mentioned here are the need to be able to run an effective
recruitment process (see page 49) and the need to ensure eagle-eyed cash flow
management (see page 84).

Innovation within a business REVISED
□
+ If entrepreneurs are loosely defined as those who are able to generate and
develop new business ideas, then there is a role for them even in large
firms.
+ The kind of creative and disruptive thinking that entrepreneurs can draw
on is increasingly being sought by large businesses.
+ They want to nurture innovation within their businesses as a way of intrapreneurship
maintaining a competitive advantage. is the name given to
+ Entrepreneurial behaviour within the setting of a large business - the encouragement of
intrapreneurship - can be seen in many successful large businesses, such entrepreneurial behaviour
as Facebook. within larger businesses.
Barriers to entrepreneurship REVISED

□
Funding
Following the financial crash in 2008, banks in the UK remain less willing
to lend to small firms and business start-ups, considering them relatively
high risk for relatively low return as they are often believed to be relatively
unprofitable. Without institutions willing to lend, entrepreneurship may die
back in the UK.
Gender bias
UK entrepreneurs are three times as likely to be male as female. This
statistical mismatch between the population/market and the people starting
new businesses is likely to mean that much entrepreneurial talent in the UK
is going to waste.
Lack of public sector support Making links

Although the image of the entrepreneur has improved significantly in
the UK over the past 20 years, some who work in the public sector view innovation lies at the
entrepreneurs sceptically, suspecting tax avoidance or motives based heart of new product
on greed. This perception in the public sector may lead to an education development - as explored
system that fails to value entrepreneurial skills or creates other barriers to within the product life cycle
entrepreneurship. topic in Chapter 3.
Anticipating risk and uncertainty in the

business environment F REVISED
□
+ Risk and uncertainty characterise the business environment for many
firms. Making links
+ This is because of the wide number of external variables that the business Risk and uncertainty are
cannot control, and may not even be able to influence. perhaps most noticeable
+ The role of the entrepreneur must include understanding the ways that when tackling quantitative
uncertainty affects the business. sales forecasting (see
+ In some cases the main cause of uncertainty can be reduced, such as Chapter 13) and can be
introducing new products into the firm’s portfolio, thereby reducing the carefully considered via the
dependence on the sales of one brand. use of scenario planning -
covered in Chapter 16.
Now test yourself
Explain why entrepreneurs may find it harder to secure funding from banks than
they did 20 years ago.
4 What four habits are important for any entrepreneur to develop if they want to
successfully start up their business?

Entrepreneurial motives and
characteristics

Who makes a good entrepreneur and why do
they do it?
Characteristics and skills REVISED
□
The main characteristics required to become a successful entrepreneur are:
Figure 5.1 Characteristics of successful entrepreneurs
Taking sensible risks involves weighing up the risk and rewards that a course
of action offers. Risk consists of the likelihood of things going wrong and the
size of the consequences of things going wrong. Good entrepreneurs accept
risk but will not take on any risk they consider to be too great.
Good entrepreneurs will need to be able to demonstrate a range of common
skills:
+ Financial skills: This involves understanding key financial documents and,
more fundamentally, how finance allows a business to function.
+ Persuasive abilities: Good entrepreneurs find a way of persuading many
people to do many things that their business needs, from suppliers to staff
to customers. Making links
+ Problem-solving skills: These are frequently shown by the ability to identify
Understanding financial
causes of the problem and solve the problem by addressing these causes. statements, through the
+ Networking skills: With a wide range of possible business contacts, use of financial ratios
entrepreneurs are more likely to find someone who can help when the (explored in Chapter 15), is
business needs help. an important skill for any

□ entrepreneur.
Sort the following into two groups: personal characteristics of successful

entrepreneurs and skills required by entrepreneurs:
Networking, passion, understanding the market, problem-solving, persuasive,
ability to cope with risk, determined, understands finance, resilient.
6 Briefly explain a good entrepreneur's attitude to risk.
State three types of people on whom an entrepreneur may need to use their
persuasive abilities.

Reasons why people set up businesses REVISED
□
Table 5.1 Reasons to set up a business
Profit maximising This means to continually seek to get the most profit from every business transaction.
Though this may seem the way to get rich, it will often cause long-term problems, with
consumers feeling exploited or even cheated with substandard work caused by skimping on
materials and workmanship.
Profit satisficing Long-term success may well be based on satisficing, with the need to accept lower than
possible profits in the short-term to build a brand or a reputation.
independence Entrepreneurs sometimes set up their own business to avoid the need to take orders from
others or fit in with company policy. Research shows the attractions of 'being your own boss'
to be a very common motive.
Home-working Being able to work at, or from, home can be another form of independence, especially valued
by those with family commitments.
Ethical stance For those with strong beliefs in how business should be done, their ethical stance may lead
them to feel the need to start their own business. They are unwilling to compromise their
beliefs by working in a business with whose practices they feel uncomfortable.
Social entrepreneurship Although this has a clear cross-over with ethical beliefs, some entrepreneurs will start up a
business whose major aim is to make a positive contribution to their community, perhaps
by providing a service that benefits people in need. Sadly, some may pretend to be social
entrepreneurs while profit remains their real goal.
Profit satisficing means

Making links
blending a desire for profit
The table shows that for some entrepreneurs, the topic of business ethics, explored in with other factors, such as
more detail in Chapter 14, can form the very foundation of their enterprise. building a good reputation
or having a good work-life
balance.

□ Exam tip
What are two common financial motives for starting a business?
An entrepreneur's motives
Why can profit maximisation damage a firm's long-term chances of success?
will be a major determining
Why may entrepreneurs who take an ethical stance struggle to make a profit, even factor behind their decision
in the long term? making. Decisions taken
Answers available online by an entrepreneur who is
seeking to maximise profit
will differ greatly from those
taken by an entrepreneur
Business objectives driven by an ethical stance. y
Setting targets for a business

Business objectives are targets set in order to ensure that the whole business
An objective is a specific
is working towards the same goals. Objectives are set by those in charge of
target set by a business.
the firm, such as the chief executive. Once objectives have been set, a plan for
achieving the objectives - a strategy - can be devised. The strategy will lay out The strategy is the plan
what each department of the business will need to do in order to enable the devised by the business to
business to reach its objectives. achieve its objectives.
Making links
For larger organisations, the formal processes of setting corporate objectives and then
devising a corporate strategy (see Chapter 11) are at the heart of their planning - just
as they would be even for a small business.

Figure 5.2 How business works
SMART objectives REVISED
To gain most from objectives, they should be SMART:

+ Specific
+ Measurable
+ Achievable
+ Realistic
+ Time-bound
Common business objectives ' REVISED

□
Common business objectives can be seen in Table 5.2.
Table 5.2 Common business objectives
Typical Explanation Typical circumstances

objective
Survival Focusing on generating sufficient cash When starting up, or when a challenging external environment
to sustain the business threatens the future of the business, such as a recession or the
arrival of a powerful new competitor
Profit Earning the most profit possible in a A common objective for businesses - reflecting the need to
maximisation given time period generate profit for owners as a primary purpose of business
Sales Growing the number of customers, in a rapidly growing market, firms may try to maximise their
maximisation without a major focus on controlling share of the market, with an expectation of generating profits
costs once the market growth has slowed and competition reduces
Market share Increasing market share to a dominant Market leaders will often seek to increase their lead and thus
level helps to ensure long-term power by enhancing market share
success through greater distribution
and preventing new entrants from
challenging in the market
Cost A focus on seeking to minimise the This objective will be key for firms that are trying to follow a
efficiency costs of producing a product or service strategy where they will aim to undercut all their rivals on price,
and the running costs of the business if they can keep costs low they should still be able to make a
profit even with a low selling price
Employee Looking after staff, by treating them Where people play a key role in gaining a competitive
welfare well, and looking to develop them using advantage, whether that be in customer service or through
training and internal recruitment innovation
Customer Prioritising the need to ensure This will be crucial where attracting new customers is costly and
satisfaction that every customer has a positive losing existing customers is very expensive, such as when providing
interaction with the business a regular service such as mobile phone networks or banking
Social Objectives that relate to the beneficial Some businesses see improving society as a key purpose and
objectives role a business can play within society will therefore set social objectives in a meaningful way. social
enterprises will have social objectives as a top priority

Exam tip
Successful firms choose the right objectives to suit their circumstances. Carefully read
the right-hand column of Table 5.2 to ensure you understand when different objectives

are most appropriate.
11 Why do businesses set objectives?

12 What does SMART stand for?
what are the eight common business objectives?
Forms of business
Who will own the business and how
The topic referred to as ‘Forms of business’ refers primarily to the legal status
of the organisation. However, later in this topic, ‘Other forms of business’
covers issues such as licensing the use of a business’s name, running a
business enterprise to improve society, running a business as part of a
lifestyle choice and running a business purely online.
Table 5.3 Different forms of business
Legal forms of business covered in Other 'forms of business' covered -

this topic not specifically relating to legal status
Sole trader Franchising
Partnership Social enterprise
Private limited company Lifestyle businesses
Public limited company Online businesses
Businesses with unlimited liability 1 REVISED
Sole trader
A sole trader is a person who starts and runs a business without turning it
Liability refers to the
into a company. This explains why the law sees the business and the owner
extent to which the owner(s)
of the business as the same. As a result, the owner is personally liable for
of the business must
any debts built up in running their business. If the business goes bust, the
repay debts incurred in the
owner has to use personal assets to repay those to whom the business running of the business.
owes money.
Typical mistake
Sole traders can employ staff. Too many exam answers wrongly state that a sole
trader has to run the business by themselves, mistakenly believing sole traders are
literally one-person businesses. The 'sole' refers to the owner - just one owner. There
can be as many staff employed as the owner wishes.
Table 5.4 Benefits and drawbacks of a sole trader business
Key benefits Key drawbacks

+ Owner has full control over decisions + Owner has unlimited liability for debts
+ Owner keeps all profits made + Hard to raise finance
+ Minimal paperwork needed to start up

Partnership Unlimited liability means
While a sole trader is the single owner of a business, a partnership is perhaps that the owners of the
best thought of as a sole trader where several owners are allowed. This business must take personal
helps to raise finance as each partner can bring capital into the business. In responsibility for covering
addition, the burden of responsibility for running the business can be shared, debts run up by their
potentially among people with varied skills and experience. As with a sole business, if the business
trader, partners still have unlimited liability for debts incurred in running goes bust, the owner/s
the business. can be forced to sell their
own personal assets to
repay lenders, suppliers or
employees to whom money
Table 5.5 Benefits and drawbacks of partnerships is owed.
Key benefits Key drawbacks

+ More owners can allow more finance to be raised + Partners have unlimited liability
+ Partners may bring varied skills and experience + Potential for disagreement among partners
4- Shared burden of responsibility among partners
Now test yourself
Which two types of business organisation offer their owners no limited liability?
5 Which method of finance used by all limited companies is not available to sole
traders or partnerships?
Typical mistake
Liability for debt only becomes an issue if the business goes bust. The owners'
personal assets will only be taken if the business goes under but still owes money
after the assets bought for use in the business have been sold to raise money. Too
many student exam responses simply state that with unlimited liability, a businesses
owner will lose their personal assets, without adding that this will happen if the
business ceases trading owing more than the value of business assets.
Businesses with limited liability ' REVISED

□
For businesses happy to undergo increased legal formalities, limited liability
Limited liability is a form
for owners offers a great safety net from which to build a much larger
of legal protection for
business. Without this protection, far fewer investors would be willing to
business owners which
invest their money into multi-billion pound firms whose debts could run into ensures that owners of a
billions of pounds. limited company can only
lose the money they have
Private limited company invested in the business.
The simpler form of limited company to start is a private limited company
with no minimum share capital. Increased legal formalities include having
accounts independently audited each year at a probable cost of several
thousand pounds.
Typical mistake Typical mistake

Some exam answers wrongly suggest that private limited companies can keep their Private limited companies
accounts hidden from public view, in fact, one responsibility for all limited companies are required to use the
is to send a simplified copy of their accounts to Companies House. Anyone can letters Ltd as part of their
inspect any business's accounts at Companies House or via the Companies House name. The letters PLC are
website (sometimes for a small fee). reserved for public limited
companies.
Public limited company

+ A public limited company is the only type of business that can sell shares
via the stock market to the general public.
+ This allows them to raise vast sums of share capital.

+ However, in order to become a public limited company, a business must Making links
have a minimum of £50,000 share capital.
+ In addition, there are considerable regulatory requirements involved in You will have noticed that
floating the company on the stock market. different forms of business
+ Continuing to meet the annual requirements of the stock market will cost ownership have a significant
tens or hundreds of times more than running a private limited company. impacton the availability
of different sources of
TESTED finance - this is explored in
Now test yourself
Chapter 6.
16 What is the minimum share capital required to form a public limited company?
7 Why might it be more dangerous to use a plumber operating as a private limited
company than one operating as a sole trader?
Other forms of business REVISED

□
Franchising
Franchising offers the opportunity to start a business using a tried and tested A franchise is a licence
formula. For the franchisor, franchising can be a relatively cheap and quick way to use another business's
of expanding their business rapidly. For the franchisee, there are both benefits name and business model
and drawbacks relative to starting entirely independently, as shown below. in return for payment.
A franchisee is an
Table 5.6 Benefits and drawbacks of buying a franchise entrepreneur or company
that buys a licence to use
Benefits Drawbacks
another business's name
+ Access to a tried and tested formula for + The franchisee may feel and business model.
business success frustrated at being unable to
+ Support from the franchisor in providing make decisions dictated by the A franchisor is a business
materials and fixtures and fittings franchisor that sells the right to use its
+ Advice and training on all business functions + There is likely to be an initial name, logo and business
+ Possibility of a national advertising franchise fee to buy the licence model to other businesses
campaign from the franchisor (perhaps several hundred or entrepreneurs.
+ A guaranteed local monopoly for that brand thousand pounds for the most
+ Easier access to loans, as banks recognise popular franchised brands)
the lower risk involved in starting as a + The franchisor will also expect
franchisee royalties, a percentage of revenue
Making links
While attention at this stage is on the use of franchising as a method of starting up a
new business, the franchise model is the key to successfully growing a business - as
covered in Chapter 12 - especially in the global fast food sector, where household
names such as Subway and McDonalds have relied heavily on franchising to take over
the world.
Social enterprise
Social enterprises place the desire to fix a social problem above the profit
motive when making decisions. This is, of course, a terribly broad definition
but that is necessary given the wide range of businesses that can be classed
as being, in some way, social enterprises.
Lifestyle businesses
Some entrepreneurs start up a business because it suits their desired lifestyle.
+ This may mean that maximising profit is far from the most important
issue considered when making decisions for these businesses.
+ For some, running their own business may give flexibility in working
hours to fit around family commitments.

+ For example, a person may choose to leave a highly paid job that requires Making links
long periods away from home in order to start up a small business, such
as a computer repair business, that allows them to fit work commitments The idea of an online
round their children’s sports days and Christmas plays. business keeps cropping

+ Other lifestyle businesses may be based around hobbies or pastimes. up: as a form of business,
+ For example, starting up a football coaching business can offer an as a method of distribution
entrepreneur the chance to spend not just their spare time but also their (place) and even when
work time on a football pitch, doing the thing they love. considering the impact of
+ In such cases, maximising profit may be less important than simply technological factors on
making enough money to sustain the lifestyle. business in Chapter 11.
Online businesses
As the internet has grown over the past 30 years to become a huge part of
modern life, business opportunities have grown out of the technology. Most
important is the way the internet has enabled businesses to connect with
consumers effectively without the need to ever meet face to face. The result
is that traditional ‘bricks and mortar’ businesses now face competition
from many online-only companies. In general, online offers two powerful
advantages over traditional ‘bricks and mortar’ businesses:
+ Lower costs (with no need to spend on physical premises)
+ Higher potential revenues (with the scope to sell worldwide).
Now test yourself
State two benefits of starting a business by buying a franchise.

State two drawbacks of buying a franchise rather than starting a business
independently.
Business choices
Key principles in decision-making
Rather than worrying about learning too much in this topic, the need to be
aware of opportunity cost, choices and trade-offs, should help to structure the Opportunity cost is the
thought processes you need to write excellent responses to examination value of the next best
questions. option foregone when a
business decision is made.
Opportunity cost r REVISED

□
+ Too often business decisions are made without a real appreciation of the
opportunity cost. In order to genuinely understand the opportunity cost of
any decision, it is vital to ensure that all possible options are appropriately
quantified.
+ However, this generally needs accurate forecasting, a challenge that most
businesses struggle to achieve.
+ Frequently, decisions may be based on personal preferences from business
leaders - leaders in a position to influence the data on which the decision
will be made.
+ Though this may sound conspiratorial, it may in fact simply be a reflection
of the enthusiasm that particular leader has for their ‘great idea’.
+ If the best decisions are to be made, cool heads must carefully identify the
opportunity costs involved in making a particular business choice.
Identifying opportunity costs requires careful thought and analysis. Figure 5.3
helps to illustrate this.

Figure 5.3 Opportunity costs of new product launch
Choices and trade-offs F REVISED

□
The choices a business faces are likely to involve some form of compromise - Making links
a trade-off between competing objectives - such as minimising costs and
maintaining quality standards. Successfully managing these trade-offs will Techniques such as
need several attributes on the part of decision-makers including: investment appraisal (see
+ experience page 159) and decision trees
+ understanding of consumer tastes (see page 163) are designed
+ a broad understanding of the business’s current position to help managers cope with
+ an understanding of the external issues influencing the decision. these issues of opportunity
cost and trade-offs.
Now test yourself
20 Explain the meaning of the term 'opportunity cost'.

21 Explain the meaning of the term 'trade-off'.
2 Explain how the manager of a clothes shop may face a trade-off between ensuring
good cash flow and making sure customers can always get the size they want
in store.
Moving from entrepreneur to

leader
How the role of a business’s founder changes
as the business grows
Once a business start-up has been successful, for those entrepreneurs who
are happy to grow their business a number of problems may emerge. Some of
these issues will be caused by changes within the business. One of the most
common, though, is the challenge for the founder in making the transition
from entrepreneur to leader.

Table 5.7 Common issues when moving from entrepreneur to leader
Common business issues Common personal issues

Matching production to demand Delegating

Financing growth Maintaining effective communication
Overtrading Co-ordinating far more people
Change in structure Keeping an eye on the big issues
Business issues 1 REVISED

□
Matching production to demand Making links
+ In order for growth to take place, the business must stimulate more
demand. Underpinning a business's
+ This is likely to be achieved by targeting new markets, perhaps by opening ability to match production
a new branch in a different town or by launching new variations of the to demand are decisions
original product to suit different tastes. over capacity and capacity
utilisation - covered in
+ In each scenario, the business will need to attempt to forecast demand in a
Chapter 9.
less familiar market than the one in which it has been operating thus far.
+ An overly optimistic forecast will result in too much cash being tied up in
stock, causing significant cash flow problems.
+ Underestimate demand and the expansion can be doomed to failure if
first-time customers arrive to find empty shelves or products unavailable.
Financing growth
+ In order to expand, output will need to increase and this is likely to require
Making links
extra cash in order to finance increased materials, wages and possibly
rental or purchase of new property or facilities. Clearly the issues explored
+ The challenge for a new business is to find a way of raising extra finance in Chapter 6 about raising
that avoids giving away too much of the business or facing excessive costs finance link closely to
of finance. the challenges faced by
entrepreneurs looking to
The common methods of financing growth, along with the associated expand their businesses.
drawbacks are listed in Table 5.8 below.
Table 5.8 Drawbacks for main methods of financing growth
Method of financing Potential drawback

Sell shares This will result in loss of control for the entrepreneur
Loans interest and repayments will drain cash from the business
and security may be required
Overdraft Interest rates are even higher than on loans
Leasing new equipment This will lead to higher costs in the long term as leasing fees
will need to be paid for as long as the equipment is in use.
Ideally, retained profits can be used as a source of finance, but this source will
not be available until the business has actually made a profit in the first place.
Typical mistake
Retained profits can only be used once as a source of finance. For example, if retained
profit has already been spent on buying new equipment, that money is gone. It is also
important to remember that not all profit is retained in a business - with interest and
tax to pay, and shareholders usually expecting to receive a dividend, businesses may
not retain much of their operating profits.
Overtrading Overtrading occurs when

a firm expands too rapidly
The risk of overtrading is all too real for any business that expands rapidly.
for its capital to cope with.
Figure 5.4 shows how overtrading can occur.

Figure 5.4 How overtrading happens
Overtrading illustrates why it is so important to ensure that growth is

appropriately financed.
Change in structure
+ With more staff being taken on, extra layers are likely to need to be added
Making links
to what may previously have been simply a two-level hierarchy, featuring
the entrepreneur as boss and all other staff one level below them. Business growth usually
+ To avoid the span of control getting too wide, managers or supervisors necessitates a change in the
will now be required, but adding layers to the organisational structure organisational structure -
fundamentally changes the way a business works. generally by adding layers.
+ Much of the change relates to personal issues faced by the entrepreneur as The consequences of this
their role shifts. were covered in chapter 4.

□
3 Why is retained profit unlikely to be a source of finance for the early stages of the
growth of a business?
24 In what two ways does a loan result in cash draining out of a business?
Personal issues ' REVISED

□
Successful entrepreneurs are often successful because they leave nothing to
Making links
chance and rely on checking everything themselves. As a business grows, a
single boss will eventually reach a point where they cannot check absolutely Although Herzberg and
everything themselves - there are too many things to check each day. This Maslow (see pages 56
means they will need to start delegating authority. and 57) felt delegation
was an effective way to
Delegating motivate staff, it must be
A successful entrepreneur, used to making all the decisions about the remembered that many
business, can find it hard to let go of authority. But for the delegation to leaders find it hard to do.
succeed, the subordinate must feel trusted to make decisions without
interference from the boss. If the business is to grow, letting go of control can
often be the single hardest challenge faced by an entrepreneur.
Maintaining effective communication

Once an organisational structure begins to develop within a growing
business, good communication is vital, but harder to ensure:
+ The boss will still need to know what customers are saying or what morale
is like among shop-floor staff. For this to happen, information must be
able to flow upwards through supervisors and managers (bottom-up
communication) who may be hesitant to tell the boss about problems.

+ If the boss is still going to set the direction for the firm and exert a strong
influence over how things get done within the business, top-down
communication will be vital. But in a bigger organisation, orders and
instructions may get distorted as they pass through several layers of

management.
Co-ordinating far more people

In a start-up the boss is likely to know all staff on a personal level. Once the
total workforce of a business passes a certain size, the boss may struggle
to develop the personal relationships that had marked out their successful
start-up, however all staff (and other business resources) will still need to be
heading in the same direction. It is down to the boss to ensure this still takes
place, even without the ability to personally work with all members of staff on
a regular basis.
Growth requires an entrepreneur to make the change from hands-on boss
to leader/manager. As discussed in Chapter 4, these two roles - manager
and leader - are different. In order for effective growth to take place, the
entrepreneur will have to develop management skills of co-ordination or
employ effective managers who can take over this role.
Keeping an eye on the big issues

+ The role of leader, as explained in Chapter 4, involves being able to
understand exactly where the business should be heading and inspiring
others with a vision of how the business is going to get there.
+ As a business grows, subtle changes of direction can take place.
+ The entrepreneur-turned-leader will need to keep an eye on the big issues
facing the firm, such as what to sell and who to sell to, while ensuring the
management of resources is still taking place efficiently.
25 Why do many entrepreneurs find delegation so hard?

If bottom-up communication is poor, whose views may leaders no longer
understand as their business grows?
Exam practice
After a successful career in banking, Robert Southey had with risk - but he is not willing to take risks without trying
already started one business trading company debt and to minimise the chances of failure. His overall strategy,
other financial products. His first business had not been as of trying to minimise costs wherever possible in order to
successful as he had hoped. Robert was disappointed with enable Southey capital Ltd to make a profit on deals that
how little work his partner had been doing, so for his new competitors would find loss-making, is paying off.
venture he decided to 'go it alone' with Southey Capital
Questions
Ltd. Much of the finance was raised with his own personal
savings. Robert was keen to avoid loans as banks were not 1 Identify two benefits to Robert of starting his
offering attractive rates of interest. With the need to build business as a private limited company. [2]
up his turnover as quickly as possible, in order to build a 2 Identify two benefits to Southey Capital Ltd of
reputation in the markets he was dealing with, Robert's having a clear business objective. [2]
initial goal was to maximise revenue in the first year of the
3 Assess the potential opportunity costs to Robert's
business. He employed four staff to help manage the office
new business start-up of employing four staff. [10]
and research the deals he uncovered. However, Robert
watched them like a hawk, always with a keen eye for 4 Assess the extent to which a strategy of minimising
detail and an unwillingness to let his business suffer from costs is likely to always lead to success. [10]
somebody else's mistake. There is no doubt that Robert Answers and quick quiz 5 online
has that vital skill for an entrepreneur - the ability to cope

Summary
+ Five major sources of business ideas are: observation, + Objectives are targets for a business.
brainstorming, thinking ahead, personal or business + A strategy must be devised to achieve objectives.

experience, innovation. + Objectives provide a clear sense of direction for all
+ Business opportunities may arise as a result of changes parts of the business.
in technology, society, the economy, the housing + Common objectives include: survival, profit
market or the use of market research. maximisation, sales maximisation, market share, cost
+ The market research that precedes business start-ups efficiency, employee welfare, customer satisfaction
will almost always be done on a very small budget. and social objectives.
+ Common habits for successful entrepreneurs include: + Sole traders and partnerships are legal business forms
measuring performance accurately, stepping back from whose owners have unlimited liability.
the day-to-day work, having an eye for detail and loving + Limited companies can be private or public, depending
what they do. upon who shares can be sold to.
+ The major characteristics of an entrepreneur include: + Good decision-making requires an understanding of
understanding the market, determination, passion, opportunity cost.
resilience and the ability to cope with risk. + Most business decisions involve trade-offs.
+ The key skills required by an entrepreneur are: financial + As small businesses grow they face a range of
skills, persuasive abilities, problem-solving skills and problems.
networking skills. + Many problems of growth are personal challenges
+ Major motives for starting up your own business are: faced as the role of entrepreneur changes to that of
profit maximisation, profit satisficing, independence, manager/leader.
home-working, ethical stance and social
entrepreneurship.
Exam skills
+ Being able to ensure that your answers recognise and + For example, the story of a small business owner who
use the context in which a question is asked will give a quit their job so they could fit their work around their
huge boost to the mark you achieve. family, choosing their own working hours, would expect
+ whether a short data response or a longer case study a recognition of this motive when tackling questions
style question is being tackled, there will be features of about what the entrepreneur should do. Ignoring the
the context that will make certain theoretical answers entrepreneur's motive may lead to you recommending
wrong. a course of action that would boost profit at the cost of
+ For example, if asked about the best source of finance the entrepreneur spending more time travelling - away
for a sole trader, an answer that advises them to use from their family. It would be better to conclude that in
share capital is wrong, while a data response scenario this case, lower profit may be a price worth paying to
based on a private limited company means that selling maintain a decent work-life balance.
more shares through the stock market is not an option + The contexts that business exams can throw at you
without converting to a public limited company. are endless - but several of this chapter's issues are
+ However, context is far broader than simply the type of commonly used by examiners to see if you can recognise
business ownership. Also considered in this section are the context within which a question is asked rather than
motives of entrepreneurs. simply trotting out a purely theoretical answer.

6 Raising finance
Sources of finance: internal and

external
Where can businesses gain the money
needed to start, operate and grow?
Several circumstances may lead to a business needing to raise finance:
+ Starting up
+ Growing
+ Dealing with a cash flow problem
+ Financing extra materials needed when a large order is received
Making links
It is vital to remember the detail of these sources of finance when considering
business growth. As covered in Chapter 12, how growth should be financed is usually
a fundamental challenge to a growing business.
Internal finance F REVISED
Owner’s capital: personal savings sources of finance

Most likely to be used as a source of start-up finance, an owner’s own are places from which
personal savings, or even redundancy payment, is considered to be an businesses may gain
internal source of finance. This money could be provided in the form of share finance. These can be
capital or lent to the business as a loan. internal or external sources.
Retained profit
Once all costs have been covered and dividends paid to shareholders, any
profit left is retained in the business and can be used as a source of finance. It
is probably the safest and most common form of internal finance for
Exam tip
established businesses.
Retained profit must still be
Sale of assets available in the form of cash
if it is to be used as a source
Another internal source, especially available when established businesses are
of finance. So look at the
changing strategy, is cash generated by the sale of assets. Especially where balance sheet for evidence
a firm has adjusted its strategy, there may be assets that will no longer be that there is sufficient
needed and can thus be sold in order to generate the cash necessary for other cash available within the
projects. business. Bear in mind
that where retained profit
Making links
appears on a statement
Pay attention to the non-current assets section of the balance sheet (in Chapter 5) to of financial position, this
assess what assets a business may be able to sell. is merely an indicator that
money has been retained.
It does not imply that that
Now test yourself TESTED money is still available as
a source of finance. Look
Why is retained profit not a viable source of finance for a new business?
instead under current
Answers available online assets at the cash figure.

External sources of finance REVISED
Places from which a business can generate finance may also be considered as
external to the business itself. These include the following:
Family and friends

In many cases, family and friends provide extra start-up capital necessary for
business start-ups. This may be by taking an equity (shareholding) stake in a
business set up as a limited company. Alternatively, family and friends may
provide loans where banks may be unwilling.
Typical mistake
Do not always assume that family and friends will provide interest-free loans or gifts.
Those who are rich enough to consider providing finance to a friend or family member
may well be so because they are financially wise enough to ensure that even in
seemingly personal circumstances they do not lose out financially.
Banks
Loans to start-ups are not very common. Banks see start-ups as an extremely
risky proposition. Where a loan is provided, banks will insist on some collateral Collateral is something
as security, either a business asset or a personal asset belonging to an owner. of value that is used as
security when a loan is
Typical mistake offered, in the event of
If the owner of a private limited company takes out a personal loan and then uses this the business being unable
money to invest in their business, they remain fully liable for the debt. Their decision to pay the loan back, the
to invest the loan made to them as an individual means that they are investing that asset is transferred to the
money into the business, money that can be lost if the business goes bust. bank and sold in order to
generate the money due for
repayment.
Peer-to-peer funding
A recent development as a source of finance, peer-to-peer funding relies on
websites that can match investors willing to lend to business start-ups with
start-ups needing finance. These loans will generally be at a fairly high rate of
interest, but provide an option where banks are unwilling to lend.
Business angels
These are extremely rich individuals who provide capital to high risk, small
business ventures or start-ups. The Dragons in the BBC’s Dragons’ Den are best
thought of as business angels, willing to invest in risky business start-ups and Business angels or angel
become involved in the strategic management of the business in the hope of investors are individuals
high returns. who invest in the very early
stages of a business taking
Crowdfunding a significant equity (share)
stake.
+ Another source of finance that has risen to prominence thanks to the
internet is crowdfunding. Crowdfunding is obtaining
+ It allows small investors to find business start-ups in which they are external finance from many
willing to invest through crowdfunding websites. small investments, usually
+ No single investor is likely to be big enough to provide all the finance through a web-based
needed for each business using the site, but the beauty of crowdfunding appeal for investors.
is that many small investors can be gathered in order to provide all the
finance necessary.
Other businesses
+ Some businesses, especially large firms, actively seek out small businesses
either starting up or in their early stages and help them out by providing
finance.
+ In return, they will take a shareholding.

+ Commonly, this practice occurs in technology-based industries, with large
tech firms looking to find and cash in on ‘the next big thing’, even if they
did not develop it themselves.
Which is the only external source of finance listed above that is not likely to involve
some transfer of ownership?
Methods of finance REVISED

□
Loans A method of finance is
+ Loans can be provided by banks, but could also be provided by friends, the process through which
family or directors of the business. a source of finance provides
+ A loan involves providing a lump sum of cash, which will be repaid over an money to a business.
agreed period of time.
+ In addition, interest payments will also be made over the course of the
loan: these represent the ‘cost’ of the loan.
+ Interest rates may be variable or fixed, decided at the time the loan is
taken out. Many lenders, certainly banks, will expect collateral to provide
security for the loan.
Making links Typical mistake
The attractiveness of loans will be affected by the current interest rate - an external A limited company only
factor covered in the economic influences section of Chapter 10. receives capital when each
share is first sold. If the
shareholder subsequently
Share capital sells that share on, either
When a private company is formed, the ownership of the business is split into privately or, for a public
limited company, via the
shares. These shares can be sold to investors who become shareholders.
stock market, the company
When the share is first sold, capital enters the business.
receives none of the
proceeds of this onward sale.
Venture capital
Where selling shares through the stock market or taking out a bank loan are
not viable options, especially where a business opportunity is considered high
risk, a venture capital company may provide finance:
+ This is generally done through a mix of loans and share capital.
+ As the investment is high risk, the loan is likely to be at a relatively high
interest rate and the venture capitalist is likely to expect a relatively large Venture capital is a
shareholding, as well as a meaningful say in decision-making. method of providing finance
+ Venture capital is generally used to fund a significant period of growth for in higher risk investments,
an established small business. generally through a
combination of loans and
shares.
Overdrafts
An overdraft is a facility
Overdrafts offer a flexibility that other methods fail to offer. A business using offered by a bank to allow
an overdraft only pays interest on the overdraft when it is using the facility; a customer to continue
in other words, when the account is negative. Admittedly, the interest rate spending money even when
charged is likely to be higher than that on a loan but, as long as the business their account becomes
stays out of their overdraft most of the time, the total cost of this method of negative. There will be an
finance may not be prohibitive. agreed limit to the overdraft.
Leasing an asset is an
Leasing alternative to buying the
asset outright, instead,
Leasing is a sensible method of avoiding large chunks of cash outflows each
the asset is rented for a
time a major new asset is purchased. Although in the long term leasing will
monthly fee for a set period
be more expensive than purchasing an asset outright, buying assets can put
of time.
too great a strain on a business’s cash flow.

Trade credit
Trade credit is incredibly common in business-to-business transactions. On
Trade credit means that
average, two months’ credit is offered to customers, acting as a method of
goods or services provided
6 Raising finance
financing the purchase of, most frequently, materials used in production. Not
by a supplier are not paid
all businesses will be able to access trade credit. Start-ups or those with a
for immediately.
poor record of payment in the past may be refused credit by suppliers.
Grants
Grants are handouts, usually to small businesses, from local or central
government. They are very rare, no matter what politicians claim, amounting
to less than 2 per cent of UK start-up finance. The only start-ups that may
receive a grant are those likely to create jobs in areas of economic deprivation,
or hi-tech firms competing with foreign rivals.
Different methods and sources of finance tend to be more or less appropriate
in different circumstances. Table 6.1 summarises key issues.
Table 6.1 Methods of finance
Category Source/method Appropriateness

Internal sources Owner's capital/ Only relevant in a start-up or small business context
of finance personal savings
Retained profit The business must have made a profit and not spent it on anything else. This
method is not possible for a new business start-up
Sale of assets Only for an established business, especially for those planning to do
something new, which may make existing assets redundant, thus available to sell
External sources Family and friends Almost certainly limited to small business contexts - most commonly at start-up
of finance Bank Most widely applicable source of finance, but many businesses continue to
find it hard to get help from banks, certainly at reasonable interest rates
Peer-to-peer funding Rare, most likely to be used for a particularly risky start-up
Business angels Another rare source, most likely to be a start-up or recently started business
that may offer high rewards
Crowdfunding Another source that tends to be limited to start-ups rather than established
businesses
Other businesses Rare - only a few businesses are likely to offer this and almost always in high-
tech sectors to new start-ups
Methods of Loans Note that some collateral will be needed and start-ups may find it hard to
finance negotiate a loan at an affordable rate of interest
Share capital Can only be used by a limited company - sole traders and partnerships cannot
sell shares without converting
Venture capital Only used for higher risk businesses. They tend to be small businesses looking
to achieve a significant spell of growth
Overdraft Only to be used infrequently - a business that uses an overdraft as a long
term source of finance will pay a lot of interest. OK for a short-term cash-flow
problem, not good for purchasing new assets
Leasing Can only be used for major assets
Trade credit Start-ups will struggle to convince suppliers to offer them credit
Grants Only likely to be relevant to a business creating jobs in an area of economic
deprivation or very high-tech firms trying to compete internationally

□
3 Identify two methods of finance on which interest must be paid to a bank.
4 Which method of finance is not available to either sole traders or partnerships?
Identify four common reasons why businesses need to raise finance.

Liability and finance
How does the form of ownership affect the
sources of finance available?
The concept of limited liability was first explored in Chapter 5, page 70. There
are major implications to a business of its choice of ownership type with
particular reference to the liability of owners for business debts.
Implications of limited and unlimited liability ' REVISED
Table 6.2 Limited and unlimited liability
Unlimited liability Limited liability

Sole trader Private limited company (Ltd)
Partnership Public limited company (PLC)
Making links
The foundation for this section lies in the forms of business section of Chapter 5,
which explains the owners' liability of different forms of business.
Those businesses whose owners have unlimited liability (sole traders and
partnerships) are unlikely to grow significantly due to the potential downside
of business problems:
+ As the owners’ liability for business debts is unlimited, they can lose all of
their personal assets if the business goes into administration.
+ This is because the businesses/people owed money can chase the owners
to settle those debts incurred by their business.
+ This can include customers who have paid in advance and not received the
products or services promised, or suppliers who have supplied goods on
credit but not been paid.
In many ways, this makes doing business with a sole trader or a partnership
less risky because in the event of the business running into problems,
customers or suppliers know that they can legally pursue the owners for
debts owed. This, though, means that running as a sole trader or partnership
can feel riskier as the owners have no protection of their personal assets in
the event of things going badly wrong.
Owners of limited companies (shareholders) have the legal protection of
limited liability. This means they cannot lose any more than they invest in the
business. Without this protection, it is unlikely that businesses would grow
to the size of many large businesses today. Individuals would be unwilling to
take such large risks if it weren’t for the protection of limited liability.
There is a downside to limited liability: the ability of unscrupulous individuals
to set up limited liability companies.
+ These then rack up debts before the owners place the business into
voluntary liquidation. Liquidation occurs when
+ If it can be proved that they had fraudulent motives, then limited liability a company's owners close
is no protection against a prosecution for fraud. down the company, selling
+ However, business incompetence is not fraudulent, and if a limited off its assets to generate
company goes into liquidation and still owes money after all its assets cash to pay off the debts of
have been sold, then those to whom money is owed may lose every penny. the business.

□
What name is given to the owners of limited liability businesses?

Effect of liability on sources of finance REVISED
□
Sole traders and partnerships are likely to rely on the following sources of
finance:
Figure 6.1 Sources of finance for businesses with unlimited liability
Private and public limited companies can use:
Figure 6.2 Sources of finance for limited liability companies Exam tip
For all established businesses, the most likely and probably the safest form of Note that any external
finance is retained profit. provider of finance may be
wary of offering funding
Now test yourself I I to a newly created limited
company, because of the
Which two types of business offer unlimited liability to their owners? protection offered to the
State two sources of finance that are available to limited companies but not to sole company's shareholders by
traders or partnerships. limited liability. Often, newly
Briefly explain why offering credit to a sole trader is less risky than supplying on formed limited companies
credit to a limited company. will be refused trade credit
in the first months of their
Answers available online existence for this reason.

Planning and cash flow
Careful financial management requires
* sensible financial planning
• The business plan REVISED
□
A business plan is a must for any start-up business or small business looking A business plan is a
to grow that needs to attract external finance. Any provider of finance, document setting out a
whether a bank, business angel or other potential shareholder, will expect to business idea and how it
see a carefully prepared, logical and viable plan. will be financed, marketed
Not only will the plan be useful in attracting finance, preparation of the plan and put into practice.
also:
+ helps to ensure the entrepreneur has carefully considered potential
problems
+ has a reference point to maintain a clear sense of direction
+ has some quantitative targets to aim for.
The main sections of a business plan should include:
1 Executive summary 5 Operational plan
2 The product/service 6 Financial plan
3 The market 7 Conclusion
4 Marketing plan
At the heart of the financial plan should be the cash flow forecast.
1( What are the four main reasons for producing a business plan?
Interpreting cash flow forecasts REVISED

□
The example of a cash flow forecast in Table 6.3 helps to show the key
sections of the document.
Table 6.3 Example of a cash flow forecast
Month £s March April May June July August

Opening 0 3,000 (5,500) (8,500) (10,000) (9,500)
balance
Capital 30,000
invested
Cash received 7,000 10,000 13,000 15,000
from sales
Cash inflow 30,000 0 7,000 10,000 13,000 15,000
Cash outflow 27,000 8,500 10,000 11,500 12,500 12,500
Monthly 3,000 (8,500) (3,000) (1,500) 500 2,500
balance
Closing balance 3,000 (5,500) (8,500) (10,000) (9,500) (7,000)
+ Cash inflow shows the places and timings from which cash flows into the
business.
+ Cash outflow shows how much cash leaves the business in each month.
+ Monthly balance, sometimes called net cash flow, shows the net effect for
the month on cash flow (cash inflow minus cash outflow).

+ Opening balance (usually at the top of the table) shows the amount of cash Exam tip
the business had at the beginning of the month. This will be last month’s
closing balance. Be careful not to over-react
+ Closing balance shows the amount of cash in the business at the end of the to one negative figure on
month, calculated by adding the monthly balance (net cash flow) to the a cash flow forecast, one
opening balance. bad month does not spell
the end for a business.
The main figures to consider when analysing a cash flow forecast are: However, examiners will
+ Closing balance: If negative this shows the need for extra finance, quite really be looking to see
possibly the need to arrange an overdraft so that the business can whether you can spot
continue to spend after its bank balance has fallen to zero. upward, or more likely
+ Monthly balance (net cash flow): This will indicate how well each month is downward, trends on a cash
expected to go for the business. flow forecast. A consistent
reduction in monthly
Negative values for either of these indicate the key benefit of a cash flow
balance could spell trouble
forecast, such as the ability to spot problems in advance, in time to do
something about them, such as arranging an overdraft or delaying a payment.
Now test yourself
1 what is the name of the figure showing cash inflow minus cash outflow?
Making links
It should be increasingly clear that cash flow forecasting is reliant on the accuracy of
sales forecasts. More detail on how quantitative sales forecasting can be conducted
is at the beginning of Chapter 13, while the start of the next chapter (Chapter 7) also
considers this issue.
Exam tip
Watch out for the effects of seasonality on a cash flow forecast when you are
interpreting it. Think about what type of business is being analysed before deciding
whether cash flow looks dangerous. Remember that a toy firm, for whom 80 per
cent of sales may be made in the run-up to Christmas, may experience poor cash
flow during the rest of the year. As long as they are able to maintain a healthy closing
balance, there will be enough cash to carry them through to cash-rich months.
Manipulating cash flow forecasts REVISED

□
Stress-testing a cash flow forecast can be a useful analytical technique:
+ Try calculating the effect on closing balance of one month’s cash inflows
being delayed.
+ Alternatively, try judging the effect on closing balance of an unexpected
cash outflow, such as an emergency repair to some equipment.
Calculating the difference between the closing balance at the end of a cash
flow forecast and the opening balance at the start of the forecast gives a clear
sense of the overall impact of that trading period on the cash flow. If overall
balances are rising, then the business should be in a generally healthy cash
position.
Noting the way the closing balances move can help to show trends. Look at
Figure 6.3 to see how the future may actually be looking brighter by August,
despite negative balances.

-12,000 -*
Figure 6.3 Closing balance from Table 6.3
Try to explore how much credit the business gives and receives. A poor
looking cash flow forecast can be vastly improved by chasing credit
customers to pay up on time, a task that may be far easier than finding brand
new customers. Alternatively, a poor closing balance can be survived if the
firm is able to negotiate extra credit from a supplier, to prevent cash flowing
out until the next month.
Uses of cash flow forecasts REVISED

□
The fundamental use of a cash flow forecast is to spot cash problems
in advance so that action can be taken in time to prevent a major crisis.
Examples of actions that help to improve cash flow include:
+ producing and distributing products as quickly as possible, reducing the
time between paying for materials and receiving cash for finished goods
+ chasing customers to pay quickly. This could involve incentivising cash
payment with a discount, or more careful credit control, such as chasing
credit customers to remind them to settle their payments on time
+ keeping stocks to a minimum, as stock represents cash spent, but not yet
converted back as a cash inflow
+ minimising spending on equipment, using leasing or renting as methods of
finance, or even postponing investments.
Limitations of cash flow forecasts REVISED

□
+ The forecast is only as good as the estimations that have been made in
order to generate the figures.
+ Since most entrepreneurs tend to be fairly optimistic, there can be a great
danger that cash inflows are forecast too high, or to arrive too predictably.
+ A table of figures can give the impression of factual data whereas, in
reality, a cash flow forecast remains a best guess of what is likely to occur
in the future.
+ If users of the cash flow forecast trust the accuracy of the document too
much, they may be lulled into a false sense of security.
12 For whom are most business plans primarily produced?

3 What forms the heart of the financial plan within a business plan?
How can many businesses survive a short time with a negative closing cash balance?

Exam practice
Fresh out of school, Phoebe Hart was ready to start Her elder sister, who had been saving to buy a flat, was
her new business, a business she had been planning persuaded to lend Phoebe £10,000 at a low rate of interest,
throughout her time studying Business in the Sixth while Phoebe's other savings were also ploughed into
Form. With no local tanning salon, but a consumer base buying the equipment and lease needed to start up. in
increasingly 'beauty conscious', Phoebe's suspicions were addition, Phoebe approached her bank about arranging
confirmed when she found secondary research confirming an overdraft to help her through quieter periods. Phoebe
strong growth in the tanning market. employed a 16-year-old college leaver to help her run the
salon as he was willing to work for a low wage.
Slightly worryingly, her secondary research had also
revealed some major claims for damages from customers With her plans firming up, Phoebe produced a thorough
of other tanning salons who had suffered injuries and business plan, which she showed to the bank, included
burns following their treatment. However, Phoebe was was a cash flow forecast. Extracts from the cash flow
confident she could avoid these problems and set about forecast are shown below:
planning how to raise the finance she needed to start up.
Month £s
April May June July August September
Opening balance 0 (2,000) (2,200) (2,000) (1,800) d
Capital invested 15,000 0 0 0 0 0
Cash from sales 0 2,500 3,000 3,000 2,500 2,800
Cash inflow 15,000 2,500 3,000 3,000 2,500 2,800
Cash outflow 17,000 2,700 2,800 2,800 c 2,700
Monthly balance a (200) 200 200 (200) 100
Closing balance (2,000) b (2,000) (1,800) (2,000) (1,900)
Questions 3 Assess whether Phoebe was right to start her business

as a sole trader. [10]
1 Fill in gaps on the cash flow, labelled a-d. (2 marks each)
2 Explain two benefits to Phoebe of producing a Answers and quick quiz 6 online
business plan. [4]
Summary
+ Common situations in which a business needs to raise + A business plan is also useful to the entrepreneur in
finance include starting up, growing or trying to solve a planning and running their business.
cash flow problem. + Forecasting future cash flows helps to spot problems
+ Sources of finance can be internal or external. early enough to take action.
+ Different methods can be used to raise finance. + Several quick calculations can help to analyse what
+ Unlimited liability businesses cannot raise finance by a cash flow forecast is showing about a business's
selling shares. finances.
+ Limited companies have a wider range of sources and + Always consider the context of the business when
methods of finance available. making judgements on what a cash flow forecast
+ Producing a detailed business plan helps attract finance. shows.
Exam skills
An answer to a business question that shows an examiner for a small business, or the vital importance of careful
a grasp of the realities of business will stand out from a forecasting will seem naive, while dropping into an answer
more naive answer from a student who has not tried to the throw-away comment 'the business can just take out
grapple with what running a business is really like. Most a loan' suggests an incorrect assumption that banks hand
students taking an A-level in Business are blessed with out loans to anyone who can be bothered to apply.
youth -17- and 18-year-olds have spent most of their lives
Fortunately, business lessons, textbooks and many of the
in full-time education. They have therefore not had the
other resources you have accessed during your course
time to spend years working in or running a business. The
should be stressing the realities of business - make sure
result is that business examiners can often be presented
your answers do the same.
with answers that show little grip of reality. Any answers
that downplay the difficulties of managing cash flow

Sales forecasting_____________________________________
Trying to predict how much a business will
sell in the future
Sales forecasting forms the basis of almost all future planning. Without plans
for the future, businesses would be left to simply react to changes, and would
fail to deliver effective products and services when consumers want them.
Purpose of sales forecasts F REVISED

□
A range of plans will be required within a business to ensure each functional
Making links
area is able to operate effectively. The sales forecast will be the basis of each
of the following: Notice how sales forecasting
+ HR plan: In order to ensure that, in the medium to long term, the right links closely with forward
number of staff with the right skills are employed, and in the short term, planning in all business
the right number of staff are actually at work, the HR department will functions.
carefully consider sales forecasts.
+ Marketing budgets: In order to decide how to allocate its marketing budget,
a business such as Mars uses sales forecasts for each brand, to know
whether to boost sales of a star such as Maltesers, or to try to revive the
sales of a struggler such as the Mars bar.
+ Profit forecasts and budgets: When planning how much the firm is
expecting to make in revenue and profit, the basis will be accurate sales
forecasts. These will help to shape expectations of spending, as shown in
budgets for different departments.
+ Production planning: If the business is to satisfy demand for their product
or service they will need to ensure that enough products are made and,
before that, that enough raw materials are bought. Planning production and
inventory levels will take place by working backwards from sales forecasts.
1 Using the term 'supply' and 'demand', explain why sales forecasting is vital in
planning production levels.
Factors affecting sales forecasts REVISED

□
Consumer trends
Consumer trends - tastes and habits - change as time passes. Effective sales
A trend is the general path
forecasting must therefore allow for the effect on demand of these changing that a variable takes over a
tastes and habits. Examples of changes in consumer tastes and habits could period of time.
include increased demand for more convenient foods or a trend towards
healthier eating for some consumers. Other consumer trends may be based on:
+ Demographics: The UK has an ageing population, meaning increased
demand for products aimed at the elderly.
+ Globalisation: This is an increased willingness to buy products, from food
to holidays, which recognise the global nature of today’s world.
+ Affluence: Despite short-term economic problems, over the past 70 years,
UK consumers have become wealthier, thus are more able and willing to
spend on luxuries.

+ Economic variables: As explained in detail in Chapter 2, page 26, income
elasticity is the calculation of the impact on demand for a product of a
change in consumers’ incomes. Therefore, an economic fluctuation, such
as a recession, can have a major impact on sales, especially of income
elastic products. Therefore, to forecast sales effectively, a business must
pay attention to economic forecasts and use knowledge of their products’
income elasticity to help forecast future sales.
Economic variables
In addition to changes in the economic cycle, changes in individual economic
Exam tip
variables can affect sales:
+ Value of the pound: A decrease in the value of the pound makes imports Examiners love to see you
more expensive and may push consumers to favour UK-produced products. combining knowledge
+ Changes in taxation: Taxes on individual items, such as alcohol, can affect from different areas of
demand, as well as changes in general taxation, such as the rate of VAT. the specification into one
+ Inflation: If inflation is higher than the rate of increase of average incomes, argument. If answering
consumers will need to tighten their belts, spending less and damaging a question about sales
sales of some products and services. forecasting, you are
extremely likely to be able
Taken together, these issues mean that no sales forecast should be conducted to use income, or even
without paying attention to expert economic forecasts. Many economic price elasticity, within your
changes can have a significant effect on sales for a wide range of businesses, argument to effectively
especially those with income elastic products and services. develop the point you are
trying to make.
Actions of competitors
Even harder to predict are the potential actions of competitors and the impact
these may have on sales. Key competitors’ actions that may affect sales are:
+ Changing price: A competitor that begins to undercut your prices is likely,
depending on price elasticity, to steal sales, thus rendering your sales
forecast overly optimistic. If you respond by cutting prices, although you
may still sell the same number of products, sales revenue may be lower
than expected, affecting profit and cash flow forecasts.
+ Launching new products: A competitor launching a new product, or a new
competitor entering your market, can have a dramatic negative effect on
forecasted sales.
+ Promotional campaigns: Competitors running successful promotional
campaigns to try to steal market share from your product can again leave
sales forecasts looking overly optimistic.
More so than any of the other factors affecting sales forecasts, the actions of
competitors are usually likely to have a solely negative impact. Worryingly, they
are also harder to predict than economic changes or change in consumer tastes.
Difficulties of sales forecasting r REVISED

□
+ Most sales forecasts use a technique called extrapolation, meaning they Exam tip
assume that past trends will continue.
+ However, as explained above, there are many reasons why past trends can The further ahead a sales
change. It is the ability to forecast these changes to past trends that marks forecast looks, the less likely it
out the best sales forecasters. is to be accurate. The reason
+ Great sales forecasting is as much an art as a science, as the ability to spot is that with more time to
future changes in trends may be impossible to find in past data. pass, there is more scope for
changes in trends to take place
Now test yourself TESTED that will render the forecast
nonsense. An established
2 State three types of plan that rely on a forecast of sales as their basis. business in a stable market
List three broad categories of factors where changes may have a major influence should be able to forecast the
on the accuracy of sales forecasts. next few weeks or months
fairly accurately. Forecasts
4 Explain why forecasts lose accuracy as they look further into the future.
that look far into the future
Answers available online must be treated with care.

Sales, revenue and costs
The basic financial data that must be
recorded by a business
Calculating sales volume and sales revenue r REVISED
□
+ The two ways to measure how much a business has sold are:
+ sales volume
+ sales revenue.
+ Knowing how many products have actually been sold is fairly
straightforward, even for a large business, as long as they have effective
internal accounting systems.
Exam tip
+ Calculating the value that those sales have generated is trickier, as sales
revenue is calculated by multiplying sales volume by selling price. The formula for calculating
+ For a business selling a range of products at different prices this adds sales revenue is: sales
complication. If a business sells the same product at different prices volume x selling price
depending on where or when the product is sold, even more careful
recording is needed to generate an accurate figure for sales revenue.
+ To boost revenue, businesses can either increase their selling price (as long Making links
as sales volume is not hit too hard) without having a major impact on sales
Whenever contemplating
volume, or look to increase sales volume without reducing their selling
a change in price, the
price significantly. measured responsiveness
+ The choice here is likely to depend on price elasticity (see Chapter 2, of sales to price changes -
page 26). price elasticity (see page 24)
is a valuable tool.
Table 7.1 Price elasticity
Price elasticity Change to price Effect on sales revenue

Price elastic Increase Revenue falls
Decrease Revenue rises
Price inelastic increase Revenue rises
Decrease Revenue falls
If a business sells 30 products at a price of £20 and 15 products priced at £50,

what is their total revenue?
6 For a business selling a price elastic product that wants to increase its revenue, in
which direction should it change its selling price?
Calculating fixed and variable costs REVISED
+ To run a successful business, managers must understand not just how

much they are selling but also whether they are receiving more in revenue Exam tip
than it is costing to run their business. Notice again that using
+ No business can survive in the long term if its costs exceed revenues. price elasticity as part of an
Recording and monitoring running costs is therefore vital. argument about a question
+ When calculating the costs of producing a product or providing a service, a on how to increase sales
common classification for costs is to split them into: revenue can show an
+ fixed costs examiner how good you
+ variable costs. are at combining different
+ When added together, these figures allow a firm to see their total costs for business concepts to help
a time period, which can be compared with sales revenue. build an argument.

Fixed costs
These are costs that do not change as output changes. They are linked to time
Exam tip
(e.g. rent per month) rather than to how busy the business is. Fixed costs have
to be paid even when a business is not producing. However, they will be the This concept of spreading
same whether the business had a great month or an awful month in terms of fixed costs fits with the
sales volume. concept of capacity
utilisation, explored later in
Table 7.2 Examples of fixed costs Chapter?, page 110.
Rent Business rates (local tax) Management salaries
Interest charges Advertising spending Heating and lighting
As these costs won’t change as output changes, a rise in sales will spread Typical mistake
these fixed costs over more units, meaning the fixed cost per unit is lower.
This is especially important for a business for which fixed costs are higher Fixed costs do change as
than variable costs. time goes by, for example
the landlord may decide
to put up rent next month.
Variable costs They are fixed in relation to
These are costs that change in direct proportion to the level of output. So, if a the amount produced, not
manufacturer doubles the amount produced, material costs would double. forever.
Table 7.3 Examples of variable costs
Raw materials Piece-rate pay

Fuel costs Packaging
Variable costs may not actually rise in direct proportion to output. This is
because as a business increases its output, they may be able to negotiate a Exam tip
lower price from material suppliers, meaning that the cost of materials Questions frequently state
may not quite double as output doubles (economy of scale). However, for the variable costs of one
the purposes of simple profit calculations and break-even analysis, this unit of output. To calculate
effect tends to be ignored. the total variable costs it
is crucial to remember to
Total costs multiply this figure by the
number of units produced:
Adding together variable costs and fixed costs shows the total costs of
running a business for a period of time. This is the figure that is deducted Total variable costs =
from sales revenue to calculate profit. variable cost per unit x
Analysing the proportion of total costs that is fixed against the proportion number of units produced
that is variable can help a business to understand the importance of boosting (output)
sales volumes. Remember that:
+ A business with a high proportion of fixed costs is better off trying to
boost sales volumes so that fixed costs are spread over more units of
output.
+ For a business with relatively low fixed costs but higher variable costs, it is
Typical mistake
easier to operate at low levels of output, since their fixed outgoings each
month will be relatively low. As variable costs are often
stated 'per unit', students
Now test yourself sometimes get confused
as the variable cost per
7 State the two ways in which the sales of a business can be measured. unit does not change. They
8 Define fixed costs. are variable in the sense
9 Define variable costs. that the total amount spent
on, say, raw materials
Explain why a business with high fixed costs should seek to maximise sales volumes.
will double if the output
Answers available online doubles.

Break-even
Calculating how much must be sold before
the business can start making a profit Break-even describes a
position where a business is
selling just enough to cover
Knowing the break-even point is useful to managers of a business as it allows
its costs without making a
them to have a minimum target of sales to aim for to ensure that they are not
profit.
making a loss.
Break-even point REVISED

□
To calculate the break-even point, a business needs to know the following:
+ selling price
+ variable cost per unit
+ fixed costs.
Break-even is calculated using the following formula:
fixed costs
Break-even =---------------------------------------------------
(selling price - variable cost per unit)
The bottom line of the formula shows the amount each unit sold contributes
towards covering the fixed costs of the business.
Using contribution to calculate break-even ' REVISED

□
Selling price minus variable cost per unit (the bottom line of the break-even
formula) is called contribution (or more accurately contribution per unit). This
figure can be used to calculate profit:
(Contribution per unit x units sold) - fixed costs = profit
Break-even charts REVISED

□
It is possible to illustrate the break-even point on a graph, known as a break
even chart. This shows costs, revenues and therefore profit at any possible
level of output for a business. On the horizontal axis, all possible levels
of output are shown, while the vertical axis shows costs and revenues,
measured in pounds.
The example break-even chart in Figure 7.1 shows the break-even point which
Break-even
output
Output (000 kg)
Figure 7.1 Example break-even output chart

Note the following features of the graph:
+ The fixed cost line is flat, showing that fixed costs are the same at all
levels of output.
+ The total cost line shows the effect of adding fixed costs and variable costs
together. It therefore starts on the left at the fixed cost line and moves
upwards in line with the rate of increase of variable costs.
+ The total revenue line begins at point (0,0) since no revenue is generated if
nothing is sold.
+ The break-even output is identified by dropping a vertical line down
from the point at which total revenue and total costs cross to read off the
amount of output that needs to be sold to cover costs.
Measuring the vertical gap between total revenue and total costs at any level
of output allows the profit to be easily identified. For example, the profit when
50,000 kg is produced is £50,000.
Now test yourself
Explain why the fixed costs line on a break-even chart is a flat horizontal line.
2 Explain why the total cost line on a break-even chart starts at the same place as
the fixed cost line.
3 On a break-even chart, by how much does the total revenue line increase each
time a new unit is sold?
Margin of safety REVISED

□
The horizontal distance between the actual output of a business and its break
even output is called the margin of safety. This shows how far demand can
fall before the firm slips into a loss-making position, and can be a vital figure
to look out for during difficult trading periods.
Figure 7.2 Margin of safety
Figure 7.2 shows the margin of safety if the business sells 40,000 kg. Margin of
safety is 40,000 kg - 25,000 kg = 15,000 kg.
Interpreting break-even charts ' REVISED

□
In addition to showing the break-even point and margin of safety, break-even
charts also serve useful planning purposes.
Being able to read off profit or loss at any given level of output can help a
business plan for success or failure.
The chart can also allow other ‘what if’ questions to be asked, relating to what
would happen to profit, break-even or margin of safety if:
+ selling price was reduced or increased
+ variable cost per unit reduces or increases
+ fixed costs change.

Each of these requires a fresh line to be drawn on the graph, showing the
effect of the possible change.
Table 7.4 Effects of change on break-even charts
What could What line would Direction of Effect on break

change need to be redrawn change even point
Variable cost Total costs up up
per unit Down Down
Fixed costs Fixed costs and Total up up
costs Down Down
Selling price Total revenue UP Down Typical mistake
Down Up A change in sales or output
does not change any lines on
Making links the graph. The effect would
simply be shown by moving
Noticing the impact on the break-even point of changes in price shows how the along the horizontal axis to
concept of break-even should be considered when the marketing department make read off the new figures at
pricing decisions (see page 34). the new level of output.
Limitations of break-even analysis F REVISED

□
Break-even analysis relies on certain simplifying assumptions. These may
well be false in a real, dynamic business environment:
+ Variable costs are assumed to increase constantly. In fact, they may
increase more slowly at higher levels of output due to bulk-buying
discounts.
+ Break-even analysis assumes that the firm sells all its output in the same
time period, which may well be untrue.
+ Break-even analysis is based on a firm selling only one product at a single
price.
Exam tip Overhead costs are those

that are incurred by the
Calculating the break-even point for individual products sold by a multi-product firm is business as a whole but
quite possible, and very useful. However, this relies on splitting up the firm's can be difficult to attribute
overhead costs and allocating some to each product. to a particular section of
the business. For example,
+ Any break-even chart is a static model, showing only the possible situation the costs of running
at one moment in time. The business environment is dynamic, so break Nestle's Head Office can
even is not well suited to showing the effects of changing external be hard to attribute to
variables such as consumer tastes or the state of the economy. the actual production of
any one of its hundreds of

□ different products.
14 What formula is used to calculate the break-even point?

15 What is the formula for calculating profit using contribution? Exam tip
16 What three lines are drawn on a break-even chart? Although these assumptions
17 How is margin of safety calculated? weaken the power of break
If the variable cost per unit of a product decreases, what would be the effect on even analysis, exam answers
the break-even point? should never underestimate
just how important this type
what would be the effect on a firm's break-even point of deciding to cut the selling price?
of, albeit flawed, analysis is
Answers available online to business planning.

Future financial plans
Budgets represent the way in which most medium to large businesses A budget is a target for
manage their finances. Budgets will be set for both income and expenditure: revenue or costs for a
+ Income budget: This sets a target for the value of sales to be achieved. future time period.
+ Expenditure budget: This gives budget-holders a limit under which they
must keep their department’s costs.
Making links
An example of a simple budget statement is shown in Table 7.5.
The process of budgeting is
Table 7.5 Example of a budget statement
reliant on sales forecasting,
January February March as explored at the start
of this chapter, it is also
Income 25,000 28,000 30,000 worth noting that a cash
Variable costs 10,000 12,000 13,000 flow forecast, covered in
Fixed costs 10,000 10,000 11,000 Chapter 6, can be referred
to as a cash budget.
Total expenditure 20,000 22,000 24,000
Profit 5,000 6,000 6,000
Note that setting both income and expenditure budgets allows for a budgeted
profit figure to be identified in each month.
Purpose of budgets r REVISED

□
+ They focus expenditure on the company’s main objectives for a time period.
+ Expenditure budgets are set to ensure that no department or individual
spends more than the company expects.
+ All budgets provide a yardstick against which performance can be
measured.
+ Expenditure budgets allow spending power to be delegated to local
managers, who may understand local conditions better and be better
placed to decide how money should be spent at a local level.
+ Both income and expenditure budgets can help to motivate staff in a
certain department to try to hit targets.
Directors agree a
'master budget' for the whole firm and divide it between ...
Regional managers
who allocate a budget to each ...
Branch manager
who divides the branch budget between ...
Section managers
who will try to get all their...
Shopfloor workers
to help meet the budget targets
Figure 7.3 Budget holders

Types of budget REVISED
□
The process of setting budgets can take place in two broad ways:
+ A historical budget is set using last year’s budget as a guide and then making
adjustments based on known changes in circumstances for the department,
so if 10 per cent more staff have been employed at a branch, that branch’s
income and expenditure budgets may be increased by 10 per cent.
+ Zero-based budgeting involves setting each budget to zero each year and
then expects each budget-holder to justify a budget figure that they can
work to for the coming year. This is very time-consuming, but can prevent
the wastage that occurs if all budgets simply creep upwards year after year
under a system of historical budgeting.
In reality, to prevent too much time being wasted, many businesses will use
zero-based budgeting every few years before a period of historical budgeting.
The result is shown in Figure 7.4.
Exam tip
Whichever method of
setting budgets is used,
perhaps a more important
concept is the extent to
which budgets are agreed
Figure 7.4 The benefits of zero-based budgeting or imposed, imposing
budgets reduces the
sense of responsibility
that a budget-holder feels
compared to their desire to
hit targets that they have
agreed with their managers
Variance analysis ' REVISED

□
Setting budgets is a helpful planning technique. However, the real power of
budgets probably comes from variance analysis. Variance analysis involves
+ Variance analysis, which in most large firms will take place using a looking back to calculate
spreadsheet system such as Microsoft Excel, allows managers to spot areas the difference between a
where there is a significant difference between the budget and the reality. budgeted figure and the
+ With an automated system it is possible to flag up variances of a certain actual figure that occurred.
size only, so that managers can focus their attention on areas with a
significant variance.
+ It is in the analysis of the causes of these variances that successful
financial management tends to lie.
Variances can be:
+ Adverse: The actual figure was worse than the budgeted figure.
+ Favourable: The actual figure was better for the business than the
budgeted figure.

Making links
Setting budgets and then using variance analysis to monitor them allows significant
control to be delegated to managers (budget holders). Both Maslow and Herzberg (see
Chapter 4) suggest that this may be a powerful tool for motivating those managers.
Table 7.6 Variance analysis
Type of budget Relationship between Effect on profit Classification of variance

budget and actual
income Actual lower than budget Lower than expected Adverse
Actual higher than budget Higher than expected Favourable
Expenditure Actual lower than budget Higher than expected Favourable
Actual higher than budget Lower than expected Adverse
Typical mistake
Whenever calculating a budget variance it is vital to note whether the variance is
adverse or favourable. The answer to a question asking you to calculate a variance
should be the actual size of the variance and the word 'adverse' or 'favourable'.
Typical mistake
Budget variances can occur for three underlying reasons. Only one should
really result in the budget-holder being blamed: Budget variances should
+ The original budget was unrealistic. not be recorded as positive
+ The target was not met due to factors beyond the budget-holder’s control. or negative, as an income
+ The target was not met due to factors within the budget-holder’s control. figure higher than budget
is a good thing but an
Holding a manager to account for either failing to meet an unrealistic target or expenditure figure higher
for missing a target as a result of issues over which they had no control will than budget has a negative
only demotivate that manager and probably others within the business. impact on profit. This is
Senior managers should therefore take care over investigating the causes of why the words adverse and
budget variances before taking action as a result of those variances. favourable are used.
Difficulties of budgeting 1 REVISED

□
Problems with budgeting systems can occur in several key areas:
Table 7.7 Problems with budgeting systems
Problem with budgeting system Explanation

Setting budgets It can be hard to ensure targets are set
realistically, but also to avoid budgets
creeping upwards over time
Agreeing or imposing budgets imposing budgets is far less motivating
and effective than giving budget-holders a
genuine say in setting their own targets, in
agreement with senior managers
Failing to understand the causes of a Blaming a budget-holder for failing to meet
budget variance a target that turned out to be impossible
is a sure-fire way of demotivating that
manager
The costs of the system outweighing the in small businesses, there is less need
benefits for financial control to be delegated as a
single boss may be able to keep an eye on
all the finances without taking the time to
set up a system of budgets

if actual income is lower than the budgeted figure, would the variance be adverse Many aspects of the
or favourable? budgeting process may be
hard for an entrepreneur
3 If actual expenditure is lower than the budgeted figure, would the budget variance
be adverse or favourable? trying to adjust to the role
of leader, as they must
Answers available online use budgets as a way of
allowing others to make
decisions (see Chapter 5).
Exam practice
Haroon Ahmed plans to set up a small firm manufacturing Variable cost per unit = £8
specialist signalling devices for use in vehicles. As an
Fixed costs = £24,000 per month
experienced entrepreneur, he has taken care to produce
an accurate sales forecast. He has also carefully planned Questions
his finances, in order to identify his break-even point. In
1 Using the information provided, calculate Haroon's:
addition, he has set budgets as a way of checking the
a) Break-even point [3]
success of the business as he goes along. A range of
information about his business is provided below: b) Profit or loss in January [3]
c) Margin of safety in March [3]
Sales forecast for first three months:
2 Assess two factors that may cause Haroon's sales
January -1,600 units forecasts to be inaccurate. [8]
February-2,400 units 3 Assess how useful break-even analysis will be to
Haroon in starting up and running his new business. [10]
March - 3,000 units
Selling price = £20
Summary
+ Sales forecasts are at the heart of most business + The break-even point is a useful piece of information
planning. for managers.
+ Sales forecasts begin by assuming past trends will + Break-even charts show profit or loss at any possible
continue. level of output.
+ The art of successful sales forecasting lies in being able + Contribution can be used to calculate profit.
to spot when the future will not reflect the past. + Break-even analysis has several limitations.
+ Sales can be measured by volume or value (revenue). + Break-even analysis allows a business to ask 'what if'
+ Costs of production can be split into variable costs and questions.
fixed costs. + Budgets are used to manage a firm's finances.
+ Total costs are calculated by adding total variable costs + Variance calculations allow performance to be
to fixed costs for a time period. measured against budgeted targets.
+ Budget variances can be adverse or favourable.
Exam skills
+ There can be a danger that, having studied numerate + instead of ghastly generalisation such as 'all forecasts
topics for a while, students presented with numerate will be inaccurate', you should be encouraged to show
data fail to recognise the difference between fact and some insight when assessing numerate information.
forecast. + Consider what may make data inaccurate, how likely
+ Much of the data presented will be forecasted data those events are and then consider what impact
that is subject to many influences that would be inaccuracies may have on the decisions being made.
unpredictable when the forecast was made. + Break-even points have a nasty habit of changing if
any of the variables used in their calculation cannot be
adhered to.

8 Managing finance
Profit
What’s left over from revenue once costs
have been deducted
Profit is the difference
Profit is a simple concept. What can make it less clear is when businesses
between the revenue of
report on different kinds of profit. This is done so that businesses can identify
a business and the costs
where things are going well or badly for them by analysing the differences
generated by the business
between the different types of profit.
during a period of time.
Calculating different types of profit REVISED
Each type of profit is calculated after allowing for different types of cost.
Gross profit
This is a raw measure of profit that deducts the cost of sales from total Cost of sales is the
revenue to show what is left after taking away the costs directly involved in collective name given to the
making a product or providing a service. costs directly associated
Gross profit = total revenue - cost of sales with making a product, such
as materials and the costs
Operating profit of the factory.
Fixed overheads are the
Fixed overheads are deducted from gross profit to calculate operating profit. costs that have to be paid
This is perhaps the clearest indicator of just how well a business has been no matter how well the
run during a year. As the name suggests, this is the profit generated by the business is performing,
normal operating activities of the business. such as management
Operating profit = gross profit - fixed overheads salaries and rent on the
head office.
Profit for the year (net profit) Net financing cost is the
income from interest on bank
The final measure of profit on your specification shows profit net of all costs deposits minus the interest
(including any interest costs payable on loans) except for corporation (profit) charges from overdrafts
tax, which is usually charged at 20 per cent. and loans. It will usually be a
Profit for the year (net profit) = operating profit - (net financing cost and corporation tax) negative number.
Ways to improve profit REVISED
Improving profit can sound simple. There are only three basic routes:
+ Increase revenue
+ Reduce costs
+ Do a combination of the two.
Unfortunately, each choice tends to involve a trade-off. Increasing revenue
can be achieved by spending more on advertising, but that pushes up costs.
Reducing costs may involve making sacrifices on quality or customer service,
which could damage revenue too. This is why running a business is so hard.
Now test yourself
Explain why cutting the price on a price elastic product may lead to an increase in
revenue but a fall in profit.

Statement of comprehensive income REVISED
□
+ All public limited companies are required to produce and publish a A statement of
financial document known as the statement of comprehensive income. comprehensive income
8 Managing finance
+ Most people refer to this as the profit and loss account. This is the is a document produced by
document in which the different types of profit can be found. public limited companies
+ In addition, comparing this document with previous years’ allows that shows revenue, a
judgements to be made about the performance of the business for the break-down of different
current financial year. types of cost and different
types of profit for a year.
Measuring profitability REVISED
While profit is an absolute number of pounds, each different profit figure can
only tell us so much about the performance of a business. More powerful than
Profitability states profit
figures for profit are figures that show profitability. Profitability allows us to
as a percentage of sales
make meaningful comparisons between firms of different sizes in order to
revenue.
judge who has been more successful.
Gross profit margin Typical mistake

This shows gross profit as a percentage of sales revenue:
Do not confuse profit
gross profit
(measured as a number of
Gross profit margin =------------------ x 100
sales revenue pounds) with profitability
(measured as a percentage).
A business that is able to take relatively cheap raw materials and turn them
into highly priced products would have a high gross profit margin. A good
example is a coffee shop. Making links
Operating profit margin Pricing decisions (see page 34)

can have a major impact
This is the main focus for the analysis of overall company performance. It
on gross profit margins -
shows operating profit as a percentage of sales, and therefore includes the
increasing price without
impact that deducting fixed overheads has on profitability.
any corresponding change
operating profit in costs will lead to an
Operating profit margin =---------------------- x 100 increase in this margin.
sales revenue
Profit for the year (net profit) margin Exam tip

The profit for the year (net profit) margin shows profitability after allowing for
all business costs (apart from tax). For all profit margins, the
higher the better.
profit for the year (net profit)
Profit for the year (net profit) margin =--------------------------------------- x 100
sales revenue
What are the three most commonly quoted types of profit?

What is the difference between profit and profitability?
Ways to improve profitability REVISED
In order to increase profit margins, a business faces two simple options:

Increase selling price
+ Increasing the selling price will increase profit margin but may decrease
overall profit. This is because an increase in price may lead to a drastic fall
in sales volume.
+ The wisdom of increasing price hinges on price elasticity. For a price
inelastic product, the fall in demand that results from a price rise may be
10 so small as to be outweighed by the increased revenue per unit. However,
for a price elastic product, increasing price is almost certain to reduce profits.

Cut costs
Typical mistake
+ As explained in the Typical mistake box, cutting costs is rarely simple.
+ Using cheaper materials or employing fewer staff can damage a company’s in the real world,
reputation and thus revenue. businesses would never
8 Managing finance
+ Only where genuine waste can be identified and painlessly removed from deliberately pay too much
the business is cost reduction likely to lead to a straightforward increase in for something. If they pay
profitability. more than rivals there is
likely to be a good reason.
Exam tip You should therefore never
state that a business can
Look for the trade-offs involved in cutting costs as a way of boosting profitability. This improve profitability by
helps you to identify a two-sided argument, perhaps arguing about whether to buy simply cutting costs; there
cheaper materials and whether consumers will stop buying your brand. This offers is likely to be a reason they
opportunities to display the skill of evaluation by offering and justifying your judgement have not done so before.
as to which option is best for the business.
Distinction between cash and profit REVISED

□
Profit is not the same as net cash flow. The reasons are two-fold:
+ Sales revenue does not equal cash inflows.
+ Costs do not equal cash outflows.
The simplest way to illustrate this is to consider a business that offers credit
to its customers and receives credit from a supplier. Sales revenue is recorded
when a product changes hands, so selling an item on 60 days’ credit generates
sales revenue, but will not lead to a cash inflow for up to 60 days.
Likewise, when the business buys materials on credit, the cost is incurred
when the materials are delivered. However, no cash flows out until the
supplier is actually paid, 30 days later.
Table 8.1 helps to illustrate this and other differences for a number of typical
business transactions.
Table 8.1 Differences between cash inflows and revenue
Financial item Cash inflow Revenue

Cash sales made to customers V V
Credit sales made to customers X V
Capital raised from share sales V X
Rent charged on flat upstairs V V
£20,000 bank loan V X
Carry out a sale and leaseback V X
Making links
Notice that many of these differences between cash and profit arise from choices
made over sources of finance (see page 78). Therefore, if discussing sources of
finance, be sure to choose correctly between the terms cash and revenue/profit.
It is this difference between cash flow and profit that explains why profitable
businesses can go bust when they run out of cash. Selling on credit can be
especially dangerous. As long as the bank manager believes credit customers
will pay, an overdraft will still be available. However, a bank may withdraw
the overdraft facility, leaving the business with no cash to pay its bills on a
day-to-day basis.
01

Exam tip Typical mistake
Examiners will be impressed if you can show an understanding of the difference Never use the word 'profit'
between cash flow and profit (as this is something so few students seem to grasp). when explaining what a
Explaining how boosting sales can boost profit, but doing so by offering more credit cash flow forecast shows.
could damage cash flow, would score well. Likewise, do not state that
cash flow must be good if
a business makes a profit.
The distinction should be
clear.
What financial document shows different types of profit for a public limited company?
5 Give an example to illustrate why cash flow and profit are different.
Liquidity
Do we have cash or will we have enough in
time?
Statement of financial position (balance sheet) ' REVISED
□
+ Every year, all limited companies are required to send a statement of financial
position, commonly known as a balance sheet, to Companies House.
+ This shows what the business owns, as well as what it owes and where it
got its money from. Liquidity is the ability of a
business to find the cash
+ For the first two themes of your specification, the key question answered
it needs to pay its bills.
by a statement of financial position is: Does the firm have enough cash to
The cash must be readily
pay its bills? This question means testing the firm’s liquidity.
available either in the bank
Making links account or in the form of a
payment from a customer
Balance sheets are revisited in the second year's material on assessing that is due very soon.
competitiveness - in Chapter 15.
Current assets are items
the business owns that are
Measuring liquidity in the form of cash or can
be easily turned into cash
+ A balance sheet shows more information than is needed to measure
quickly without a major loss
liquidity. in their value. There are
+ If looking at a whole balance sheet, the section to be concerned with is three current assets: cash,
just above halfway up - the section that shows current assets and current money owed by customers
liabilities. (receivables/debtors) and
+ Measuring liquidity involves comparing the value of current assets against stock.
the current liabilities that will need to be paid. This can be done in two
Current liabilities are
ways: calculating current ratio and calculating acid test ratio.
debts owed by the business
that are due to be paid
Calculating current ratio within the next 12 months.
The current ratio is a calculation that enables a simple judgement to be made The two main current
about a firm’s liquidity. Accountants tend to state that the ideal current ratio liabilities are trade creditors
is 1.5:1. The formula used to calculate the ratio is: and overdrafts.
current assets
Current ratio =------------------------
current liabilities
This therefore means that if a company has a current ratio of 1.5:1, they will
have £1.50 of current assets for each £1 of short-term debt they have. If the
ratio is significantly lower than 1.5:1, this could mean that they will face
problems settling their short-term debts. If the ratio is significantly higher
than 1.5:1 the business could be criticised for having too much of their
resources tied up in non-productive current assets.

Calculating acid test ratio
Often referred to as a tougher test of liquidity, the acid test ratio does not
count stock as a liquid asset that can be set against current liabilities. The
formula is therefore:
8 Managing finance
(total current assets - stock)
Acid test ratio - ----------------------------------------
current liabilities
+ The ideal value for the acid test ratio is 1:1. This would mean that a firm
has £1 of cash or money owed by customers for every £1 of short-term
debt, so liquidity is sound.
+ If the acid test falls far below 1:1, that really could spell trouble for a
business trying to find the cash to pay its bills.
+ Some firms can trade on surprisingly low acid test ratios, notably Tesco,
which rarely has an acid test of more than 0.5:1. This is less of a problem
for a business that can generate millions of pounds through its tills every
day or one that is large enough to be likely to access bank finance fairly
easily when needed.
Stock control (Chapter 9) has an impact on the current ratio, especially in its difference Notice that stock forms the
with the acid test ratio. High levels of stock will mean a current ratio that is far higher difference between the two
than the acid test ratio, while a just-in-time stock control system will generate a liquidity ratios. A company
current ratio that is very similar to the acid test ratio. with a high current ratio but
low acid test is likely to have
Now test yourself TESTED high stock levels, which
could cause a problem.
On which financial document can the information to test liquidity be found? The size of the problem will
7 a) what two ratios can be calculated to test liquidity? depend upon how quickly it
b) What is the ideal value for each? can turn its stocks into cash.^
Improving liquidity REVISED

□
Improving liquidity relies upon bringing extra cash onto the balance sheet. Fixed assets are items
This could involve one or more of the following: owned by the business
+ Selling under-used fixed assets such as equipment or machinery which it intends to use over
+ Raising more share capital and over to generate profit.
+ Increasing long-term borrowing through loans Examples include property
+ Postponing planned investments and machinery.
Managing working capital F REVISED

□
Capital injected
into the Sell to
business customers
on credit
Produce Customers (debtors)

goods pay up
Buy
materials
Working capital is the
Figure 8.1 The working capital cycle money that is available for
the day-to-day running of
Figure 8.1 shows the different stages through which working capital passes as 103
the business.
a business buys, produces and sells products or services. Managing this cycle,

to ensure that there is always enough working capital in the system to
prevent blockages or delays, is crucial to successful financial management.
Actively managing the working capital cycle involves:
+ ensuring there is enough money in the system altogether
+ making sure cash moves through the cycle as quickly as possible.
If these two requirements are to be met, financial managers are likely to
consider the following actions:
+ Control cash used. This involves keeping the amount of cash used as low
as possible, by reducing stock levels, controlling credit periods offered to
customers and gaining as much credit as possible from suppliers, and
getting products on sale as quickly as possible.
+ Minimise spending on fixed assets. This can be helped by leasing rather
than buying new assets, which prevents large outflows of cash draining
working capital from the system.
+ Plan ahead to estimate carefully the amount of cash that will be needed in
the next few months. This will give time to ensure that adjustments to the
cycle can be made in good time.
Making links
Note how the idea of cash flow forecasting will have a positive impact on a company's
liquidity (see page 102).
Business failure
Why do some businesses fail?
Ultimately, any business that fails will do so because it does not have enough
cash to pay the bills. However, the reasons why businesses run out of cash can
be complex. Not all, or even many, of these are caused by financial issues. It is
other causes that lead to the financial problems that bring down the business.
Major issues tend to focus on marketing or strategic problems, such as:
+ not really understanding consumers
+ a failure to differentiate from rivals
+ failing to communicate what is special about the product or service to
consumers
+ poor leadership
+ not being able to find enough ways to generate revenue.
Internal causes of business failure REVISED

□
Marketing failure
Problems understanding changes in the marketplace, or even what
consumers are really looking for, will lead to a shortage of revenue. Poor
decisions relating to the marketing mix can often result from this.
Financial failure
Managers need to manage finances actively, planning ahead and making
adjustments when necessary. Failing companies sometimes stumble into
cash flow crises without seeing them coming.

Systems or operations failure
If IT systems simply do not provide the right people within the business with
the information they need, things start to go wrong. If physical systems break
down, such as manufacturing or ordering stock, the business will find itself
8 Managing finance
unable to satisfy demand for its product and will rapidly lose customers.
Making links
Here we see that business failure as a concept can clearly be linked to several other
topics, from marketing, through finance, to operations and resource management.

□
1( How can marketing mistakes lead to business failure?
1 Why are consistent stock control problems likely to lead to business failure?
External causes of business failure

Shifts in the external environment within which a business is operating can
F REVISED
□
lead to business failure. In these cases, it is perhaps easier to find sympathy
for business managers brought down by factors that are outside their direct
control. However, really good leaders are adept at anticipating and adapting to
external changes.
Changes in technology
A major technological advancement can destroy a company’s sales very
rapidly. As its product struggles to compete against a better product, price
cutting is almost assured and, ultimately, the company may fail to operate at
its break-even point.
New competitors
A new rival entering a market that is able to operate far more efficiently, perhaps
as a result of innovative processes or distribution channels, may cause such a
large effect as to drive existing businesses out of the market and out of business.
Economic change
In times of economic downturn, orders for luxury goods tend to dry up. If
economic growth does not recover quickly, some businesses will find it hard
to continue operating above their break-even point - those with insufficient
cash will fail.
Behaviour of banks
The banks have a vital role to play in providing finance to business:
+ to fund long-term investments designed to raise competitiveness
+ to provide short-term finance to help working capital management.
A failure to supply credit to businesses, or forcing businesses to accept
unreasonably high interest rates, can both lead to business failure. This
helps to explain why banking is a crucial but controversial sector of the UK’s
economy.
Making links
Now test yourself
Further links to the external
12 state three external causes of business failure. influences covered in Chapter
3 How do good leaders ensure their business survives negative external changes? 10 can be seen when looking
at these external causes of
Answers available online business failure. 105

Exam practice
Hickmet and Hickmet Ltd was a chain of Turkish Extracts from statement of financial position
restaurants, in late 2020, the business failed. Analysts (balance sheet)
suggested that the failure was down to external causes.
The directors were convinced there was nothing they could Three years Two years Last year
have done to tackle the twin external factors of: ago (£m) ago (£m) (£m)
+ three months' closure caused by the Coronavirus Total current 8 6 5
pandemic assets
+ increased ingredients costs caused by the fall in the inventories 5 4 4
value of the pound since Britain voted, in 2016, to leave
the EU. Current 3 4 1
liabilities
However, analysis of extracts from the company's
accounts suggested that the directors could have seen Questions
problems coming.
1 For each of the three years shown, calculate:
Extracts from statement of comprehensive income a) Gross profit margin [4]
Three years Two years Last year b) Operating profit margin [4]
ago (£m) ago (£m) (£m) c) Profit for the year (net profit) margin [4]
Revenue 52 48 45 2 Use these results to comment on trends in the firm's

profitability. [4]
Gross profit 26 22 18
3 For each of the three years shown, calculate:
Operating 6 1 (4)
a) Current ratio [4}
profit
b) Acid test ratio [4]
Profit for 1 0.2 (5)
4 Use these results to comment on the firm's liquidity. [4]
the year
5 Assess the directors' view that the failure of the
business was entirely due to external factors. [10]
Summary
+ There are three main types of profit. + internal causes of business failure include poor
+ Profit and profitability show different things. marketing, poor financial management or systems
+ Cash flow and profit are not the same. failure.
+ Liquidity measures the availability of cash to meet + External causes of business failure may include
short-term debts. technological change, the arrival of a new competitor,
+ Liquidity can be measured using the current and acid economic problems or the behaviour of banks.
test ratios. + Ultimately, most business failures are the result of the
+ Successful working capital management is the key to business running out of cash.
ensuring healthy liquidity.
Exam skills
+ it is well worth noting that a section focused initially on + Profit is a number of pounds, an absolute figure - what
profit comes around in the end to considering possible is left from revenue once costs have been deducted.
reasons for business failure. + Profitability is a reference to profit margins - the
+ Profit may seem a glamorous term - conjuring images of proportion of revenue left as profit.
wealth and luxury. Yet, in reality, profit is what a business + Avoid using the terms profit and profitability
needs to consistently secure in order to stay around. interchangeably. Think carefully about which fits
+ This section also raises another fine example of the what you are trying to say and build your arguments
need for accuracy in the use of business terminology. accordingly.
Profit and profitability are not the same thing.

Production, productivity and

efficiency
How to make things, and how to do it as
effectively as possible
The process of creating a product or delivering a service can be a crucial
source of competitive advantage. Choosing how to organise production
and ensuring it is efficient are vital in making sure business resources are
managed effectively.
Methods of production REVISED

□
How to organise production tends to be a trade-off between uniformity and
speed on one hand against the ability to adapt a product to meet individual
customers’ needs on the other.
Job production
Job production involves
Job production, making tailor-made products to suit customer tastes, brings making one-off items to suit
benefits and drawbacks. each customer's individual
requirements.
Table 9.1 Benefits and drawbacks of job production
Benefits of job production Drawbacks of job production Making links

Can charge a higher price as products can Cost per unit is very high, due to high level
As job production allows
be tailored to meet exact specifications of skill and low rates of production
products to be tailored to
Work should be more interesting for staff Finding staff with sufficient skill can be suit the needs of individual
hard and pay will have to be high customers, it can be a
great way to add value (see
page 17).
Batch production
Batch production is really a kind of compromise between job production and Batch production makes
flow production (see page 108). a group of products to one
specification at a time,
Table 9.2 Benefits and drawbacks of batch production
allowing some variation
Benefits of batch production Drawbacks of batch production in products, yet some
specialisation.
Allows variation in the product being More costly to set up than job production
made as some specialist machinery will be
needed
Speedier than job production as making Cost per unit will still be higher than flow
a batch of identical products speeds up production as machinery will need to be
production adjusted between batches
Making links
Niche marketing may rely on
1 is job production likely to be labour or capital intensive? batch production - with a
small market, demand may
Briefly explain why most small bakers use batch production for producing bread rolls.
be insufficient to allow for
Answers available online full-scale flow production.

Flow production
Flow production allows huge volumes of output to be produced extremely
Flow production refers
quickly and cost effectively. It is likely to rely heavily on automation.
to continuous production
of a single, standardised
Making links
product.
Given the high cost involved in building a flow production system, introducing flow production Automation means using
may well go hand in hand with the need to find new sources of finance (see page 78). machines to complete tasks
within a process.
Table 9.3 Benefits and drawbacks of flow production
Benefits of flow production Drawbacks of flow production

Unit labour costs are extremely low High initial costs of installing production machinery
Huge volumes allow huge demand in mass markets to be met Products need to be identical - no tailoring to suit different tastes
Cell production
Cell production, with its roots in the Japanese philosophy of lean production,
Cell production involves
harnesses the power of group working to increase productivity, yet maintains
organising workers into
the scope to tailor-make different variations on a product within the cell. small groups or cells that
can produce a range of
Making links different products more
Other aspects of the lean production approach that would complement cell quickly than job production
production are just-in-time (see page 114), continuous improvement (kaizen) (see allows.
page 116) and total quality management (see page 115).
Table 9.4 Benefits and drawbacks of cell production
Benefits of cell production Drawbacks of cell production

Group working allows ideas to be generated within the cell As it is still heavily reliant on people rather than automation,
for improvements to processes costs are relatively high
The small, highly skilled cell can adjust products to suit Production volumes will not be as high as in flow production
customers' needs
Due to the benefits and drawbacks of each, different methods are suited to
different circumstances, as shown in Table 9.5.
Table 9.5 Circumstances when each production method is at its most effective
Job Batch Flow Cell

When every customer wants When production has to be When there is consistent, When there is a need for
something unique, e.g. a split into chunks, e.g. shoes high demand for a single flexibility but also high
wedding dress in different sizes and colours product, e.g. The Sun production volumes, i.e. lean
newspaper production
When labour costs are low, When labour costs are When labour costs are high, when labour has a lot to
e.g. suits tailor-made in high enough to mean job e.g. in France or Sweden contribute to ideas and
Bangkok production is too costly improved efficiency
When tailor-making When a firm wants to limit when efficiency allows when a degree of
something adds real value, the availability of an item, prices to be low enough to uniqueness adds value for
e.g. shoes for a marathon e.g. Hermes with its 'Birkin' boost sales on everyday the customer
runner bag items, e.g. baked beans
Which one of the following is NOT a Difficult to produce high volume of

drawback of flow production? output
a) High initial cost I) Difficult to produce product
b) Repetitive and dull for workers variations

Productivity REVISED
□
Productivity generally refers to output per worker. It is the speed at which an
Productivity is a measure
employee completes their task. It is calculated using the formula:
of the efficiency of the
total output production process. It is
Productivity =--------------------------
number of workers usually measured as output
per worker per time period.
Making links
With a huge proportion of manufacturing workers paid an hourly rate, increasing their
productivity spreads the hourly wage cost over more units of output, meaning a lower
cost per unit. That brings higher profit margins (see Chapter 8).
Typical mistake
Factors influencing productivity Productivity is not the same
Many factors influence productivity. The speed at which workers can produce as production or output.
units of output may depend on the workers or on the environment in which Output can be increased by
they are working. Key factors affecting productivity include: simply employing more staff
+ quality and age of machinery working at the same rate.
+ skills and experience of workers To increase productivity, the
+ level of employee motivation. output produced by each
worker must be improved.
Making links
Making the link between motivation and productivity (see page 195) is one of the most
common, but effective, pairs of concepts to join in a business answer.
Link between productivity and competitiveness

+ Higher levels of productivity lead to lower unit costs. This is because the
labour cost involved in making each unit falls as workers work faster.
+ If a worker is paid £10 per hour and makes 10 units each hour, the labour
cost of each unit is £1. If that worker’s productivity doubles, the labour
cost per unit would only be 50p (£10/20 units). Lower unit costs allow
businesses to cut prices while maintaining the same profit margin.
Making links
High levels of productivity linked to lower unit costs may be a fundamental aspect
of strategy for a business pursuing Porter's generic strategy of cost leadership (see
page 130).

□
Calculate productivity for a factory which employs 200 staff and makes 40,000
products per hour.
If the same factory increased productivity to 250 units per worker per hour, what
would be its new output per hour?
If the business could only sell 40,000 products per hour, how many staff could be
made redundant if productivity was 250 units per worker per hour?
Efficiency REVISED
□
Efficiency differs from productivity in that it considers waste. A process may Efficiency measures
have a high rate of productivity, but generate a lot of waste. Therefore, it is not the extent to which the
efficient. Wasted time, which is reduced as productivity rises, is certainly a resources used in a process
factor, but a highly productive system may come with a cost in terms of generate output without
quality, meaning many of the items produced are faulty and must therefore wastage.
be thrown away.

Factors influencing efficiency
The factors that determine efficiency are the same as those affecting
productivity. It is only the measurement that differs.
Table 9.6 Factors affecting production and efficiency
Factor affecting production Affects productivity because... Also affects efficiency because ...
Quality and age of machinery Newer machinery may work faster, and Fewer breakdowns mean fewer faults
break down less and newer machinery may produce
with less variation (more accuracy)
Skills and experience of workers Highly skilled staff can produce Skilled staff are likely to make fewer
things faster, while experience brings mistakes, while experience can mean
knowledge of how to complete tasks staff spot the problems that lead to
with high efficiency and quality faults before they occur
Level of employee motivation Motivated staff are likely to focus on Motivation brings pride in work,
the task without distraction and work so motivated staff will be careful
as quickly as they can not to make errors, and will lose
concentration less often
Labour intensive versus capital intensive production

The trade-off faced by firms considering how to produce their products often
boils down to the extent to which they wish to rely on machines versus Labour intensive
relying on people. production means that a
production process relies
Key issues relating to labour intensive production: heavily on human input with
+ Labour costs will form a high proportion of total costs. little use of automation.
+ Managing labour costs becomes critical, perhaps forcing a firm to move
Capital intensive
abroad to lower-wage countries or spend heavily on motivational methods.
production uses high
+ Labour intensive production offers far greater scope for tailoring products
levels of automation,
to suit customers’ needs, thus adding value, allowing a higher selling price.
reducing the role of humans
Key issues relating to capital intensive production: as much as possible,
+ Initial costs will be very high, with the need to invest specialist machinery. replacing them with
+ Running costs will be relatively low. machines.
+ It may offer little flexibility in terms of product variations.

What is the key difference between productivity and efficiency? Implementing a more
State three key factors that affect productivity. capital intensive approach
to production will usually
9 what formula is used to calculate productivity?
involve some form of
Answers available online investment appraisal
calculation (see page 159).
Capacity utilisation
How much of what we could make, are we
making?
Having unused assets sitting around in a business producing no profit is Capacity is the term used
inefficient. Therefore, businesses continually aim to operate close to full to describe the maximum
capacity to avoid waste and boost profitability. possible output of a
business.
Making links
Effective and accurate sales forecasting is critical to operating at an appropriate level
of capacity utilisation (see page 110).

Calculating capacity utilisation REVISED
□
The formula used to calculate capacity utilisation is: Capacity utilisation is
current output the proportion of maximum
Capacity utilisation =------------------------------------- x 100 capacity being used by the
maximum possible output
business.
A firm’s capacity utilisation is expressed as a percentage figure.
Implications of under-utilisation of capacity F REVISED

□
The major negative implication of under-used capacity is that fixed costs per
unit will be higher. The following worked example illustrates this:
Maximum capacity - 5,000 units per month
Total fixed costs = £10,000 per month
When capacity utilisation is 100 per cent, fixed costs per unit =
£10,000/5000 = £2 per unit.
When capacity utilisation is only 50 per cent, fixed costs per unit =
£10,000/2,500 = £4 per unit.
That means that with under-used capacity, a greater amount of the revenue
generated by each product must be used to cover fixed costs. This reduces Typical mistake
operating margins significantly. Given the implication of
In addition, under-utilisation of capacity can: capacity utilisation on
+ lead to fears for job security among staff, damaging motivation fixed cost per unit, some
+ cause poor morale among managers students falsely believe that
all businesses should try to
+ contribute to a poor reputation for the business, especially in the service
reach 100 per cent capacity
sector; imagine a restaurant that usually has many tables empty even
utilisation at all times. There
during busy periods.
are problems associated
with this, as shown by
Making links
the implications of over
Note that under-utilisation of capacity can be linked to the possibility that Maslow's utilisation of capacity (see
safety needs are no longer met for employees in fear of redundancy (see page 56). below).
What formula is used to calculate capacity utilisation?

1 How does a high capacity utilisation help to boost profitability?
Implications of over-utilisation of capacity REVISED

□
If capacity utilisation stays close to 100 per cent over a long period, two
potential problems arise:
+ The firm may be unable to accept any new orders, potentially turning
away new customers to rivals.
+ There will be little or no time to carry out maintenance on machines or to
train staff.
The ideal level of capacity utilisation is therefore close to 100 per cent, without
ever staying at 100 per cent for a long period.

Ways of improving capacity utilisation REVISED
□
There are two basic ways to boost the proportion of maximum output being
used: Making links
+ Increase current output: This is likely to be accomplished using marketing
Part of the logic behind
methods to boost the volume of sales made by the business, perhaps
dealing with excess
through advertising or cutting the selling price. Alternatively, the business
capacity by reducing
could use its capacity to make products for other businesses looking to
maximum capacity is the
subcontract work.
need to lower the break
+ Reduce maximum capacity: This will involve selling off assets or laying off
even point (see page 92)
staff. Although redundancies can be costly in the short term, reducing - less capacity lowers fixed
maximum capacity reduces fixed costs. costs, thus allowing the firm
to make a profit at a lower
Exam tip
level of output and sales.
If the causes of under-used capacity are short term, for example poor weather, it
would be foolish to reduce maximum capacity, instead, the solution is likely to lie
in boosting current demand using marketing methods. If, however, the causes are
long term, such as a change in consumer lifestyles, a longer term solution - such as
reducing maximum capacity-would be more appropriate.
State two reasons why 100 per cent capacity utilisation can be a problem.
13 What are the two basic solutions to under-utilisation of capacity?
14 if a business has monthly fixed costs of £120,000, and a maximum monthly output
of 1,000 units and a contribution per unit of £250, calculate profit when:
a) the firm is operating at 100 per cent capacity utilisation
b) the firm is operating at 60 per cent capacity utilisation.
Assume all output is sold.
Stock control
Decisions on how much stock to have available
Stock or inventory is often viewed as a necessary evil in business. Holding
stock costs money and ties up cash, but with no stock, production can grind
to a halt or customers may be disappointed.
Interpreting stock control diagrams REVISED

□
One method used to help control stock levels is a stock control diagram. A
typical stock control diagram is shown in Figure 9.1. Stock or inventory is the
materials, partially made
products and finished goods
owned by a business that
have not been sold.

Key features of the diagram include:
+ The maximum stock level set by the business, strongly affected by the
amount of space available and the firm’s stock-holding policy.
+ The minimum or buffer stock level, i.e. the amount of stock of that item
that the business aims to always have available.
+ The re-order level is the amount at which a new order for stock is
triggered.
+ The re-order quantity is the vertical jump upwards in stock level that Exam tip
occurs at the start of months 4 and 7 on the diagram. This is the amount of
On a stock control diagram,
stock that is ordered each time an order is placed.
any vertical gaps or changes
+ The lead time, or delivery time, is the horizontal gap between a re-order refer to the quantity of
being placed and the delivery of stock arriving - in this case one month stock. Any horizontal
- as stock is re-ordered at the start of months 3 and 6 and arrives at the distances are times.
start of months 4 and 7.
Buffer stocks 1 REVISED

□
Most businesses aim to keep a minimum level of stock of raw materials used
in production and, in many cases, finished goods at all times. The reasons for
this are shown in Table 9.7.
Table 9.7 Reasons for keeping buffer stocks
Reasons for keeping buffer stock of raw materials Reasons for keeping buffer stock of finished goods
If deliveries are delayed, buffer stock allows production Helps to ensure that the business can always supply customers
to continue when they need a product, with the right size or colour
if a batch of supplies is found to be faulty, the buffer Allows the firm to accept rush orders from customers
stock can be used to continue production

□
5 What name is given to the minimum level of stock a business aims to keep at all
times?
How does a stock control diagram show the time taken to deliver by suppliers?
Implications of poor stock control REVISED

□
Effective stock control is focused on always maintaining the ‘right’ level
of stock. The ‘right’ level, however, varies from business to business. Get it
wrong and the business can end up with too much or too little stock. Each
causes a number of problems.
Table 9.8 Problems with too much or too little stock
Problems associated with too much stock Problems associated with too little stock
+ Opportunity cost: This ties up capital, as stock, and + Lost customers: If an order or customer arrives
prevents that money from being used in other ways expecting to receive their products immediately and
+ Cash flow problems: Stock represents cash that has there is none in stock, that customer or order may be
been converted into stock but not yet converted back lost to competitors
into cash. Hold too much stock and there is a danger + Delays in production: If there are no materials to
the firm will run short of actual cash process, machinery and workers may be left standing
+ Increased storage costs: Keeping stock costs money; it idle until the next delivery arrives. Stopping and then
incurs space, security, or even refrigeration costs restarting machinery can be costly
+ increased financing costs: If stock has been purchased + Loss of reputation: This may occur if word gets around
using any form of borrowing, the business will that the business struggles to maintain enough stock to
experience extra interest costs meet customer needs promptly
+ increased wastage: Too much stock may lead to stock
'going off', being damaged in some way or becoming
obsolete

Making links
It is worth noting how often financial issues crop up when discussing holding stock.
The idea that stock ties up cash which cannot be used until the stock is sold links well
with a consideration of a company's liquidity.
State three problems of having too much stock.

State two problems of having too little stock.
Just-in-time stock management REVISED
Just-in-time stock management, with no buffer stock, relies entirely on

Just-in-time stock
frequent, small deliveries of materials from suppliers being delivered without
management is a
delay and without any quality problems. This brings many benefits,
Japanese-rooted approach
eliminating costs involved in stock-holding, but increases the danger of to stock management that
production halting due to a lack of materials. aims to eliminate buffer
Key issues to consider for a firm using just-in-time stock management: stock completely.
+ Suppliers must be willing to deliver frequently (often several times a day).
+ Deliveries must be absolutely reliable; missed deliveries leave the firm
without stock.
+ Suppliers may need to relocate close to the company using just-in-time.
+ Will smaller, more frequent deliveries lead to a loss of bulk-buying discounts?
+ Will frequent deliveries lead to increased congestion and pollution from
lorries?
Exam tip
Overall, the introduction of just-in-time stock management increases the importance
of the relationship between a business and its suppliers. Look for evidence in any
case study of how well a company gets on with its suppliers to help decide whether a
switch to just-in-time would work well.
Waste minimisation REVISED

□
Waste minimisation is fundamental to a lean approach to production. A just-
in-time approach to managing stock helps to reduce waste in several ways:
+ Less stock is held, meaning there is far less likelihood of stock wastage.
+ Cash is not tied up in stock, effectively wasting it.
+ Removing buffer stocks helps to highlight bottlenecks and problems in
production processes. These can be ironed out by adjusting the production
system.
Making links
An argument involving one aspect of lean production, such as just-in-time, will usually
allow links to be made with the other aspects - continuous improvement (kaizen),
cell production and total quality management (see page 116) - through pursuit of the
theme of reducing waste throughout the business.

Competitive advantage from lean production REVISED
□
Lean production, featuring just-in-time stock management, continuous Lean production is a
improvement linked with total quality management, as well as cell collective term for a range
production, can improve how businesses are run in a number of ways: of Japanese techniques
+ more input from staff designed to eliminate waste
+ a focus on quality from business processes.
+ fewer wasted resources through just-in-time and total quality management
+ a focus on reducing wasted time, so speed can become a source of
competitive advantage.
These features lead to the following sources of competitive advantage:
+ higher levels of productivity, reducing labour cost per unit
+ less space and stock, reducing fixed costs
+ higher quality, leading to reputational advantages and greater repeat custom
+ faster development of new products, allowing the firm to be first to market
with new ideas.
19 Briefly explain how introducing just-in-time stock management increases a firm's

reliance on suppliers.
How would an increase in the level of production for a short time show up on a
stock control diagram?
Quality management______________
How to ensure everything you produce
meets appropriate standards
If consumers are to buy a product or service, they expect it to be of a certain
quality. At a minimum level, customers expect the product to be fit to
perform the purpose for which it was bought. Some businesses use quality as
a point of differentiation.
There are three main methods of managing quality: quality control, quality
assurance and total quality management.
Managing quality 1 REVISED

□
Quality control (QC)
This system involves checking output to find any faults in a production
system. It is the traditional method used, reliant on inspecting output, with
inspection carried out by a separate person to those working on or making
the products themselves.
Quality assurance (QA) Typical mistake

This system focuses on producing methods of preventing quality problems
Too many students suggest
arising. These methods are checklists or procedures that form a part of
that quality assurance
company policy. If employees follow these procedures, the systems are ensures top quality
designed to prevent any quality problems. products, in reality, quality
may simply be okay; what
Total quality management (TQM) will be excellent are the
systems of paperwork
This is less of a system and more a way of encouraging all staff to think
designed to try to manage
about the business. In order for this to work, everyone in the organisation
quality.
has to understand and ‘buy into’ the idea of getting things ‘right first time’.

Quality becomes a part of everybody’s job - not just production workers, but
designers, accountants and sales people.
Table 9.9 Pros and cons of TQM, QC and QA
TQM QC QA
Pros + Should become deeply rooted + Can be used to guarantee that + Makes sure the company has a
into the company culture, e.g. no defective item will leave the quality system for every stage in
product safety at a producer of factory the production process
baby car seats + Requires little staff training; + Some customers like the
+ Once all staff think about quality, therefore suits a business with reassurance provided by keeping
it should show through from unskilled or temporary staff (as records about quality checks at
design to manufacture and after ordinary workers don't need to every stage in production; they
sales service, e.g. at Lexus or worry about quality) believe they will get a higher-
BMW quality service and may therefore
be willing to pay more
Cons + Especially at first, staff sceptical + Leaving quality for the + QA does not promise a high-
of management initiatives may inspectors to sort out may mean quality product, only a high-
treat TQM as 'hot air'; it lacks the poor quality is built in to the quality reliable process; this
clear concrete programme of QC product, e.g. clothes with seams process may churn out 'okay'
orQA that soon unpick products reliably
+ To get TQM into the culture of + QC can be trusted when 100 per + QA may encourage
a business may be expensive, cent of output is tested, but not complacency; it suggests quality
as it requires extensive training when it is based on sampling; has been sorted, whereas rising
among all staff, e.g. all British Ford used to test just one in customer requirements mean
Airways staff flying economy seven of its new cars - that led quality should keep moving
from Heathrow to New York to quality problems ahead
1 Who is responsible for ensuring quality in a quality control system?

2 Who is responsible for ensuring quality in a TQM system?
Quality circles
The people involved in doing a job tend to have real expertise in getting that
A quality circle is a
job done. This expertise includes understanding how they could get the job
group of staff who meet
done even better. Giving staff a formal system for discussing these
regularly to find quality
improvements in their working area - a quality circle - encourages an improvements.
approach of continuous improvement throughout the business.
Exam tip
Involving staff in quality circles can be highly motivating. Look to tie in answers about
this effect with the work of either Maslow or Herzberg.
Continuous improvement (kaizen) REVISED

□
Whereas automation is an attempt to take a big leap forward in productivity,
continuous improvement encourages staff to put forward a stream of small
ideas on how to do things better. Empowering staff to make changes to their
working systems brings quality and productivity improvements.
Based on cell production, each small group of employees becomes expert in
their area and so is best placed to find improvements.
Key aspects of continuous improvement:
+ cell production
+ quality circles
+ small but frequent changes
+ regular suggestions
+ quality and productivity improvements.

Competitive advantage from quality
management 1 REVISED
□
Spending money on quality management systems to ensure high quality
production and service delivery brings rewards: Making links
+ It allows a price premium to be charged (often greater than the extra cost Notice that high standards
of producing high quality). of quality within a business
+ It helps to gain distribution, with retailers confident they will not need to are likely to lead to high
deal with product returns and refunds. gross profit margins (see
+ It creates brand loyalty and repeat purchase. page 191), through premium
+ It can help to build a brand reputation that spreads to other products pricing and reduced costs
within a firm’s portfolio. of errors.
Now test yourself

Exam practice
3 What type of production is ideally suited to a system of continuous improvement?
Evaluate the likely impact on
4 What name is given to the meetings where small groups of staff discuss possible
a UK-based manufacturer of
improvements within their area?
high quality, branded clothing
5 What is the main source of ideas for improvement in a kaizen system? of introducing a system of
6 Given the list of benefits of quality management systems above, how can each lean production. [20]
lead to increased profits?
Answers and quick
Answers available online quiz 9 online
Summary
+ Job, batch, flow and cell production all have pros + Stock control diagrams can be used to help manage
and cons, meaning each is best suited to different stock and show a range of different features of stock
circumstances. management.
+ Increasing productivity leads to lower costs per unit. + Firms can face problems from having either too much
+ Efficiency differs from productivity in that it measures or too little stock.
wastage as well as speed. + Just-in-time stock management aims to eliminate buffer
+ Firms face a choice between labour or capital intensive stock.
production methods. + Lean production is an approach to production that
+ Capacity utilisation has a major impact on fixed cost includes just-in-time, TQM, cell production and
per unit and thus profit margins. continuous improvement.
+ increasing capacity utilisation can be done through + Quality management systems include quality control,
increasing current output and sales or reducing quality assurance and total quality management.
maximum capacity. + Good quality management can bring competitive
advantage.
Exam skills
For anyone who has sat at their desk for an hour 'doing + This means that any signs of inefficiency or wastage
business revision' and realised at the end of that hour they in a case study context may help to explain poor
have only been productive for 10 minutes, the importance performance from a business.
of using scarce resources - time - as productively as
The challenge you face will be to recognise inefficiencies
possible is clear.
which may not appear to be so to the untrained eye:
+ in any activity - in our case, business activity - the
+ Under-utilised machinery in a factory or shelves full of
need to maximise the amount of quality output from
attractive, but overflowing stocks in a shop, are both
a process into which finite resources are fed will
causes of inefficiency identified in this section.
determine the level of success achieved.
+ Ultimately, these inefficiencies will have a negative,
+ As a result, this section, underpinned by the concept
unsustainable impact on a business's profitability and
of productivity or efficiency, helps to explain business
thus are likely to lead to failure.
success or failure well.
+ Those organisations that are able to get the best from
the resources at their disposal will gain a competitive
edge over their rivals.

Economic influences
How changes in the economy affect
businesses
Effects on the business of economic changes REVISED
□
The economic environment within which businesses operate can have a
major impact on both revenues and costs. It is therefore a vital determinant Typical mistake
of profit. Changes in several key economic variables influence business If the rate of inflation is
performance in different ways. falling, say from 2 per cent
to 1 per cent, prices are
Inflation not going down. They are
simply rising more slowly.
If prices are rising throughout an economy, the costs paid by a business Deflation - a situation where
for raw materials, property and labour (wages) will be rising. However, if average prices are falling - is
consumers are used to prices rising, firms may be able to increase their rare in the UK and would be
selling prices in order to protect profit margins. The circumstances in which shown by a negative rate of
inflation has a major effect are: inflation, e.g. -1.5 per cent.
+ when rates of inflation are significantly above 2 per cent
+ when prices are rising faster than average earnings
Inflation is the percentage
+ when UK inflation is higher than that in most other countries. rate at which average prices
rise during a year within the
Making links whole UK economy.
The key indicator for a business that is operating during a period where inflation is an
issue is its profit margin (see page 100). Keep a special eye open for changes in the
Exam tip
gross profit margin to see whether direct costs are rising faster than prices, i.e. the gross
margin will befalling. Look for evidence of a
company’s revenues
and costs being affected
Effects of inflation on businesses differently by inflation to
+ A firm with a long-term fixed price contract may find that if costs rise show whether profits would
rapidly while the contract is being completed, the fixed price does not even be harmed or not. If many
cover their higher level of costs, damaging profitability. resources are imported
+ Firms with substantial long-term borrowings will find the real value of from countries with low
the money they repay will be lower following a period of high inflation, as inflation, costs may be
inflation has the effect of reducing the real value of money. rising more slowly than
+ If inflation in the UK is higher than in other countries, UK businesses may the business can push up
lose competitiveness against foreign rivals whose costs are likely to be domestic selling prices,
rising more slowly. This would allow foreign firms to charge lower prices. meaning profit margins may
actually rise due to inflation
□
Briefly explain what is happening to prices when the rate of inflation falls from Typical mistake
2 per cent to 1 per cent.
Too many student answers
Why can many businesses maintain profit margins during times of inflation when
to questions on inflation
their costs are rising?
simply consider the effect of
Answers available online inflation on costs, ignoring
the fact that firms may well
be able to increase their
selling prices to protect
profit margins.

Exchange rates
Changes in the exchange rate of the pound will affect UK businesses. Most
An exchange rate is the
directly affected will be UK businesses that export their products and value of one currency
services, and UK businesses that buy materials or other supplies from abroad.
expressed in terms of
another.
Making links
The impact of exchange rates will play a key role for any business operating on a
global scale. The whole of Theme 4 is about global business.
Effects of exchange rates on businesses

Table 10.1 Summary of the effects of exchange rate changes
Example impact on exports Impact on imports

£ appreciates £1 was $1.60 but now UK exports get pricier, Imports to UK get cheaper, making it
buys $1.80 so sales volumes fall harder for UK firms to compete
£ depreciates £1 was at €1.30 but now UK exports get cheaper, Imports to UK get more expensive, so
falls to €1.15 so sales volumes rise UK firms can compete more effectively
A handy way to remember the effect of a stronger pound is the word SPICED:
+ Strong
+ Pound
+ Imports
+ Cheaper
+ Exports
+ Dearer
Now test yourself
3 Which acronym can be used to help remember the effects of a strong pound on
British businesses?
Briefly explain why a major UK manufacturer that exports the majority of its output
would prefer the pound to weaken against other currencies.
Interest rates
Although different lenders will charge different rates of interest, most will
adjust their rates in line with those charged by the Bank of England. This is A rate of interest is the
amount charged by a lender
why the Bank of England’s base rate is such an important economic variable.
per year for borrowing
money. This is expressed as
Effects of interest rates on businesses
a percentage of the amount
An increase in interest rates tends to have negative effects on businesses in
of money outstanding.
four ways:
+ Consumers are likely to have less money to spend, as payments on
mortgages or other borrowings will increase. This is likely to reduce
demand.
+ The amount paid in interest on any borrowing by the business will rise,
pushing up costs. Making links
+ Consumers are less likely to ‘borrow to buy’, so products that are often Gearing, the financial ratio
bought on credit, such as cars or sofas, will see demand fall, as the credit explained in Chapter 15,
will cost more. will be a key indicator of
+ Businesses are less likely to invest, as the opportunity cost of investment how badly a business's
(keeping the money in the bank to earn interest with no risk) will be costs will be affected by
greater. rising interest rates - highly
geared firms will suffer most
Reducing interest rates is likely to have the same effects in reverse, being
when interest rates rise.
mainly beneficial to businesses.

Identify three ways in which an increase in interest rates has a negative effect on
businesses.
Why might a car dealership that has used loans to finance its expansion be
especially hard hit by an increase in interest rates?
Taxation and government spending

In the UK, government spending (the NHS, defence, education, etc.) accounts
for roughly 40 per cent of all spending in the economy. So government
decisions on spending and how to raise the money to spend (taxation) have a
major impact on businesses.
Many private sector businesses are largely dependent upon the state for their
income, such as:
+ publishers of textbooks
+ road-building firms
+ pharmaceutical firms (producers of medicines)
+ railway companies (given government subsidies).
Companies in general tend to press governments to cut their spending (and
therefore taxes levied at businesses and their customers), but many are
heavily dependent on that government money.
Effects of taxation and government spending on businesses

Governments change levels of taxation and government spending to try
to manage the economy. Their goal is to create stable economic growth.
Table 10.2 shows government aims combined with the effects of changes in
taxation and government spending.
Table 10.2 The impact of a change in taxation and government spending
Government Government Government puts Government puts

spending up spending down taxes up taxes down
To help reduce Extra spending on Reduce income tax
the level of road-building, health to enable families to
unemployment and other services keep and spend more
with big workforces of the money they
earn
To cut the growth Cut spending on Increase income tax
rate of the economy health, education and to force people to
when it is rising too defence, to take a bit think harder and more
fast of spending from the carefully about what
economy they buy
To improve the Extra spending on Cut company taxation
competitiveness of education (corporation tax)
British firms
To cut the rate of Cut benefits, e.g. state increase VAT on all
imports, especially pension, to reduce goods other than food
of consumer goods people's ability to buy and drink
exports
Now test yourself
Why would producers of products with a negative income elasticity be likely to

benefit from an increase in income tax rates?
Explain the link between reducing corporation tax and investment in new
production equipment.

The business cycle
Economic growth does not tend to follow a stable path. At times, economies
grow quickly, at other times, growth is slower, or economies even shrink
from year to year. The pattern of economic growth in the UK tends to follow
a pattern where strong growth (boom) is followed by periods of recession,
where the economy actually contracts.
Effects of the business cycle on businesses

The key impact that the business cycle has on businesses is primarily related
to demand for products:
+ If the economy slows, consumers will, on average, reduce their spending.
+ While in a boom period, consumer demand rises rapidly.
+ Changes in consumers’ incomes are the result of changes in wages or even
changes in the level of unemployment.
The effect of the business cycle on businesses is therefore mainly dependent
on one thing: income elasticity of demand.
This was covered in depth in Chapter 2, page 26. Table 10.3 summarises the
effect of the changes in income brought on by economic boom and economic
recession, according to the income elasticity of the product being sold.
Table 10.3 Effect of changes in income on different types of product
Type of product Change in real incomes Change in demand Explanation

inferior good Increase Decrease Consumers stop buying cheaper substitutes
and trade up now they have more money
Decrease Increase Consumers switch to these products to save
money as their incomes fall
Normal good Increase Increase at the same rate Increasingly affluent consumers are now able
as real income ora little to buy a little more of this type of product
slower
Decrease Decrease at the same As consumers tighten their belts they will cut
rate as real income or a back a little on these products
little slower
Luxury good Increase Increase at a faster rate As consumers' incomes rise these luxuries
than real incomes are the ones that most of their extra income
will be spent on
Decrease Decrease at a faster rate These will be the first products to disappear
than real incomes from consumers' shopping baskets when
they feel the need to tighten their belts
Effect of economic uncertainty REVISED

□
Predicting the economy is a little like trying to predict sales for every business
in the UK.
Making links
in Chapter 7, page 88, we explored why forecasting sales of just one product is
difficult. It is therefore vital to remember that forecasting the economy is an inexact
science too.
Making links
Business decision-makers love certainty. When devising plans for investment
over the next five to ten years, directors want to be sure that the money they in Chapter 5, page 65, we
spend will be recovered and generate a profit. Uncertainty means they cannot explored the reasons for
be sure. Featuring high on the list of reasons for uncertainty in business, uncertainty.
along with the reasons why sales forecasting is difficult, is economic change.
121

No business decision-makers will make any long-term decisions without
thinking first about the likely state of the economy in the future. Therefore,
business leaders prefer economic stability to the uncertainty that comes with
cyclical economic growth.
What type of products find sales particularly hard hit during a recession?
How the law affects business operations and

decisions
Laws passed by parliament are needed to ensure that businesses behave
in what is generally considered to be an acceptable way. Although many
specialist areas of the law exist covering business activities, the five main
areas in which legislation affects business are explained below.
Making links
The effects of laws on business can be linked with business ethics (see page 180).
In theory, no ethically responsible business should consider doing anything illegal. In
fact, a business seeking to maintain high ethical standards may look to do much more
for stakeholders than the minimum legal requirements.
Effects of consumer protection laws on

business REVISED
□
The main goal of consumer protection legislation is to ensure that businesses
actually deliver on what they promise the consumer. Therefore, aspects of Exam tip
this include: Many argue that businesses
+ Does the product do what it claims to do? that mistreat customers
+ Is the product correctly labelled? will ultimately gain a
+ Is the product sold in the correct weight or measure? poor reputation and lose
+ The rights of consumers to refunds or to exchange faulty products. business, making consumer
protection legislation
The driving force behind consumer protection legislation is to ensure that no
unnecessary. However,
business can gain an unfair advantage over its rivals through deceitfulness.
too many examples exist
Ultimately, competition should be based on the product and price at which it
of 'cowboys' who mistreat
is sold, not claims that bend the truth.
customers, then set up
Two major Acts of Parliament covering consumer protection are: under another name to
+ the Sale of Goods Act rip people off again, to
+ the Trade Descriptions Act. suggest that these laws are
unnecessary.
1C Consumer law aims to ensure that businesses compete on which two major factors?
Effects of employee protection on business REVISED

□
Employee protection law aims to state and uphold minimum standards of
treatment that employees can expect from their employer. Major issues
covered include:
+ fair pay
+ sick leave

+ maternity and paternity leave
+ employment contracts
+ relationships with trade unions
+ the ability of businesses to get rid of staff
+ the responsibilities of businesses to employees who are made redundant.
Almost all businesses would prefer less protection for staff, since this gives
them greater flexibility in terms of their human resources. Businesses tend
to argue against increased rights for workers, claiming that increased costs
will result and this will make it harder for them to compete with international
rivals. A summary of the effects on businesses of employee protection
legislation is shown in Table 10.4.
Making links
Treating workers in a legal manner should help to meet their safety needs on Maslow's
hierarchy (see page 56).
Table 10.4 implications of employment legislation
Key area of employment law Possible implications for firms

Minimum wage increased labour costs, which may lead to increased automation in the longer term
and increased unemployment; on the plus side, employees may be more motivated
by a fair wage that satisfies their basic needs
Right to a contract of employment Meets employees' security needs but can reduce employers' flexibility in how they
use their staff
increased right to sick, maternity increased cost of paying for cover for these staff; however, staff may feel more
and paternity leave valued as they feel well treated by employers, reducing staff turnover levels, which
saves the costs of recruiting new staff
Redundancy Reducing capacity becomes expensive due to statutory payments to staff who are
made redundant; this can mean that closing a factory or office has a negative impact
on cash flow in the short term
Trade union rights Employers can be forced to deal with a trade union if enough staff are members; this
does bring benefits as well as drawbacks
11 Briefly explain why some employers welcome tighter employee protection laws
and why others would prefer them to be weakened.
Effects of environmental protection on

business r REVISED
□
Given the broadly accepted need to regulate the effect of business on the
environment, a range of legislation now governs how businesses treat the
natural environment. Major areas include:
+ materials that firms must use for certain products
+ processes firms are allowed to use to make certain products
+ the need to use recyclable materials for certain products
+ landfill tax
+ the need to carry out environmental risk assessments for different parts of
a business’s activities.
Once again, businesses tend to resist new, tougher legislation, claiming it will
increase their costs in a way that foreign rivals will not have to cope with.
Much of the recent legislation on the environment came from the European
Union. Now that Britain has left the EU, the UK government have had to
replace many of the EU laws that governed the way UK businesses had to 123
treat the environment.
Effects of competition policy on business REVISED
□
When businesses compete with one another, they tend to keep prices at
a sensibly low level, provide a good service and generate new innovative
products and services. With no competition, prices can be pushed high,
service standards can slip and innovation dry up. Therefore, governments
seek, through legislation, to ensure that there is competition in all markets.
The key legislation is the creation in 2014 of a government-funded body called
the Competition and Markets Authority (CMA). The CMA is responsible for:
+ investigating proposed takeovers and mergers
+ investigating allegations of anti-competitive practices
+ taking legal action against those who collude to maintain high prices
within a market.
Making links
Both environmental and
competition law have their
weaknesses when dealing
with global businesses.
The work of the CMA should, indirectly or directly, ensure that:
This issue is covered in far
+ companies have to set competitive prices
more detail in the section
+ companies do not collude with others in their market to the detriment of
of Chapter 20 entitled
consumers 'Controlling multinational
+ mergers and takeovers that will create overly powerful firms will be corporations'.
prevented.
State two potential impacts on a business of complying with new, tougher

environmental legislation.
3 State two areas the Competition and Markets Authority can investigate.
Effects of health and safety on business r REVISED

□
Health and safety law is designed to protect employees and customers in the
workplace. The major piece of legislation - the Health and Safety at Work Act
1974 - places the burden on employers. Key aspects of this burden are:
+ safe physical conditions
+ precautions that firms are required to take when planning their work
+ the way in which hazardous substances should be treated in the
workplace.
12

Complying with health and safety legislation has both positive and negative
effects on businesses, as shown in Table 10.5.
Table 10.5 Positive and negative effects of health and safety legislation on
businesses
Positive effects on businesses Negative effects on businesses Exam tip

Should prevent incidents that create Extra paperwork
In spite of the fact that
negative publicity
legislation exists to prevent
Should help to motivate employees, who Need to pay for extra safety equipment unscrupulous firms
feel safe stealing an advantage,
Accidents can delay or halt production - Need to pay to adjust physical work illegal practice still occurs.
these should be avoided conditions Although some may argue
that consumers will avoid
The role of the publicly funded body, the Health and Safety Executive, is to these firms, forcing them
find and prosecute companies guilty of major breaches of this legislation. out of business, virtually
no businesses are forced

□ to close as a result of
breaking the laws that
govern business. It can be
14 Which organisation is responsible for enforcing health and safety legislation?
argued that the penalties for
5 Whose responsibility is it to ensure employees work in a safe environment?
breaking the law are simply
Answers available online not harsh enough.
The competitive environment

What effect do rivals have on businesses?
The number of businesses supplying products or services in a market can The competitive
have a major effect on how businesses operate. From monopoly markets environment experienced
with only one dominant supplier to fiercely competitive markets with many by a business refers not just
businesses fighting one another for consumers, business behaviour can vary to how many competitors
dramatically. they face, but how directly
other firms' products are in
Exam tip competition and how fierce
The best exam answers recognise the level of competition within the market, rivalries are.
suggesting courses of action appropriate to the level of competition found in the
market being examined.
Competition REVISED
One dominant business

A market dominated by a single business is bad for consumers because:
+ consumers have little choice
+ prices tend to be high
+ there is little incentive for the dominant firm to innovate or provide great
customer service.
As covered on page 124, governments generally try to prevent monopolies
occurring to prevent consumers suffering.
However, companies strive to become an effective monopoly. A key focus A monopoly is a single
of this activity is trying to build barriers to entry that prevent new firms business that dominates
entering the market. Examples of possible barriers to entry include: supply in a given market.
+ patents and technological breakthroughs
+ incredibly strong brands and high advertising budgets
+ heavy spending on infrastructure (such as mobile phone network masts).
25

Competition between a few giants
In an oligopoly market, rivalries are intense, as it is clear that in most cases An oligopoly is the
one firm can only gain market share by directly taking it from one of just a name given to a market
handful of rivals. dominated by just a few
Given the intense rivalries, it may appear odd that companies in an major suppliers.
oligopoly rarely compete on price. The reason is that they fear a price war
would start, leading to lower profit margins for all in the industry. Instead,
non-price competition exists, focusing competition on aspects such as
those in Figure 10.2.
Figure 10.2 Aspects of non-price competition
The fiercely competitive market

+ These markets tend to be characterised by many small businesses
competing with one another, often on the basis of price.
+ This keeps profit margins low and ensures consumers usually get a bargain.
+ However, a business that is able to find an effective method of
differentiation within a fiercely competitive market will stand a far better
chance of success.
+ Many of these markets tend to be for commodity products which, by
definition, are hard to differentiate.
+ For businesses selling these, there may be little choice of strategy other
than keeping costs as low as possible in the hope of undercutting rivals’
prices and still making some profit.
Making links
When assessing the
16 What name is given to a market dominated by just a few large companies? attractiveness of a new
State two reasons why monopolies tend to be bad for consumers. market, the level of
competition will be an
List three methods of non-price competition.
important issue. This links
Answers available online well with Chapter 18.
Market size REVISED
Big markets
Larger markets, even those with a few fairly dominant firms, offer scope for
new competition, usually through carving out a niche. Therefore, in a large
market there is likely to be a fair degree of competition. This is likely to keep
even dominant producers from becoming complacent, as they recognise the
need to offer good service to prevent opening an opportunity to a rival.

Small markets Making links
In a smaller market, with fewer customers and lower sales, it may be easier to
There is another whole
build up barriers to entry, carving up the market between a few businesses.
section in the second year
work (at the end of Chapter
Markets whose size is changing 11) on the competitive
Markets tend to grow or shrink over time. Predictably, the direction of this environment, in it, Michael
change in size will affect the level of competition: Porter's framework for
+ Growing markets ... attract new entrants ... seeking higher profits on offer. analysing the attractiveness
of a market is explored -
+ Shrinking markets ... see established firms exiting... as profitability tends
certainly a model you
to be low, they are unattractive.
should seek to use when
assessing a market's
Collusion competitiveness.
Through desperation or deliberate cunning, companies trying to survive in a
really tough competitive environment may be tempted to behave illegally. It
is easy to understand why a desperate business may be willing to break the
law in this way. It is harder to see it as a sensible choice, given the strength of
anti-collusion legislation in the UK. Collusion occurs when two
or more rival businesses
□ agree to fix supply or prices
within their market. This is
19 What is meant by a barrier to entry? illegal.
Exam practice
Evaluate whether uncertainties in the current external environment in the UK mean that
business success is, more than ever, down to luck rather than good decision-making. [20]
Summary
+ The major economic changes that can affect + competition law
businesses are: + health and safety.
+ the business cycle + Most changes to the law lead to an increase in costs
+ government spending and taxation for a business.
+ inflation + The competitive environment faced by a business will
+ exchange rates affect its strategy.
+ interest rates. + The number of firms in a market affects the degree of
+ Economic change is a source of great uncertainty for competition.
business decision-makers. + The size and growth rate of a market affect the degree
+ There are five main areas in which the law can affect of competition.
businesses: + Firms can compete on price and non-price aspects,
+ consumer protection including branding, advertising, product features,
+ employee protection design and innovation.
+ environmental protection
Exam skills
+ There can be a tendency to ignore the fact that all instead of producing a dull response to a question,
business activity takes place in a dynamic environment, which seems to have ignored many of the challenges
where a multitude of factors outside the control of a facing the business.
business can determine their success or failure. When planning answers, you should consider the likely
+ Once more, the importance of the context presented in impact of external influences alongside any internal
an exam paper must be recognised. issues that you want to work into an argument, and
+ Hints within a case study about economic conditions ensure that you show the examiner how these may
or clues as to the competitive environment within an influence a firm and the decisions you are asked to
industry, may well offer you the chance to build an contemplate in your answer.
answer around the most relevant factors in this case,

11 Business objectives and strategy
Corporate objectives
What the whole business is aiming to
achieve
+ A sense of direction or a clear target provides focus for any activity. Corporate objectives are
+ Productivity and co-ordination can be enhanced if staff know how their targets set for the whole
jobs will help the firm achieve its goals. firm to reach in a given time
+ All businesses are likely to have corporate objectives. period.
+ These may be specifically stated and measurable targets or, more likely
for small businesses, be implicit from the entrepreneur’s behaviour and
priorities.
Corporate aims r REVISED

□
An aim provides a general sense of what is to be achieved. The key benefit to
having a clear aim is the sense of purpose and drive that the aim can bring Exam tip
to day-to-day tasks. If everyone in a business is aware of what the firm is Corporate aims can help to
trying to achieve, they will be more driven to achieve their part of that whole. explain unethical business
Typical corporate aims could include: behaviour. An employee
+ growth who has understood that
+ maximising profit the business's primary aim
+ entering new markets is to maximise profit may
+ surviving the first two years of being in business persuade a customer to buy
+ improving the communities in which they operate. a product or service she or
he doesn't really need, in
Focusing on any one of these would help employees to understand what
order to boost profit. Many
factors should be prioritised when making decisions. This should allow financial products have
decisions to be made quickly, without the need for lengthy consultation with been sold in this way.
senior management.
Mission statements ' REVISED

□
+ If employees can be convinced to ‘buy into’ a business’s mission, they are
likely to find sufficient motivation from trying to achieve this purpose, Mission is the underpinning
purpose behind the
without the need for extra motivational techniques.
existence of a business.
+ For example, staff working in the NHS will often put up with less than
ideal working conditions and sometimes poor pay, yet still remain driven A mission statement is
in their jobs, because they believe in the mission of the NHS: to provide a catchy summary of the
high-quality medical care for all. reason why a business
+ Mission can be thought of as the reason why a business exists, exemplified exists.
by Google’s mission to ‘organise the world’s information and make it
universally available’. This is a noble goal that can give staff a genuine
sense of purpose, explaining, without the need for extra management
input, why they are doing their job and why their job is worthwhile.
+ Though mission can be a woolly concept within an organisation, many
businesses will attempt to produce a short statement that summarises
their mission: a mission statement.
+ A mission statement can be communicated widely within the business,
and even shared with other stakeholder groups, notably customers. The
mission statement can help to remind staff what, in a nutshell, they are
aiming to achieve on behalf of their employer.

Explain the difference between corporate aims and mission.

Business objectives and strategy

Influences on business mission r REVISED
□
Major factors affecting the actual sense of mission created within a business
Making links
are:
+ Purpose: Why the business exists - likely to be rooted in the founder’s Mission is a key determinant
beliefs. of business culture -
+ Values: What the business believes in doing, and guiding principles behind considered in Chapter 14. A
how it should be done. strong sense of mission or
+ Standards and behaviours: The way that people in the business actually purpose can create a strong,
act, both towards others in the business and towards stakeholders. positive culture, while a
Behaviours of managers are likely to have a very strong influence over the lack of purpose may create
behaviours exhibited by their staff. These can be thought of as the DNA of a culture characterised by
77
the company’s culture. uncertainty and contradiction.
Limitation of mission statements REVISED

□
Although a mission statement can bring benefits, suggested above, it is
vital to understand the limitations of simple words. The power of a mission
statement is to encapsulate the sense of mission shared by staff, and to act as
a focus. If there is no shared sense of purpose, a collection of words will not
create that purpose for employees.
Exam tip
Standards and behaviours in particular can be the root cause of a business acting
in a way that does not seem to reflect its founding purpose or stated values, if staff
copy managers behaving in a way that seems to follow some other goal, such as
maximising profit, what the business actually does may seem very different from its
stated mission. In some schools, teachers are placed under such pressure for results
that they may feel expected to push regulations relating to coursework or controlled
assessment.
Now test yourself *
2 State four factors that may influence a firm's mission.

3 Briefly explain why a sense of mission can be a powerful advantage to any
business.
Corporate strategy
The overall plan for the business’s future
+ Strategy can be thought of as the plan for achieving objectives. So, a
A corporate strategy is a
corporate strategy refers to the overall plan that a business chooses to
medium- to long-term plan
follow in order to reach its overall objectives.
for achieving the corporate
+ Strategic decisions are large in scale and hard to reverse, so a corporate
objectives.
strategy will address major issues for a firm for the medium to long term -
perhaps most significantly, what to sell and who to sell to.
+ Strategy should not be devised in a vacuum. A successful strategy should
consider two broad sets of influences, as shown in Figure 11.1.
129

+ At the heart of any corporate strategy will be the product portfolio. Typical mistake
Portfolio analysis, using the Boston Matrix (see Chapter 3) is used to assess
the existing product portfolio. Student responses to
answers asking for advice
Strategy on 'the best strategy’ can
I
fall victim to ignoring one
or both of these major
influences on strategy.
The best strategic
recommendations will
Firm's Firm's always make clear how the
strength(s) environment strategy plays to a firm's
strengths and addresses
the external environmental
conditions faced by the
business.
Figure 11.1 If a strategy is to achieve the objectives set, it must match the firm's
strengths to its competitive environment
+ A successful strategy must find a way to use the firm’s strength^) to

meet the conditions presented by the external environment faced by the
business over the coming years.
Distinguish between corporate strategy and corporate objectives.

Porter’s (Generic) Strategy Matrix REVISED
Michael Porter’s Generic Strategy Matrix provides advice to any business on

the potential routes to choosing a successful corporate strategy. Porter sees
this as a crucial element in achieving a long-term competitive advantage.
Lowest-cost Highest
operator differentiation
Mass
market
Low cost Differentiation
Focused Focused
low cost differentiation
Niche
market
Figure 11.2 Porter's (Generic) Strategy Matrix
The matrix shows the four major strategic choices that Porter suggests
can lead to long-term success. The key issues to consider when analysing
a company’s strategy are whether it is selling to a mass or a niche market
and how it tries to achieve product differentiation - either through being the Product differentiation
lowest cost operator or having a significant point of differentiation. describes a business's
attempts to make its
product stand out from
Porter’s low-cost strategy those of rivals, perhaps
+ Being sufficiently efficient in your operations allows a business to be able through marketing, design
to undercut rivals on price and still make a profit. or quality.
+ The key to successful cost leadership is likely to lie in harnessing an
operational advantage, such as better economies of scale than rivals or
higher productivity in factories than anyone else can manage.

+ To be effective in the long term, the low-cost strategy must be based on an
Typical mistake
advantage that rivals cannot easily copy, so outsourcing to China may not
prove the heart of a successful low-cost strategy, as that is relatively easily Low cost does not
copied. necessarily mean lowest
price. Having the lowest
Making links costs in an industry does
give firms the chance to
The key to a successful low-cost strategy is likely to be efficient management of charge a lower price than
resources - as considered in Chapter 9. rivals while remaining
profitable. But a low-cost
strategy may be a success
Porter’s differentiation strategy because a firm can charge
Differentiation works. The challenge is to find a way to differentiate the average market prices with
product which is: higher profit margins than
+ Cost effective: Adding features that cost more to add than a consumer is any rivals.
willing to pay is not profitable.
+ Sustainable: A method of differentiation that lasts is the key: doing
something to a product that rivals can quickly copy will not provide long Exam tip
term success. when considering a case
Although branding and image-building marketing methods can provide study featuring a business
successful, protectable sources of differentiation, these are not the only trying to use a strategy of
methods. Great design or amazing customer service can differentiate a differentiation, consider
business just as effectively through the work of the operations management carefully whether its
function. point of differentiation is
something that will appeal
to consumers and whether
Making links it is hard for competitors
The concept of product differentiation was first examined in Chapter 1, which explored to adapt this, destroying
the importance of meeting customers' needs. their differentiation. If the
point of differentiation is not
appealing to customers or
Focused low cost is easily copied by rivals, it
serves no purpose.
A strategy that focuses on a niche market and succeeds in being the lowest
cost provider within that niche can also bring success. Here, the key is less
likely to be cost reduction through economies of scale and more likely to be
based on operational efficiencies and high productivity levels. Making links
Remember the benefits
Focused differentiation and drawbacks of niche
marketing covered in
Successful differentiation within a niche market can also lead to long-term
Chapter 3.
success, generally with a very high-margin, relatively low-volume business
model.
Competitive advantage through distinctive

capabilities REVISED
□
A business that is clear on its core strengths has the beginning of a successful
route to long-term strategic advantage. If core strengths, such as an
innovative R&D department, hugely committed staff or creative marketing
department can be used to provide a competitive edge over rivals, then these
can be the basis of long-term success.
Exam tip
A distinctive capability need not be quite so obviously related to a business function
as those listed above. A business that has a proven track record of reacting quickly
to changes in the market, or one that has shown it learns well from mistakes, can
build a competitive advantage around these attributes. Look for evidence of 'softer'
capabilities such as these when analysing a business case study.
31

5 State three methods of differentiating a product.

6 Briefly explain why a company choosing a low-cost strategy may earn high
margins, when rivals struggle to break even.
• AnsofPs Matrix______________________
• A helpful tool for devising a corporate strategy
• Strategic direction REVISED
□
• Few decisions are more fundamental in business strategy than:
• + What products do we sell?
• + Which markets should we target?
Making these decisions sets a firm’s course for the medium to long term and
adjusting these choices is likely to take a long time and affect the whole of
the business. Therefore, these are considered to be the major choices made in
choosing the strategic direction a firm will follow with its corporate strategy.
Strategic direction and Ansoff’s Matrix r REVISED

□
Business academic Igor Ansoff devised his strategic matrix to show the major Exam tip
choices open to a business considering its strategic direction, and to highlight
the level of risk involved in each choice. When using Ansoff's Matrix
to analyse a company's
Existing Products New
strategic choice, focus your
argument on the level of
Existing
risk associated with the
Market Product choice and explain carefully
penetration development why the risk is relatively
high or low.
Markets
Market Diversification
development
New
Increasing risk
Figure 11.3 Ansoff's Matrix and risk
The level of risk is lowest in the top left-hand corner of the matrix, rising
as a company’s choices move further away, with the highest level of risk
associated with the bottom right corner of the matrix, representing extreme
diversification.
Market penetration
The commonest and lowest risk strategy involves boosting market share
through selling more of the same product to the same target market. Methods
for doing this include:
+ finding new customers within the target market
+ taking new customers from competitors
+ increasing usage of the product among existing customers.
Risks are low as the company is still operating on familiar ground with tried
and tested products.

Market development
+ While still selling existing products, the business now aims the products at
new markets.
+ This can be done most obviously by looking for new geographical markets,

often breaking into foreign markets, or by repositioning the product to
aim at a different type of customer, as Land Rover has done, moving from
targeting farmers to wealthy city dwellers.
+ The major risk factor here is that the company may not understand
consumer behaviours in the new market they are entering.
+ Although market research can help to reduce this risk, even thorough
research is unlikely to equip a firm with the depth of understanding of
consumer behaviour possessed by established rivals in these new markets.
Making links
Chapter 1 examined some of the problems of conducting valid market research -
a real challenge when entering a new market. You should also recognise that
entering a new international market should be based on a careful assessment of its
77
attractiveness - as explored in more detail in Chapter 18.
Product development
+ The new feature here is the product. A business choosing product
development as its strategic direction will still be selling to current
markets, so is likely to have a sound understanding of customers’ needs,
wants and preferences.
+ However, the plan will be to sell new products to these customers.
+ Developing new products successfully is tough; there are so many
reasons why new product launches can fail, from design problems to
manufacturing issues to, most commonly, a failure to actually meet
customers’ needs.
New products can either be making changes to an existing product or
developing and launching brand new products.
+ Changes to an existing product can be slightly lower risk, although adding
new features or ingredients can still backfire.
+ Developing and launching brand new products presents more hurdles and
thus involves greater risk.
Now test yourself HHH|| I R /"' v /*■ BB B| .
What are the main dangers of:

) market development
b) product development?
Diversification
+ Ansoffs Matrix highlights the dangers involved in attempts to diversify.
+ A business choosing this strategic direction faces the problems of product
development and market development combined.
+ Selling new products to customers of whose tastes you have no experience
is likely to be very tough to do successfully.
+ Diversification can, however, bring exceptionally high rewards. Diversification, as defined
+ As is normally found in business, higher risks are associated with the by Ansoff, means selling
potential to achieve higher rewards if the risks can be successfully new products to new
managed. markets.
33

Table 11.1 Risks and rewards in different strategies
Risks Rewards
Market penetration + Few risks should arise, other than decline + You know the customers and the
in the product life cycle competitors, so should make error-free
0) •
+ Lack of ambition may make your best staff decisions
look for more challenge elsewhere + Returns on extra investment will be
tn predictable
Market development + Subtle cultural differences add hugely + There are huge potential economies of
to risk, e.g. many UK retailers who have scale if your product succeeds elsewhere,
</) •
flopped in the US e.g. Fever-Tree
+ Practical differences matter too, such as + If you take the time to understand the
distribution channels, consumer legislation cultural differences, you may be able to
and differences in managing staff localise your product range effectively, as
McDonald's does
tn
tn Product development + Most new products fail (at a rate of about + As shown by Apple, nothing adds value
O
6/7 in the UK) so the risk level is very high and creates differentiation more than
</) + Because new product success is tough, innovative product development
m companies put their best people on it; this + Continuous, successful product
can mean too little brainpower devoted to development should mean the organisation
ordinary brands (or, in Tesco's case, its UK lives forever
supermarket heartland)
Diversification + Not knowing the market and having a + When diversification works, it can
brand new product means the risk level is transform the size of and opportunities for
multiplied by two the business, e.g. Apple in the era since
+ Therefore, it is vital to plan for the the iPod breakthrough
operational risk of diversifying by making + Radical diversification (Virgin Galactic
sure your financial position is especially space travel) can be hugely exciting for the
secure workforce, helping you recruit the best
Typical mistake
Just as many failed leaders have learned in the past, defining the market in which a
business operates is key to using Ansoff's Matrix successfully. Assumptions about
products or markets being similar to existing ones lead to a failure to understand the
risks involved in straying from existing products and existing markets.
Draw a properly labelled diagram of Ansoff's Matrix (remember to label the axes).
Briefly explain how Ansoff's Matrix illustrates the risk involved in different choices
of strategic direction.
SWOT analysis
A structure for analysing a business’s
current position
Purpose F REVISED
□
+ If a good corporate strategy involves matching a business’s strengths
SWOT analysis identifies
to the external environment within which it is operating, an analytical
a business's Strengths and
framework that picks these out has to be a helpful strategic tool. Weaknesses along with the
+ A SWOT analysis sets out to gain a full understanding of what a firm does Opportunities and Threats
well and badly and what major issues it must address in the future. It is, it faces.
therefore, a framework used to help begin the process of strategic planning.

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How to conduct a SWOT analysis REVISED
□
Top-down approach

This method tends to use external management consultants working directly
with the boss of the business.
Table 11.2 Benefits and drawbacks of a top-down approach to SWOT analysis
Benefits Drawbacks
+ A dispassionate approach to identifying Managers may fail to share all necessary
strengths and especially weaknesses. information with those conducting the
+ Detach ment from the com pany cultu re SWOT analysis in an attempt to present
may allow aspects of the business to be their area of responsibility in a more
seen in a new light. favourable light.
Consultative approach
A boss who takes the opportunity to travel around the business can conduct
a more thorough analysis about what works well and less well within the
77
business. They can do this by engaging in conversations with those who
understand each aspect best, albeit perhaps more slowly than consultants.
Table 11.3 Benefits and drawbacks of a consultative approach to SWOT analysis
Benefits Drawbacks Exam tip

+ Greater insight from a wider range of Staff may be even less willing to point
Consider how the SWOT
contributors. out problems if they feel this will reflect
analysis has been
+ The chance for the boss to gain first badly on the leadership of the person
conducted before assessing
hand understanding of the whole they are talking to.
just how reliable its results
business.
are. If a case study suggests
a top-down approach has
Making links been taken, it is worth
considering whether the
The method used will depend on the leadership style (Chapter 4) within the business, SWOT analysis will have
with an autocratic or paternalistic leadership favouring a top-down approach, and a really revealed all of the
consultative approach far more likely with a democratic management style. internal problems.
Now test yourself
0 What are two broad ways in which a business may carry out a SWOT analysis?
Internal considerations: strengths and

weaknesses F REVISED
□
+ The skill in identifying strengths and weaknesses for a business is in
picking out the areas that really matter to the business’s performance. Key performance
+ This is something of an art form, as many managers who focus simply on indicators (KPIs) are
financial data may miss a ‘softer strength’ on which a future strategy may quantifiable measures of
be based. aspects of a business's
+ However, a key part of ensuring a robust identification of strengths performance that the
and weaknesses is to focus the analysis on a few key performance business considers to be
indicators (KPIs). the main determinants of its
commercial success.
35

Examples of commonly used KPIs are shown below:
Figure 11.4 Examples of key performance indicators (KPIs)
If compared with industry rivals and/or previous years’ figures, these KPIs
can offer clear statements of strengths or weaknesses.
Typical mistake
Be careful not to consider external factors, such as a growing market, as a strength.
Strengths and weaknesses are internally controllable factors; operating in a market
which is growing simply represents an opportunity to boost sales in an existing market.
External considerations: opportunities

and threats A
REVISED
□
The external environment in which a business operates is subject to
significant changes. Few changes leave a firm unaffected. Therefore, in order
to understand the situation in which it is operating, it is vital to include
an assessment of the external environment. This is done by assessing the
opportunities and threats brought about by the environment. Key areas to
consider when looking for opportunities and threats include the following:
Demography
+ Changes to the population, especially in its structure, could be relevant.
Britain’s increasingly ageing population offers opportunities to sell to
more retired people, while the effects of immigration have opened up new
market niches for some UK businesses.
+ These issues can simultaneously represent threats to businesses that fail
to find a way to turn these changes to their advantage.
New laws and regulations

Changes in laws and regulations can open up opportunities or make existing
products obsolete overnight. The introduction of a sugar tax on soft drinks
had a significant impact on manufacturers. Perhaps even bigger still will be
changes to UK law necessitated by Britain’s departure from the EU.
Technological factors
A further source of both opportunity and threat is changes in technology. For
those who drive technological change, the factor tends to be an opportunity
seized, but for some businesses, a change in technology can destroy sales of
now outdated products within a matter of months.

Competition
The actions of competitors may represent either a threat, or, if their actions
are ill-judged, an opportunity. Porter’s Five Forces model, covered later in this
chapter, explores the nature of the competitive environment in far more detail.
Commodity prices
+ As commodities tend to be a basic building block of so many products, Commodities are
movements in their prices on international markets are likely to have basic goods, traded
direct effects on a firm’s manufacturing costs. internationally, and
+ Perhaps oil is the most significant commodity price given its use in are generally basic,
creating most plastics, plus its use in the transport sector. unprocessed raw materials
+ Although increasing commodity prices may seem to be a threat and falling such as oil, copper, wheat
prices an opportunity, this is not true in all cases, as shown in Table 11.4. or cocoa.
Table 11.4 Commodity threats and opportunities
A threat for... An opportunity for...

A rise in oil prices Airlines, as the cost of fuel rises A supplier of alternative energy
A rise in wheat prices Bread manufacturers, as input costs rise Porridge manufacturers, as consumers
switch to non-wheat breakfast options
A rise in the price of copper Plumbers, whose material costs rise Mining companies, who get more for the
copper they mine
Economic factors
Changes in the whole range of economic variables will affect a business’s
operations. Depending on the direction of the change and the business
being considered, changes in the variables below could represent either an
opportunity or a threat.
Exam tip
When assessing the effects
of economic changes
on a business's external
environment, don't forget to
use tools learned in the first
year of your course to help
Figure 11.5 Major economic variables
you understand the impact,
notably income elasticity.
For more detail on this see Chapter 12.
Influencing opportunities and threats 1 REVISED

□
Though, by definition, no business can control its external environment,
Lobbying describes the
governments can make decisions that either directly (new laws and
process of directly trying
regulations) or indirectly (economic policies) affect the external environment
to influence key political
faced by businesses. Therefore, large businesses in particular use lobbying of
decision-makers to act
MPs to try to ensure that government policies provide opportunities or at least
in the best interests of a
offer only minimal threats. business.

1 State three common KPIs used by businesses to assess strengths and

weaknesses.
objectives and strategy

State three common areas of external environmental change that may represent
opportunities or threats to a business.
Impact of external influences

How factors outside a business’s control
affect the business
11 Business
In order to better understand the external environment within which a firm
is operating, it may carry out a PESTLE analysis. This acronym sets out the six
main areas of external influences:
+ Political
+ Economic
+ Social
+ Technological
+ Legal
+ Environmental
This structure can be a helpful way to ensure that no opportunities or threats
are overlooked when compiling the SWOT analysis.
Political factors REVISED
Decisions made in the political arena can affect businesses’ fortunes.

Government policies encouraging investment in infrastructure or exports can
represent significant opportunities to some firms.
However, without a doubt, the most significant political factor that affects UK
businesses, and will continue to affect them for the foreseeable future, is the
decision to leave the European Union. The impact of this decision will affect
businesses in a huge number of ways that could include:
+ harder to access EU markets
+ harder to fill lower-paid job vacancies without free movement of labour
from other EU countries
+ more expensive imported materials due to the reduction in the value of
the pound
+ less direct investment to the UK from foreign multinationals
+ EU laws will need to be replaced, which may allow the UK Parliament to
relax legal responsibilities placed on firms in areas such as employment
protection or environmental standards
+ a weaker pound may make exporting to non-EU markets easier for
businesses that have previously only traded domestically
+ UK businesses will find it easier to compete on price with more expensive Exam tip
foreign imports due to the exchange rate shift.
Be careful to ensure that
The media are likely to be reporting on the effects of Brexit on a daily you support arguments
basis over the next few years. It is important to stay abreast of current relating to Brexit with
developments. data and evidence. Such
a hotly debated political
Making links issue tends to encourage
assertions with no
Chapter 17 - Globalisation - includes a whole section on trading blocs, allowing you
justification from case study
to understand more fully the theoretical pros and cons of groups of countries such as
material provided.
the EU.

Now test yourself
3 State two possible positive and two possible negative effects of Brexit for British
firms.
Economic factors r REVISED

□
+ Perhaps the most widely significant external environmental factor faced
by businesses is the state of the economy.
+ The link between economic growth and average incomes does tend to
have an impact on sales of most products, dependent upon their income
elasticity.
+ However, it is important to remember that while economic gloom may
be a threat for many businesses, for others it can represent a significant
opportunity to grow.
+ For example, discount stores such as Poundland and supermarkets Aldi
and Lidl have seen significant growth in the last few years as average
incomes in the UK stagnate and consumers become more price sensitive.
Other economic factors to be assessed include:
+ The exchange rate: This impacts not only on exporters, but also on
businesses that sell imported products, or use imported components or
materials. Meanwhile, for those who compete against these firms without
using imported supplies, exchange rate movements will also have an
indirect effect.
+ The rate of inflation: As it rises this tends to cause uncertainty and lead to
reductions in investment and decisions to expand.
+ The rate of unemployment: This is where a rise will reduce average
incomes but make it easier to recruit staff without needing to offer high
wages.
Social factors REVISED

□
Changes in social attitudes and behaviour frequently relate to lifestyle. Trends
such as:
+ greater consciousness over the need to eat healthily
+ changed attitudes to smoking
+ an increased desire for convenience and speed of service
+ an ageing population
can represent both opportunity and threat to different firms. While some will
find their products becoming less desirable as society changes its attitudes,
others will see the chance to cater to new lifestyle choices. Of course, a
business practising effective strategic planning that sees a change damaging
sales of one product may be able to launch new products specifically designed
to cater for new tastes.
Making links
Social as well as economic and legal factors will play a key part in assessing the
attractiveness of new international markets, as explored more in Chapter 18.
Technological factors 1 REVISED

□
+ Changes in technology (not just information technology, but new scientific
endeavours in any field) can affect businesses in a range of ways.
+ Technological changes can allow new ways of making existing products,
lowering costs, improving quality, reliability, durability or recyclability.

+ Technological change can also allow the development of brand new
products, similar to existing ones, such as electric cars, or the launch of
really new product concepts, such as fitness trackers like the Fitbit watch.
+ Generally, businesses that develop these new technologies, or harness

them early, will be able to see technological change as an opportunity.
+ For those without access to the technology, or whose competitors
introduce the technologies earlier, these changes are likely to represent a
threat.
Making links
Technological change can be a great opportunity if a business can get its design mix
right - as covered in Chapter 3.
Legal factors ' REVISED

□
11 Business
Passing new laws can, once more, disrupt existing industries, forcing
businesses to change the way they make products or the materials they
use, or even banning certain products. Firms directly affected by such legal
changes will face a strategic challenge as to how to turn what appears to be a
threat into an opportunity.
Environmental factors REVISED

□
+ Environmental pressures, applied to businesses to ensure that their
operations do not have a harmful impact on the natural environment,
are generally seen as a threat, since mostly businesses are encouraged to
change their methods of operating.
+ However, many businesses see improving their environmental impact in
the light of environmental pressures as an opportunity.
+ This can be brought about by adopting more efficient methods that also
reduce costs or through using the business’s environmental record as a
point of differentiation from rivals.
Typical mistake
Do not always consider that tightening environmental regulations and legislation
represent a threat to all businesses. They could lead to certain niche markets growing,
thereby offering an opportunity.
What to do about external influences REVISED

□
+ Make the most of favourable external factors while they last: An external Making links
change that works in a business’s favour should be capitalised upon, giving
the business time and money to help prepare contingency plans in the The importance of scenario
event that the factor moves against them. planning is further explored
+ Minimise the impact of unfavourable external influences: This can be in Chapter 16.
through adjustments to controllable aspects of the business’s performance,
so it could cope with a negative exchange rate movement by considering
shifting factory location.
14 What does PESTLE stand for?

5 which aspects of a swot analysis does pestle help to develop?

The competitive environment
Exploring how the nature of competition in a
market impacts a business
The importance of the structure and nature of competition within a
business’s market was introduced in Chapter 1. In the context of studying
corporate strategy, this theme is developed by considering a framework
commonly used for analysing the attractiveness of the competitive
environment for businesses.
Porter’s Five Forces 1 REVISED

□
+ Michael Porter (the same one famed for his Generic Strategy Matrix)
offered a structure for conducting analysis of a business’s competitive
environment.
+ The matrix identifies five key aspects of the competitive environment that
affect a firm’s likelihood of long-term success.
+ Once a business has assessed how favourable each force is in the
particular market in which it operates (or plans to enter), it should be
better placed to decide just how attractive that market really is.
Exam tip
Using Porter's Five Forces
as a way to help you
understand the position in
which a company finds itself
is a sensible idea. Not only
will examiners be impressed
with your knowledge of the
model, but also you should
Figure 11.6 Porter's five forces gain good insight as to the
Source: Michael. E. Porter, 'The Five Competitive Forces That Shape Strategy', Harvard Business challenges faced by the
Review, January 2008 business.
Rivalry among existing competitors r REVISED

□
At the heart of Porter’s Five Forces is the intensity of rivalry between competitors
in the industry. Profitability is more likely where rivalry is less intense.
Table 11.5 Characteristics of markets where rivalry is low and high
Where intensity of rivalry is low Where intensity of rivalry is high

+ A few companies dominate the market + Many competitors of roughly equal size
+ Branding is very important to consumers + Products are relatively undifferentiated
+ Booming market gives opportunities for all + Market growth is slow
+ Little spare capacity + Capacity utilisation is low
+ High barriers to entry, e.g. a new Chinese aeroplane + Low barriers to entry, so it is cheap and easy to
facing consumer credibility issues enter the market
+ No direct competition from abroad, e.g. 'bricks' + Directly faces overseas competition, e.g.
retailing such as retail petrol manufactured goods and some services

+ Where the intensity of rivalry is high, pressure to maintain a low price and
thus keep costs low enough to still make a profit is great.
+ Those companies which are unable to keep their costs under control are
likely to disappear.

+ Where rivalry among competitors is less intense, non-price competition on
marketing, branding or innovation is more likely - offering scope for some
firms to survive without necessarily going through the pain of continually
looking for the efficiency gains that bring cost reductions.
Making links
The level of competition in a market was first explored in Chapter 1. This will have a
clear effect on the level of rivalry among existing competitors.
Threat of new entrants REVISED

□
11 Business
The danger of new companies entering the market, thus creating extra
competition, is largely dependent on the existence of barriers to entry. Barriers to entry are
factors in a market that
Typical barriers to entry include: can make it hard for new
+ patents and technical knowhow of staff companies to break into the
+ strong brand identity and customer loyalty market.
+ high costs to customers of switching supplier
+ substantial network infrastructure (such as physically building the masts
and cabling needed to construct a mobile phone network).
If the threat of new entrants is low, companies in the market may be able
to keep prices relatively high, enjoying strong margins, without the need to
worry about new rivals entering the market and undercutting them.
State three typical barriers to entry that may reduce the threat of new entrants.
Changes in the buying power of customers REVISED

□
+ When the power in any bargaining between a business and its customers
shifts in the customers’ direction, this can be unfavourable to the
business.
+ A company that sells its product to many individual customers is likely to
find this force favourable.
+ However, for businesses that sell their product to just a few large
customers, a threat from one of them to stop buying unless they are
offered a discount may be too grave to ignore.
+ If customers merge, or take over other customers, this will shift this force
against the business.
+ Customer power is reduced significantly in contexts where a business’s
product is complex or such a major investment that customers may not be
able to afford to change the firm they buy from.
Changes in the selling power of suppliers r REVISED

□
At the other end of the business lies its relative power when dealing with
suppliers. If the power in this relationship shifts towards suppliers, this is bad
news for the business and its future profitability. Factors affecting supplier
power include:
+ number of alternative suppliers available
+ uniqueness of supplier’s product or service
+ reliance of the business on technical support from their supplier.

Making links
For more information on mergers and takeovers - a key driver of buyer and supplier
power - check Chapter 12.

Threat of substitutes REVISED
□
+ Whereas Porter’s threat of new entrants considers the risk of a new firm Typical mistake
entering our market, the threat of substitutes considers the chances that a
product or service in another market may become seen by customers as a Do not confuse this force with
viable substitute for our product. the threat of new entrants.
+ For example, while airlines offering domestic UK flights from London to The threat of substitutes
Manchester or Scotland may enjoy a time advantage over other forms considers the threat posed
of transport, building a high-speed rail link to speed up train times on by indirect competitors,
rather than companies selling
longer domestic journeys may transform rail travel into a viable substitute
exactly the same type of
considered by those needing to make rapid domestic journeys within
product or service.
the UK.
77
How the five forces shape strategy REVISED
□
+ The use of Porter’s Five Forces model may identify changes in the balance
of one or more forces against the business. In these cases, the business can
look to produce a strategy that addresses this issue before it causes the
firm major problems.
+ For example, if a company considers that the power of suppliers is
increasing, they may be tempted to take over a supplier, to shift that force
right back into their favour.
+ Above all, Five Forces analysis should be seen as another model to be used
to help to analyse a business’s situation.
+ Using the Five Forces as a framework to analyse a company’s competitive
position in its markets should help to ensure that strategic decision
making is wiser, and more effective.
Now test yourself .
17 Briefly explain why Porter's Five Forces model should be used on a regular,
perhaps annual, basis by sensible firms.
If a business is to be profitable, state which forces it would like to be high and
which it would prefer to be low.
Exam practice
1 To what extent are methods of analysing a company's regulations, stalling economic growth and intense rivalry
position, such as SWOT, PESTLE or Porter's Five Forces, among existing rivals in the UK market, the decision has
of limited value due to the increased speed of change been made to launch the product in three European
in markets such as mobile phone handsets and other markets: Austria, Germany and Switzerland. With no
consumer electronics products? [20] experience of operating abroad, N and N Ltd plan to
conduct thorough market research in these markets.
N and N Ltd have experienced great success since
launching a new range of remote control toys ten years 2 a) Explain why Ansoff would consider N and N Ltd's
ago. Priced a little above the market average, these strategy as riskier than remaining in the UK. [4]
toys used recycled materials and completely recycled b) Assess how weak economic growth and intense
packaging. This allied to the company's mission 'to enrich competition among UK rivals might affect N and
the lives of children while improving the environment'. N N Ltd. [10]
and N Ltd has taken the decision to pursue an objective of c) Assess the importance to N and N Ltd of
growth. The strategy they are considering is to maintain maintaining the clear sense of corporate mission
their point of differentiation as the most environmentally that led to their initial success. [10]
friendly supplier of remote control toys. However, as
a result of a range of external factors, including new

Summary
+ Mission explains primarily to staff why a business + SWOT considers both internal strengths/weaknesses
exists, creating a shared purpose. and external opportunities and threats.
+ Corporate aims provide a general statement of + PESTLE is an analytical framework that focuses on a
0) • direction for a business. business's external environment, using the following
+ Corporate strategy is the plan a company devises to headings:
c/> • achieve their corporate objectives. + Political
+ Michael Porter's Generic Strategy Matrix shows four + Economic
potentially successful strategic choices available to all + Social
</) • businesses: + Technological
+ low cost + Legal
+ differentiation + Environmental.
+ focused low cost + Another method of considering a firm's competitive
+ focused differentiation. position is Porter's Five Forces analysis.
c/) + Porter's strategies focus on the need to develop a + Porter's Five Forces are:
c/) distinct capability as a long-term source of competitive + competitive rivalry
O
advantage. + threat of new entrants
</) + Ansoff's Matrix clarifies key choices in deciding on + buying power of customers
3
m • strategic direction. + selling power of suppliers
+ The matrix highlights the choices of market and + threat of substitutes.
product faced by a business. + Where all Five Forces are in a business's favour, the
+ SWOT analysis is a framework used to help inform business is likely to be highly profitable.
strategic planning.
Exam skills
+ The need to recognise context when addressing a + It can be hard, at times, to decide on a definitive
question is made clear throughout this chapter. From answer in a business exam, but the underlying
the need to set achievable objectives, through devising determinant of whether a new plan or course of action
a corporate strategy that fits the external environment is right or wrong should be its success in achieving the
faced by the firm, context rules. business's corporate objectives.
+ Perhaps most notably when making judgements in + Use this idea as the heart of judgements that you make
exam questions, success or failure should be measured and you can be assured that those judgements will be
according to the objectives the business has set. contextualised and relevant.

12 Business growth
Growth
Increasing the overall size of a business
Not all businesses grow, but many aim to do so, either through a planned
strategy of gradually expanding capacity or, more radically, through taking
over other businesses. Some growth can be unplanned, where owners are
caught unawares by the success of their product. In all cases, growth can
bring benefits, but also presents potential dangers.
Reasons why firms grow F REVISED

□
To increase profitability
Growth is likely to mean more customers. More customers can bring more
revenue. Increased revenue, where each new customer spends more than the
costs of servicing them, means more profit. In cases where a business can
grow revenues faster than their fixed costs rise, profit margins are likely to
increase too.
To achieve economies of scale

Growth should bring benefits in terms of lower running costs for the firm.
Typical economies of scale include: Economies of scale are
+ Purchasing economies of scale: This is where firms are able to negotiate reductions in unit cost
a cheaper unit cost for supplies they buy as they buy in greater bulk caused by the growth of a
following an increase in the scale of their operations. business.
+ Managerial economies of scale: Growing businesses are more likely to
be able to hire specialist managers to handle particular areas within
the business, so instead of having one HR manager a business that has
grown may be able to justify employing a specialist training manager and
Typical mistake
a specialist recruitment manager. Specialists are likely to bring greater
expertise to their role, thus reducing unit costs. Too often any reduction
+ Technical economies of scale: This is where growth allows a firm to afford in unit costs is referred
to buy in specialised machinery and equipment, so reduced unit costs may to by weaker students as
follow. an economy of scale. Unit
costs may fall for many
In addition, as a whole industry grows, there can be ‘external’ economies of
reasons. Economies of
scale. Benefits may emerge such as local colleges offering specialist training
scale only come into play if
courses to improve the relevant skill levels of the local workforce. In addition, the reduction in unit costs is
other specialist services, such as waste disposal or specialist component a direct result of an increase
suppliers, are more likely to open in an area where an industry has grown. in total capacity.
Increased market power over customers and

suppliers
+ Growth in size is likely to boost the power that a business has over both
customers and suppliers.
+ This is a clear reference to two of Michael Porter’s Five Forces. As Porter
suggests, the ability to influence factors in your favour is likely to boost a
company’s overall long-term profitability.
+ Power over suppliers would be increased by growth, as a firm that has
grown would be likely to have become a more significant customer as it
increases the quantity of supplies purchased.
+ Meanwhile, power over customers increases as one business’s growth may 5
well have led to a reduction in choice available to customers.

Increased market share and brand recognition
Growth that boosts market share will, by definition, involve taking share
from rivals. This will help to boost power over customers as explained above.
Growth will also lead to wider recognition of a company’s brand. The benefits
12 Business growth
of this are twofold:
+ Customers tend to buy brands they recognise, thus increased recognition
can lead to a further boost in sales as consumers start choosing its, more
recognisable, brand.
+ As brand recognition increases, it is possible to make cuts to marketing
budgets if awareness-boosting advertising is no longer necessary. This
reduces the firm’s overall operating expenses.
Making links
Successful growth tends to occur when there is a clear, strategic objective for the
growth taking place. When growth is a carefully selected business objective - as
explained in Chapter 5 - as with any business objective, it brings benefits to a firm.
Now test yourself
1 State three different types of economy of scale.

List three possible reasons why a business may choose to grow.
•
Problems arising from growth
----------------------------------------------------------------------------
' REVISED
□
Though undoubted benefits can flow from growth of a business, there
are problems involved in growth. These can be managed and their effects
lessened. However, these help to explain why, for some firms, growth can
lead to disaster.
•
Diseconomies of scale
Growth can make organisations harder to manage. A small business that was
Diseconomies of scale
once efficient, with a massively committed staff, can become a large business
are the inefficiencies related
which suffers from one or more of the following problems:
to growing as a business
that can lead to upward
Poor internal communication pressure on unit costs.
Growth can lead to a worsening of communication within an organisation for
several reasons:
+ Larger organisations tend to rely on more written forms of communication
than oral. This can harm the effectiveness of communication.
+ Larger organisations need to add more layers of organisational structure
to ensure spans of control do not become too wide. This means that
messages need to pass through more layers of structure.
+ The effectiveness of communication is affected by the motivation levels
of sender and receiver. As motivation can suffer in larger businesses (see
below), this can have a negative impact on communication.
Poor employee motivation

As a business grows and personal contact is reduced between staff members
and managers, employees can feel a growing sense of alienation. They
may feel their work goes unnoticed and may struggle to see how their
achievements can impact on the success of the business. The result can be
falling motivation levels as businesses grow.

Poor managerial co-ordination Exam tip
+ Ensuring that everyone is heading in the same direction in a small
business can be achieved by the boss maintaining regular contact with It is worth noting that
everyone and monitoring their progress. economies of scale
+ As an organisation grows, the boss will struggle to keep an eye on tend to be easier to
everything. measure, or quantify,
+ The result may be hiring managers, but these can head off in subtly different than diseconomies. For
this reason, advocates of
directions unless the boss ensures that they meet on a regular basis.
growth can often justify
+ These meetings can take up valuable time and become ignored.
their case numerically by
Controlling more resources will always be tougher in a bigger business.
calculating the likely cost
+ A failure to co-ordinate effectively can cause mistakes that drive up costs.
savings that come from
economies of scale. It
Overtrading is less likely that growth
+ Organic growth that happens too fast can cause overtrading. projections will manage
+ If a business grows rapidly, its level of cash outflows rises consistently as to quantify the effects of
it expands. diseconomies of scale.
+ As most firms need to wait several weeks or even months between
spending money on materials or assets before those assets generate a
return or the materials can be processed and sold, cash inflows only rise to Overtrading occurs when
a higher level after that period of time. a business experiences
+ This can create a situation where a business is trying to fund a large-scale cash flow problems as a
operation with cash inflows from the smaller organisation it was several result of expanding too
weeks or months previously. quickly without sufficient
cash in the bank.
+ The result can be a cash crisis.
Making links
One key to avoiding overtrading is exceptionally careful cash flow forecasting - a
technique covered in Chapter 6.
State three different diseconomies of scale.
Organic growth
Where growth is internal
Inorganic versus organic growth 1 REVISED
□
The difference between these two types of growth concerns whether growth
comes from within the business or outside it. Inorganic growth involves
growing by taking over other businesses. Typically, inorganic growth strategies inorganic growth means
would be used by businesses fitting one or more of the following criteria: growth that occurs as a
+ a poor record of new product development and innovation result of taking over or
+ a need to grow very quickly merging with another
+ a business looking to eliminate a competitor. business.
Organic growth is growth

Typical mistake
which takes place without
Consider the criteria that make inorganic growth a sensible choice. Just because any merger or takeover
organic growth carries less risk does not always mean it is the best choice for a activity.
business.
Organic growth does not involve the purchase of other businesses; instead,
the business grows ‘from within’, expanding its own capacity or opening new
branches.

Methods of growing organically REVISED
+ Organic growth involves harnessing the power of a business’s resources,

primarily its staff and its financial resources. Exam tip
12 Business growth
+ Staff, especially the culture developed within a business, if nurtured and When considering growth of
successful, can allow the firm to naturally expand its operations following a business, how the growth
the same blueprint with the same leaders doing things the same way, is funded will provide rich
simply on a larger scale. material for analysing
+ Meanwhile, organic growth tends to allow a business to finance the the wisdom of a growth
growth through retained profits, rather than seeking riskier sources of strategy.
external finance, such as loans.
Advantages of organic growth REVISED

□
The leader’s influence stays strong
+ Organic growth prevents the need to merge two workforces and replace
the leadership team of a business that has been taken over.
+ In those cases, the leader of the predator company will need to assert
their leadership and find a way to get new staff to embrace the original
company’s culture.
+ This is avoided when growth is organic; there is a far greater chance
of preserving the original organisational culture, which is likely to be Organisational culture is
successful as it has put the company in the position to grow. the term used to describe
acceptable norms of
Making links behaviour within a business:
'the way we do things round
This theme of a dominant founder becoming a leader was first examined in Chapter 5. here'.
Reduction of financial risk

+ As organic growth will tend to be far slower than inorganic methods, the
finance required is likely to be needed in smaller, more steady batches.
+ This suits the use of retained profit as a source, since using the profit
generated each year to continually grow the business should enable the
firm to steadily grow, without the need to take on debt, with its extra cost
of interest and the cash-draining impact of repayments as well as interest.
Making links
in Chapter 15, we will cover the gearing ratio which shows the extent to which a
business is reliant on loans. Organic growth is likely to prevent the dangers of an
increased gearing ratio that inorganic growth often brings.
Secure career paths

+ As a business grows over time, the management team who have led the
growth may be looking to turn their success into higher powered and
higher status jobs.
+ If the business continues to grow, its structure will grow and more senior
managerial positions will open up.
+ Internal promotions to fill these will prevent middle and junior managers
leaving the business to develop their careers: their skills, talents and
experience are retained within the business.
Making links
Showing an understanding of how organic growth can help to satisfy Herzberg's
motivator of growth and advancement or Maslow's esteem and self-actualisation
needs allows this topic to be linked to motivation theory - as fully explored in Chapter 4.

Disadvantages of organic growth REVISED
□
Limited speed leading to limited size
72 Business growth
By its nature, organic growth tends to be a far slower process than inorganic
growth. This may mean that a business sticking to an organic growth
strategy may fall behind growing rivals who use takeovers to add rapidly and
significantly to their scale. The result can be that rivals are able to achieve
economies of scale that make competing with them far harder.
Failing to fully exploit a short-lived opportunity

With shortening product life cycles as rates of change in many markets
increase, a firm that fails to fully expand its capacity before the product enters
the decline phase in the marketplace may have missed out on significant
levels of sales as a result of ignoring opportunities to grow inorganically.
Predictability
Organic growth will often (not always) involve doing the same thing in a new
place year after year after year. This can prevent staff who are looking for new
and exciting challenges staying with the business in the long term, leading to
a turnover of potentially innovative and entrepreneurial staff.
Briefly explain why organic growth may be less risky financially than inorganic growth.
5 Which is generally faster, organic or inorganic growth?
6 State three potential drawbacks of choosing to grow organically.
Mergers and takeovers____________

Growth involving changes in ownership
Growth can be achieved through merging with or taking over another business.
Reasons for mergers and takeovers REVISED

□
Table 12.1 Common reasons for mergers and takeovers
Reason Explanation Synergies are the benefits

Growth The ability to increase the size of an organisation is the general motive of two things coming
behind any merger or takeover. The specific benefits expected are together that could not exist
likely to be one or more of those below when they are separate,
such as economies of scale
Cost When a business grows through merger or takeover, its increased size
resulting from a merger of
synergies is likely to lead to economies of scale, allowing it to reduce its unit costs.
two businesses.
Other cost savings can come by eliminating duplicated functions and jobs
Diversification A company that wants to spread the level of risk for its business can do so
by using a merger or takeover to enter new markets with new products,
reducing its reliance on one market or product in case of problems
Market power When two firms in the same market come together, the combined
business is likely to increase its power over customers, perhaps
enabling it to raise prices to boost margins, while also benefiting from
increased power over suppliers
Distinction between mergers and takeovers REVISED

□
A merger occurs when two businesses of roughly the same size agree to come
together to create a brand new single business, where the owners of the two
businesses will share the ownership of the new firm.

A takeover occurs when one business buys over 50 per cent of another
Exam tip
business’s shares, thus effectively gaining control.
Mergers may be less
Now test yourself TESTED successful than takeovers
12 Business growth
as managers from both the
State three possible reasons, other than pure growth, behind a merger or takeover.
original firms may tussle for
Answers available online a long time in a bid to assert
their dominance in the
new business; a scenario
Exam tip takeovers would avoid.
Some takeovers are considered hostile, when the directors of the target company
do not recommend the offer to their shareholders. Friendly takeovers occur when
Typical mistake
directors of the target company do recommend that shareholders accept the offer The terms merger and
made by the predator for their shares. This would be because they feel this represents takeover should not be used
good value given the company's relative prospects without and with the takeover. interchangeably. They are
different types of transaction.
Types of integration REVISED

□
Figure 12.1 Vertical and horizontal integration
Vertical integration
Vertical integration refers to a merger or takeover involving two companies
at different stages of the same supply chain. Forward vertical integration,
where a company buys a customer, may involve a manufacturer buying a
retailer to secure distribution for its products. Backward vertical integration
occurs when a company buys a supplier, so a retailer may buy a distributor or
a manufacturer.
Horizontal integration
Where a business buys or merges with a rival, in the same industry at
the same stage of supply chain, the deal is called horizontal integration.
Economies of scale, reductions in costs as a result of elimination of duplicated
roles, and one less competitor allowing prices to be increased should all lead
to increased profit margins.
Conglomerate integration
Where a merger or takeover involves the coming together of two unrelated
businesses, the deal is called conglomerate integration. The main benefit
is that the new business is no longer reliant on just one market or product.
This is designed to spread risk for the new business. If one product or market
suffers, the firm’s other product or market is unlikely to be affected.

The key benefits and potential drawbacks of each type of integration are
shown in Table 12.2.
Table 12.2 The key benefits and drawbacks of integration
Type of Benefits Drawbacks

integration
Backward + Secures supplies + Can tie the business into a supplier that may not always offer
vertical + Should lower the cost of supplies the best option
Forward + Guaranteed outlet for the + Consumers may resent the loss of choice - with one firm's
vertical business's products products dominating these outlets
Horizontal + Likely to provide clear + Can lead to diseconomies
economies of scale + Could be confusion over which firm's culture should be
adopted in some areas
Conglomerate + Diversifies the business - + Potential failure to understand the target company as it will be
spreading risk into different in an unfamiliar market
markets + May distract management from original business due to
unfamiliarity and slowness to integrate
Now test yourself
Describe each of the following transactions using the correct terminology:

a) A manufacturer buys one of its customers.
b) A supplier of car parts buys another supplier of similar car parts.
c) A coffee manufacturer buys a coffee plantation.
I) A mobile phone manufacturer buys a specialist wooden furniture retailer.
Two airlines agree to come together to share costs and routes within their
global networks.
Takeover decisions and Ansoff’s Matrix r REVISED

□
+ Ansoff’s Matrix can be used effectively to consider the likely risks and
rewards involved in takeovers. Making links
+ As covered in detail in Chapter 11 (see page 132), the matrix allows an You can remind yourself
analysis to take place of the market and products being sold by the firm of Ansoff's Matrix by
being taken over. flicking back to Chapter 11
+ Horizontal integration, of businesses operating in the same market selling where the model was first
almost identical products, would be lowest risk: Ansoff would consider this introduced.
market penetration.
+ Risk levels would rise if the takeover target operates in another country or
sells products unlike those sold by the buyer.
+ A combination of new product and new market - diversification -
represents the riskiest type of takeover.
+ However, risk and potential reward correlate positively, so diversification,
though highest risk, can bring the highest rewards if successful.
Financial risks and rewards REVISED

□
Most takeovers are funded by debt. Borrowing to grow makes sense as long as Exam tip
the rewards from the growth outweigh the cost of the borrowing:
When assessing the likely
If return on investment from takeover > interest rate on loans required success of a takeover,
then the deal makes sense consider the long term as
This is more likely to be the case when the economy is performing well or well as the short term. Even
a deal that is currently likely
interest rates are particularly low. However, if sales dry up due to economic
to succeed could fail in the
downturn, or the Bank of England pushes interest rates up, the equation could
longer term as external
turn. In such circumstances, the funding of takeovers through debt could lead
conditions change.
to the demise of a previously sound business.

Problems of rapid growth REVISED
Inorganic growth, through merger or takeover, sees much more rapid

transformation than organic growth. The speed of growth can present
12 Business growth
significant issues, mainly focused on relationships:
+ With new management structures in place, staff may find themselves
working for a new boss.
+ At least one set of staff are likely to need to make adjustments to operate
in a new business culture: many will feel uncomfortable.
+ Customers and suppliers who may have had a long-standing relationship
with their contact in the business may be discomforted by the need to deal
with somebody else, or to be dealing with a larger, perhaps less personal
organisation.
When does borrowing to finance a takeover stop making sense?
Reasons for staying small

Sometimes growth can be dangerous
Typical mistake
Do not assume that all businesses aim to grow as large as possible. As discussed
above, there are problems that come with scale. Many large businesses attempt to
structure themselves internally to mimic small businesses so they can take advantage
of the benefits of being small.
Growth can certainly bring advantages to a business. However, it also

brings problems. Some businesses will choose to avoid growth to avoid
the associated problems. Many other businesses will stay small because
their objectives do not require growth; in fact, growth may directly
contradict their objectives. Table 12.3 helps to explain the relationship
between business objectives and size.
Table 12.3 Business objectives and size
Objective importance of size

Survival Smaller firms have lower fixed costs to cover, making it easier to break even, BUT, with
smaller customer numbers and perhaps over-dependence on a single product, changes
in the market can destroy a small firm quickly
Profit maximisation Bigger firms are able to generate higher total profits due to their higher revenues, as well
as economies of scale
Sales maximisation Maximising sales is inextricably linked to growth as a business
Market share Small firms may enjoy healthy shares of market niches, but to attain significant market
share in a mass market requires growth
Cost efficiency Although growth brings economies of scale, diseconomies of scale are likely to arise as
a result of growth. Smaller firms may be able to identify wastage more easily and thus
keep a tight rein on costs
Employee welfare Although large firms may offer bigger bonuses and fringe benefits, working in a large
firm can leave employees without the sense of belonging that comes from working in a
small business
Customer satisfaction With fewer customers, small businesses may be better placed to offer customer
satisfaction by potentially building a personal relationship with all of their customers
Social objectives Many social enterprises are set up to address local needs and thus want to stay small

Survival in competitive markets REVISED
+ Successfully operating in a competitive market needs a source of

Making links
competitive advantage.
72 Business growth
+ Competitive markets tend to see price competition and product innovation Remembering issues
as common features. covered in Chapter 5 -
+ Therefore, surviving in these markets is likely to require a business to exploring the willingness
either have the lowest costs, allowing price flexibility, or a strong point of of entrepreneurs to take
differentiation. risks - should help you
+ As Porter suggested, there can be only one cost leader in a market, so large to understand why small
firms, with their economies of scale, are likely to take this spot. Small businesses are better
firms must look for other ways to thrive. This is likely to rely on flexibility suited to respond quickly to
market changes than larger
and agility.
businesses are.
+ The ability to cope with rapid change in the marketplace may be the key
strength of small businesses. They do not have large, unwieldy decision
making structures. Often, the boss will be able to make rapid and effective
decisions to respond to changes in market conditions. In this way, small
firms can stay ahead of larger rivals in the hunt for differentiation.
Reasons to stay small REVISED

□
Product differentiation and USPs
+ Porter’s Generic Strategy Matrix helps to explain how some small firms Making links
can trade successfully in the long term.
+ A strategy of focused differentiation, whereby a business finds a point of Remember product
differentiation was first
differentiation while selling to a niche market, is perhaps easiest for small
introduced way back in
businesses.
Chapter 1.
+ Without the need to push for growth by looking for a wider market, or
finding other ways to differentiate, a small business can spend all its time
protecting and deepening its point of differentiation.
Flexibility in responding to customer needs

With nimble management structures and less need to worry about what
the stock market may think, small businesses will have greater speed of
response to market changes. In addition, decision-makers are likely to know Exam tip
about changes in the market sooner. With fewer layers between bosses and To gain better analysis
customer-facing, lower-level staff, feedback from the shop floor is likely to marks when explaining a
reach managers more quickly, enabling quicker response times than in larger point such as the flexibility
businesses. of small firms, be sure to
spell out why small equals
nimble. The ability to show
Customer service the sequence that leads
+ Great customer service will only be delivered by highly motivated staff. from small to nimble, i.e.
Where staff are part of a small, close-knit workforce, they will understand small = fewer layers =
clearly how their performance affects the overall success of the business, decision-makers closer
and this should be highly motivating. to customers = quicker
+ Contrasted with staff who work in one of many branches of a large response to changing
organisation, who may feel little loyalty to the business, it is clear to see tastes, shows good
how small businesses may survive through delivering great customer analytical skills.
service.
E-commerce
+ The magic of e-commerce for small businesses is the ability to reach a
global market. The worldwide web is just that: a medium through which
the smallest business can reach customers anywhere in the world.
+ It is this that can allow businesses to carve out incredibly specialist niche
markets, which would not be large enough to support a business on a
national scale. 53

+ However, a business that specialises only in selling, for example, one brand
of second-hand vintage toy can be viable if selling to collectors worldwide.
12 Business growth
State two business objectives which may be easier for small firms to achieve than
for large ones.
1 Which of Porter's generic strategies is ideal for a small business with an unusual
idea?
12 Briefly explain why great customer service may be easier to achieve for a small
business.
Exam practice
1 To what extent is a strategy of growth essential if UK Finnish subsidiary. Part of the firm's original success has
based PLCs are going to continue to offer the continual been founded on the reputation for customer service
growth in earnings expected by the stock market? [20] and on-time delivery, which stem from great internal
communication systems. The Chief Executive was
Wilson Hooper Holdings Pic (WHH Pic) has been
confident that the takeover would improve, rather than
manufacturing high-quality wooden furniture for the last
worsen, this aspect of the business's operations.
30 years. Started in a single workshop, the firm grew
slowly, reinvesting profits to expand to operating from a 2 a) Explain one benefit that WHH Pic may have
factory, allowing it to service the whole UK market. During received by pursuing organic growth. [4]
this period, the firm enjoyed low levels of labour turnover; b) Identify the type of integration that the purchase of
a loyal and highly skilled workforce emerged. The fall in the timber supplier would represent. [1]
the value of the pound, allied to quality problems with c) How would Ansoff classify this takeover? [1]
the materials delivered, has led the company to decide d) Assess the likely benefits and problems that the
to buy a timber supplier in Finland. Concerns were raised proposed takeover may create for WHH Pic. [12]
at the directors' meeting about the potential clash of
cultures between the UK business and its proposed
Summary
+ Reasons for growth include: increased profitability, + A takeover occurs when one business buys another.
economies of scale and increased power in the market. + Types of integration are classified according to the
+ Diseconomies of scale can arise from growth, namely extent to which the two businesses operate in different
problems with co-ordination, communication and industries or at different stages of the supply chain.
motivation. + Ansoff's Matrix is a useful tool for analysing the risks
+ A business that grows too quickly for its capital base to associated with takeovers.
cope with may fall victim to overtrading. + some firms choose to stay small as this brings
+ Organic growth occurs without mergers or takeovers advantages over bigger rivals, such as faster reaction
and tends to be a slower but safer option than to change, easier differentiation and potential for better
inorganic growth. levels of customer service.
+ A merger occurs when two firms agree to come
together to form a single business.
Exam skills
Themes 3 and 4 offer increased opportunities to link finance to buy new equipment, and extra staff training
different business concepts. to ensure staff can operate it.
+ With examiners looking for evidence of a broad + when exploring the impact of any strategic business
knowledge of the subject within your answers, these decisions internally, force yourself to see whether
opportunities should be seized upon. you can demonstrate that you understand how these
+ Business growth has implications for all functional different departments are interdependent by thinking
areas of the business. Therefore, when building an through the checklist of business functions:
answer about whether or how to grow, as you explore + Marketing
the implications of an increase in scale it is worth + Finance
bearing in mind that you may have the opportunity + Human Resources
to explore links between business functions, such as + Ooperations.
the fact that increasing production may require extra

Quantitative sales forecasting____________________

Numerical methods to calculate how much a
business expects to sell in the future
Making links
Chapter 7 introduced the importance of sales forecasting for businesses. This section
explores numerical methods used to forecast sales.
Sales forecasting is necessary as it underpins most of the forward planning

needed to run a business:
Table 13.1 Sales forecasting helps with all business planning
HR plan in order to ensure that, in the medium to long term, the right
number of staff with the right skills are employed, and in the
short term, the right number of staff are actually at work, the HR
department will carefully consider sales forecasts
Cash flow forecast in order to estimate cash inflows, and, for any variable costs, to
estimate cash outflows, the cash flow forecast has to be based on
a sales forecast
Profit forecasts When planning how much the firm is expecting to make in
and budgets revenue and profit, the basis will be accurate sales forecasts.
These will help to shape expectations of spending, as shown in
budgets for different departments
Production If the business is to satisfy demand for its product or service it will
planning need to ensure that enough products are made, and before that,
that enough raw materials are bought. Planning production and
inventory levels will take place by working backwards from sales
forecasts
In order to forecast sales for an existing business, the commonest method

used is to identify past trends. These trends form the basis of the three
quantitative sales forecasting techniques you need to understand:
+ moving averages
+ extrapolation
+ correlation.
Moving averages ' REVISED

□
To identify an underlying trend in a set of data with strong seasonal
A moving average is a
variations or an erratic pattern, a moving average is useful. Table 13.2 shows
quantitative method used to
how the moving average is calculated, firstly by adding several months’ worth
identify underlying trends in
of raw data (the three-month total in column 2), then calculating the average
a set of raw data.
for those months and centring that figure on the middle of the period (the
centred three-month average in column 3).
55

Table 13.2 Example of a moving average
Raw data Centred three- Centred three-

(monthly sales) (£) month total (£) month average (£)
January 48,000
February 57,000 52,000
March 51,000 156,000 49,000
April 39,000 147,000 47,700
May 53,000 143,000 46,300
June 47,000 138,000 45,300
July 36,000 136,000 44,700
August 51,000 134,000
The graph in Figure 13.1 shows just how effectively this technique helps to
clarify the long-term trend, even when the raw data seems erratic.
Typical mistake
It is vital, when looking
for trends in data that has
a strong seasonal peak,
such as toy sales, that a
12-month or four-quarter
average is calculated. This
eliminates the effect of
seasonal variations, by
Month including one peak period in
every average.
Figure 13.1 Underlying sales trends revealed by a three-month moving average
1 Delete the wrong option in each pair of words in italics:

Moving averages iron out differences/fluctuations within data. This helps to identify
trends/causes within the data. They are especially useful when raw data is
erratic/smooth.
Forecasting sales using extrapolation r REVISED

□
Basic human behaviour, and consequently most businesses, predict the future
Time series data Is a
by assuming that past trends will continue: the future will be just like the
series of figures covering an
past. In simple terms, the long-term trend identified in time series data is
extended period of time.
extended into the future, as shown in Figure 13.2.

The challenge in using extrapolation comes when the trend is not quite as
Extrapolation means
clear cut. Figure 13.3 illustrates a situation in which the sales forecaster must predicting by projecting past
decide whether the recent downward trend is a blip and the longer term trends into the future.
upward trend will dominate, or whether the recent downward movement is a
trend that will continue for the foreseeable future.
Figure 13.3 Requirement for judgement when extrapolating trends
This indicates the art and skill involved in sales forecasting. Even using
quantitative techniques, thought is required to examine and understand
underlying causes behind the data being used to extrapolate.
Scatter graphs (correlation) 1 REVISED

□
Plotting the relationship between two variables on a scatter graph can provide
great insight relating to the extent to which those variables are linked. Where
there is a link between sales and another variable, the relationship can be
used to forecast sales if the other variable is controllable or predictable. Such
links include:
+ sales and advertising expenditure
+ sales and temperature
+ sales and the number of stores open
+ sales and the level of staff bonuses available.
Plotting the data from the past, on advertising expenditure and sales, for
example, as shown in Figure 13.4, shows a clear relationship between the two
variables.
Figure 13.4 Strong positive correlation between advertising expenditure and sales

+ Clearly, as one variable rises, the other rises in line.
+ This indicates that there may be cause and effect at work.
+ Forecasters will then need to decide which variable causes the other;
in this case it is likely (though not certain) that changes in advertising Correlation expresses a
expenditure have a strong impact on sales. relationship between two
+ When a strong correlation exists, as shown by a line of best fit that passes variables.
close to all the points on the scatter graph, the relationship may be a
helpful forecasting tool.
Exam tip
Once a business has decided how much it plans to spend on advertising in a
given period, it can plot the level of expected sales that is likely to result. when exploring causality,
consider all possibilities.
Making links Although, in Figure 13.4,
it may be assumed that
Chapter 2 introduced price elasticity and income elasticity of demand. Notice that changes in advertising
both are ways of exploring the correlation between demand and another variable. expenditure cause changes
in sales, it is also possible
that the firm deliberately
Typical mistake spends more on advertising
Too often correlation is assumed to imply causality. Relationships can occur by in months when it expects
chance; it takes judgement to decide whether one variable causes movements in the to be busy: to capitalise
other, or vice versa, or whether any correlation is merely down to chance. perhaps on seasonal trends.
Limitations of quantitative forecasting

techniques REVISED
There are two major limitations to quantitative forecasting techniques, which

help to explain almost all false predictions:
1 The future may not be like the past: changes in any number of external
factors may have a significant impact on sales. Many of these external
events may be highly unpredictable, such as changes in tastes and fashion
or new entrants to the market.
2 The quality of a forecast is reliant on the ability of the forecaster to
interpret the data being used to generate the forecast. Decision-making is
needed when forecasting, such as whether a dip in trend growth is likely
to continue in the long term or just be a short-term change to trend. In
the case of correlation, the challenge is in understanding which variables
to pair up, and then exploring the causality, if any, involved in the
relationship.
Making links
At the beginning of Chapter 1, there is a small section explaining the difference
between risk and uncertainty. These ideas of risk and uncertainty are central to
understanding how reliable a sales forecast might be - forecasting may carry a far
higher risk of being inaccurate in some contexts than others. That will depend on how
many uncertainties are at play in that context.
What is the name of the forecasting technique that predicts the future by assuming
past trends will continue?
Briefly explain how a clear correlation between the hours worked by sales staff
and total sales volume will help to predict next month's sales.

Investment appraisal
Quantitative methods and qualitative issues
Decision-making techniques
involved in investment decisions
The three methods of investment appraisal are:
+ Payback period investment appraisal
+ Average rate of return is the process of using
+ Net present value. forecast cash flows to
assess the financial
All three methods begin with a table or graph showing the forecast cash flows
attractiveness of an
involved in the investment (see Table 13.3). investment decision, linked
with a consideration of
Making links non-financial factors.
With all quantitative investment appraisal reliant on cash flow forecasting, links
73
can clearly be made to both cash flow forecasting (covered in Chapter 6) and sales
forecasting techniques, explored earlier in this chapter.
Table 13.3 Example cash flow table (*NOW = the moment the £60,000 is spent; can
also be called the initial outlay or the sum invested)
Cash in Cash out Net cash flow Cumulative Exam tip

cash flow
Examiners may only present
NOW* £60,000 (£60,000) (£60,000)
you with cash inflows and
Year 1 £30,000 £10,000 £20,000 (£40,000) cash outflows. You may
Year 2 £30,000 £10,000 £20,000 (£20,000) need to construct the last
two columns yourself.
Year 3 £30,000 £10,000 £20,000
Year 4 £30,000 £10,000 £20,000 £20,000
Years £30,000 £10,000 £20,000 £40,000
Figure 13.5 Cumulative cash flows on an investment of £60,000
Payback period 1 REVISED

□
Assessing the period of time a business must wait until the initial investment
has been recovered allows a firm to prioritise risk reduction when making
investment decisions.
Calculation
Payback occurs when the cumulative cash flow reaches zero. In the example
above (Table 13.3), this point is easy to identify as it occurs exactly at the end
of year 3. Not all forecasts work out as neatly. If payback occurs part-way
59

through a year, you must calculate how far through the year it occurs. Apply
this formula:
outlay outstanding
monthly cash flow in year of payback
In Table 13.3, if year 3’s net cash flow was £30,000 instead of £20,000, payback
would happen after two years and:
£20,000
----------------- = 8 months
(£30,000/12)
Interpretation
+ Payback calculates the length of time that the money invested is ‘at risk’.
Once payback has occurred, the firm is at least not losing money on its
investment. Therefore, a quicker payback is best.
+ However, projects with a quick payback may not turn out to be most
profitable in the long term, so ideally, another method of investment
appraisal should be considered alongside the payback period.
Now test yourself
Calculate the payback period for the following investment:
Year Net cash flow

0 (120,000)
1 50,000
2 50,000
3 50,000
Average rate of return (ARR) REVISED

□
This method considers the profit generated by an investment. It involves
calculating the average annual profit as a percentage of the initial outlay.
Calculation
There are three steps involved in calculating the ARR: Typical mistake
+ Step 1: Calculate the total profit over the lifetime of the project by adding
The most common
all net cash flows and deducting the initial outlay.
errors made by students
+ Step 2: Divide by the number of years the project lasts. calculating arr are
+ Step 3: Apply the formula: forgetting to deduct the
average annual profit (from Step 2) initial investment in Step 1
or omitting Step 2.
initial outlay
A simple worked example is shown in Tables 13.4 and 13.5.
Table 13.4 [add caption?]
Year Net cash flow Cumulative cash flow

0 (£20,000) (£20,000)
1 + £5,000 (£15,000)
2 + £11,000 (4,000)
3 + £10,000 + £6,000
4 + £10,000 + £16,000

Table 13.5 Applying the three steps
Exam tip
Step 1 Identify lifetime profit £16,000 To contextualise an arr
Step 2 Divide by number of years (4) £4,000 result it can be compared
Step 3 Calculate annual profit as a £4,000 / £20,000 x 100 = 20% with the company's overall
percentage of initial outlay Return on Capital Employed
(ROCE). A project whose
ARR is lower than the
Interpretation current ROCE generated
Simply put, the higher the ARR, the more profitable the investment. by the whole business is
unlikely to be attractive,
Now test yourself TESTED since it would reduce
the overall ROCE for the
Calculate the ARR for the following investment. business if accepted.
Year Net cash flow

0 (120,000)
1 50,000
2 50,000
3 50,000
Net present value (NPV) using discounted

cash flows REVISED
□
+ Future cash flows may not be worth what they seem.
+ This is not a reference to inaccurate forecasting, but noting that money
that is received sooner can be used for other purposes.
+ In other words, money tied up in an investment has an opportunity cost.
+ This can be accounted for by discounting the value of future cash flows to Exam tip
allow for a given percentage return that could be achieved if the money
were available now and generated that return. You would never be
+ Considering the likely rate of interest that will be missed out on by tying expected to calculate the
money up in the investment allows the choice of a discount factor to use; discount factors required
for an NPV calculation.
for example, a 10 per cent discount factor allows for a return of 10 per cent.
Calculation
Each year’s net cash flow is multiplied by the relevant discount factor to
calculate the present value of the cash flow. These are then totalled to give
the overall net present value (NPV) of the project. The example shown in
Table 13.6 compares two projects, using 10% discount factors.
Table 13.6 Project Z versus Project Y
Project Z Project Y
Year Net cash Discount Present value Year Net cash Discount Present value
flow factor (£s) flow factor (£s)
0 (£250,000) 1.00 (£250,000) 0 (£250,000) 1.00 (£250,000)
1 +£50,000 0.91 £45,500 1 +£200,000 0.91 +£182,000
2 +£100,000 0.83 £83,000 2 +£100,000 0.83 +£83,000
3 +£200,000 0.75 £150,000 3 +£50,000 0.75 +£37,500
NPV = +£28,500 NPV = +£52,500

Interpretation
A positive NPV shows that a project generates a greater return on its initial
outlay than simply putting the money in the bank at an interest rate equal
to the percentage discount factor used. The higher the figure, the more
profitable it will be.

□
6 Calculate the NPV for the following investment.
Year Net cash flow

0 (120,000)
1 50,000
2 50,000
3 50,000
use 10% discount factors: Year 1 = 0.91, Year 2 = 0.83, Year 3 = 0.75.
Strengths and limitations of quantitative

investment appraisal techniques REVISED
□
Table 13.7 Strengths and limitations of quantitative investment appraisal techniques
investment Strengths of the method Limitations of the method

appraisal method
Payback + Easy to calculate and understand + Tells us nothing about profitability
+ May be more accurate as it ignores longer- + Ignores what happens after payback is
term forecasts which may be less accurate achieved
+ Takes into account the timing of cash flows + May encourage a short-termist attitude
+ Very useful for businesses with weak cash flow
Average rate of + Clear focus on profitability + Ignores the timing of cash flows
return + Considers cash flows over the whole + Therefore values far distant inflows as
project's lifetime much as more immediate inflows, which
+ Easy to compare with other measures of are 'worth' more
return expressed as percentages, such as + including forecast data from far in the
interest rates future may reduce the reliability of the
forecasts and therefore results
Net present value + Takes the opportunity cost of money into + Complex to calculate and communicate
account + Meaning is often misunderstood
+ One calculation which considers both + Only comparable between different
amount and timing of cash flows to indicate projects if the initial outlay is the same
profitability
Making links
The choice of investment appraisal technique used may well depend on whether a
company is taking a short- or a long-term view on investments - an idea explored
further in Chapter 14's section on corporate influences on decision-making.
Other factors affecting investment decisions REVISED

□
Non-financial factors
Given the limitations of these techniques, even if all the numbers (the results
of calculations of quantitative measures of investment appraisal) point one
way, sensible decision-makers consider other, non-financial factors. Some of
these are listed in Table 13.8.

Table 13.8 Non-financial factors to consider when making business decisions
Factor Explanation
Corporate objectives Does the chosen investment focus on achieving the agreed objectives of the business?
Company finances Expensive investments that may place the firm's financial health at risk if they require external
finance may be better ignored
Confidence in the data It is always worth considering the likely accuracy of the forecasts on which calculations are
based: who prepared the forecasts, do they have a record of success in forecasting, do they
have some bias that could cause them to over-or under-estimate cash flows?
Social responsibilities If an investment clearly helps to meet a business's social responsibilities, some businesses
may be willing to proceed even if the project is not the most financially attractive option
Investment criteria
These are specific targets that directors may set that any investment is
required to reach before it can be approved. They will include targets for one
or more of the investment appraisal methods, such as:
+ payback within three years
+ ARR of at least 15%
+ positive NPV using 10% discount factors.
Risk and uncertainty

+ No investment decision should be undertaken without broader
appreciation of the risks and uncertainty involved.
+ With forecasts stretching far into the future in some cases, great
uncertainty may be attached to cash flow forecasts.
+ This intensifies the risk associated with the project. Ideally, a business
should avoid investing in any project on which it cannot afford to lose the
initial investment, thus reducing the risk to the business as a whole.
Now test yourself
which investment appraisal method is likely to be favoured by firms looking to

reduce the risks involved in their investments?
Which investment appraisal method considers both the timing of cash flows and
profitability?
Decision trees
A probability-based aid to decision making A decision tree is a
diagram showing the
When faced with quantifiable decisions, an analytical approach to setting out
options and possible
the problem and assessing the alternatives is to draw a decision tree. These
outcomes involved in
diagrams allow the calculation of expected outcomes of alternative courses making a decision along
of action. This can help to provide a clearly favourable option on numerate with the probabilities of
grounds - it can help managers to see the wood for the trees! outcomes occurring.
Step-by-step approach r REVISED

□
The basics
A decision tree sets out a decision problem from left to right. On the left is a
square, representing the initial decision to be made. Sprouting off to the right
are the possible options as branches of the tree. The branches consist of:
+ a decision to be made, shown by a square (see Figure 13.6).
+ chance events beyond the firm’s control, shown by a circle (see Figure 13.7).
163

Robot proves effective from the start
‘Note that 'do nothing' is an option for every business decision
Figure 13.6 Decision tree showing a decision to be made Figure 13.7 Decision tree showing chance events
beyond the firm's control
The possible outcomes following chance events must have a probability

attached. The probabilities following each chance event must add up to 1.
At any square, the business can choose which branch to take. The most
profitable option will always be chosen. Figure 13.8 shows the initial decision
followed by the chance event that follows the installation of a robot welder.
Robot proves effective from the start
0.8
Invest in a robot welder
Robot proves unreliable
0.2
Retrain existing staff
'Do nothing'
►
Figure 13.8 Following a decision
Drawing the tree

+ Begin drawing the tree for the left with a single square.
+ Run a branch for each option out to the right of the square.
+ Note the cost (if any) of each option by the line.
+ Draw a circle whenever a chance event could occur.
+ Run a branch out of the right of each circle to show each possible outcome.
+ Record the probability below each branch.
+ Add squares and circles in the order in which they occur as explained
within the case study, representing decisions and chance events as
required.
+ When a branch has no further chance events or decisions to follow, note
the expected returns at the end of the branch, as shown in Figure 13.9.
Figure 13.9 A completed decision tree

Making calculations Expected value is the
With the tree drawn, a series of calculations are required to help identify the average outcome expected
most attractive option at each decision square. Working from right to left, for following a chance event.
each chance event (circle) multiply each expected return by the probability of
each possible outcome, so in Figure 13.9, the calculation would be:
Typical mistake
(£15m x 0.7) + (£3m x 0.3) = £11.4m
Students and some
This is known as the expected value attached to a chance event.
managers can too often be
fooled into believing that
Showing decisions decision trees show facts,
Working from right to left, once a square is encountered, compare the expected as they generate a clear
values of each decision option. The business will choose the higher value. numerical result. The results
Cross through the other options to show these choices would not be taken. may look precise, but they
are only forecasts. It is
Now test yourself vital to consider the likely
accuracy of the numbers
What shapes are used to represent a) chance events and b) decisions on the tree that have been put into the
diagram? tree when assessing the
10 How is the expected value of a chance event calculated? reliability of the results it
generates.
The value of using decision trees REVISED

□
Decision trees as a technique to aid decision making can be useful but it is
vital that users are fully aware of their limitations.
Table 13.9 Advantages and disadvantages of using decision trees
Advantages of using decision trees Limitations of decision trees

The technique allows for uncertainty Gathering the data required is hard and is likely to involve an element of guesswork
Trees force managers to consider all New problems mean previous occurrences cannot be used to base estimated
possible options probabilities and outcomes on, reducing the reliability of the data still further
Problems are set out clearly, encouraging An element of bias can be introduced by whoever is estimating probabilities
a logical approach and outcomes if they wish to influence the outcome of the decision
Quantification of problems is encouraged Decision trees can lead to a failure to consider qualitative aspects of decisions
by the drawing of the tree and
subsequent calculations
Making links
Now test yourself
Chapter 14 explores the
Using calculations, state whether option A or option B should be chosen based on tension between evidence
the decision tree below. based and subjective
decision-making. The use
of decision trees is a clear
indicatorof a business
sticking as closely as
possible to an evidence
based approach.
Exam tip
If presented with a decision
tree in a case study, it is
always worth checking where
the data came from and
whether there may have been
any bias generated by the
source of the data favouring
one option over others. 165

Critical path analysis
A technique used to plan and manage
projects involving many activities
When a complex project needs to be completed as quickly as possible, critical
path analysis can help. Time can be crucial in order to: Critical path analysis is a
technique used in planning
+ get a product to market as quickly as possible
the most time-efficient
+ construct new premises to move into as quickly as possible
way to complete complex
+ move offices or production facilities to a new location.
projects.
The technique involves constructing a network diagram which shows:
+ the order in which tasks must be undertaken
+ an estimated length of each task
+ the earliest date when each task can begin.
Drawing critical path analysis diagrams r REVISED

□
The two key components of a network diagram are:
Making links
+ lines which represent activities to be completed as part of the overall project
+ nodes placed at the start and end of activities. Critical path analysis is
frequently used in the
Five handy rules for drawing network diagrams are:
management of change,
1 Networks must start and end on a single node.
explored further in
2 No lines should cross one another.
Chapter 16.
3 Do not draw the node at the end of an activity until you are sure which
activity follows.
4 There must be no lines that do not represent an activity.
5 Nodes should be drawn large (to make room for the figures that must be
recorded in them), while lines should be drawn short, to keep the diagram
manageable.
Figure 13.10 shows a network diagram drawn to show the tasks involved in
running a ‘30p off price promotion.
Delivery
7 days
Figure 13.10 '30p off' network
Now test yourself □

12 Using Figure 13.10:
i) Which two activities must be completed before delivery can take place?
b) Which three activities can begin immediately?
Which activity can only begin once the sales force have been briefed?

Earliest start times and latest finish times REVISED
□
+ The power of critical path analysis becomes evident once earliest start
The earliest start time
times (ESTs) and latest finish times (LFTs) are added to the diagram.
(EST) of an activity is the
+ Figure 13.11 shows the ‘30p off’ promotion network with ESTs and LFTs earliest possible date on
added and the descriptions of the activities replaced by letters. which it is possible to begin
+ The EFTs are shown in the top right-hand corner of the node before each the activity.
activity. The LFT of an activity can be found in the bottom right-hand
corner of the node following the activity.
+ The earliest start time shown in the first node is always 0, showing that
The latest finish time
any activity not dependent on prior activities can start immediately.
(LFT) for an activity is the
+ Node 2 shows the earliest start time of activities C, D and E, none of which
last possible date by which
can begin until activities A and B are complete.
it must be complete to avoid
+ Because activity B must be completed, C, D and E cannot begin until day 14, delaying the overall project.
even if activity A was done within 4 days.
+ ESTs are calculated from left to right, before any LFTs are filled in.
+ In the final node, the EST represents the shortest possible time in which
the entire project can be completed. This becomes the ‘deadline’ for the
whole project and thus the LFT of preceding activities (in this case I).
+ To calculate earlier LFTs, deduct the duration of the activity from its LFT -
in this case 70-7 means F and H must be completed by day 63, shown in
node 4.
Table 13.10 ESTs and LFTs clarified
ESTs show... LFTS Show... Float time describes

The earliest date resources specially required Deadlines for each activity any slack time available
for an activity may be needed, preventing attached to an activity. The
wasting money on them before they are LFT minus the duration of
needed the activity minus the EST of
the activity shows if there is
The earliest completion date for the whole The float time (if any for each activity)
float time.
project The critical path of the project
Making links
Identifying an activity's EST is crucial if a just-in-time approach (see Chapter 9) is used,
whereby resources only arrive just in time for the activity for which they will be needed
The critical path REVISED
+ The critical path consists of the series of activities that take the longest to
The critical path of a
complete. Because they take the longest time, they are the ones whose
project is the sequence
on-time completion is critical in ensuring that the project is not delayed.
of activities on which any
On the ‘30p off network’ the critical path is B, D, F and I.
delay will delay the whole
+ The simplest way to spot the critical path is to look for activities whose
project: the activities with
nodes show ESTs and LFTs as equal. The longest activity between these zero float time.
nodes will be the critical path.

+ Show the critical path on a diagram by drawing two short lines across the
critical activities.
+ Identifying the critical path allows managers to focus their attention on
these and their smooth running.
+ Non-critical activities can be delayed by a certain amount (the float time)
without delaying the project. A delay on a critical activity will delay the
whole project.
Float time F REVISED

□
Having float time on an activity, such as the 10 days of float time on activity
A in our example, shows that some slippage on that activity is available. The
formula for calculating the float time on any activity is:
LFT of the activity - duration of the activity - EST of the activity
Remember that activities on the critical path have zero float time.
Calculate the critical path on the project shown below.
Benefits and limitations of critical path

analysis r REVISED
□
Table 13.11 Benefits and limitations of critical path analysis
Benefits Limitations
The careful planning required to work out each activity The diagram can lull managers into a false sense of
involved, its likely duration and what activities must be security. It shows what can happen. To hit deadlines
completed before another can begin, forces a thorough work must actually be completed, which will need careful
planning process. monitoring.
Identifying activities that can be carried out simultaneously Diagrams for really complex projects may become
shortens the overall duration of the project. unmanageably large.
Resources needed for a given activity can be delivered or Not drawing activity lines to scale could be said to devalue
hired just in time for the activity to begin. This delays cash the diagram's visual use.
outflows and avoids having expensive resources sitting
around waiting to be used.
The network diagram shows possible ways of dealing with
any unforeseen delays and getting back on track (perhaps by
allocating extra resources to subsequent critical activities).

14 what formula is used to calculate the float time on an activity?

How can critical path analysis enable a just-in-time approach to managing a
project?
Exam practice
1 Given the weaknesses in quantitative techniques such as decision trees and critical path analysis, their value
rarely outweighs the costs of conducting the techniques. To what extent do you agree with this statement? [20]
2 Calculate the best course of action shown by the following decision tree. [8]
Project A - Net cash Project B - Net cash

flow (£m) flow (£m)
Use 10% discount factors: Year 1 = 0.91; Year 2 = 0.83; Year 3 = 0.75
a) Calculate the minimum time necessary to complete the project shown in the network diagram above.
b) Identify the critical path.
c) Calculate the float time available on activities A and E.

Summary
+ Moving averages, extrapolation and correlation can be + Discounting future cash flows allows investment
used to forecast sales. appraisal to account for the time value of money.
+ Calculating a moving average allows the identification + Net Present Value (NPV) uses discounted cash flows to
of an underlying trend in time series data. assess a project's profitability.
+ Extrapolation means projecting a past trend into the + Qualitative factors should be considered when making
future as a way of forecasting. an investment appraisal decision.
+ Correlation can be used to forecast sales by spotting a + Decision trees set out the options and chance events
relationship between sales and a controllable variable, associated with a decision.
such as advertising spend. + Calculations allow decision trees to give a clear,
+ Using correlation needs very careful consideration of numerate outcome to a decision.
whether and how two variables are causally linked. + Decision trees are usually constructed based on a
+ Payback is a method of investment appraisal that series of estimates.
calculates how long the initial investment takes to be + Critical path analysis is a useful tool for planning and
returned. managing projects.
+ Payback's key weakness is to ignore profit. + ESTs and LFTs for each activity provide vital information
+ Average rate of return (ARR) is a simple to understand in planning the smooth running of a project.
measure of the profitability of an investment. + The critical path of a project is the series of activities on
+ ARR ignores the timing of cash flows. which any delay will delay the whole project.
Exam skills
+ At the end of a section on quantitative decision-making Throw away finishes to answers about a decision tree
techniques, it may seem strange to advise you to treat based question, such as 'Of course, it is all based on
all of these techniques with a pinch of salt. However, assumptions and therefore is likely to be incorrect', add
for each technique you will have noticed that you are no real value to the quality of the answer, so don't use
expected to demonstrate an understanding of their them.
limitations. instead, carefully considered recognition of a
+ Each relies on some kind of simplifying assumption technique's limitations, in context - through exploring
and/or forecasting of the future, which partially how the data used was gathered or devised, and then
undermines their usefulness. making a sensible judgement on the likelihood of its
+ Remember, though, that these techniques form a part accuracy-will demonstrate a real understanding of the
of the specification you are studying, are widely used role of quantitative techniques in business decision
within real businesses and thus must have some value. making, rather than an ill-considered statement about
+ As is so often the case, you must consider the value of results being completely reliable or unreliable.
these techniques with a balanced view. They are neither
perfect nor useless. Your answers must reflect this.

14 Influences on business decisions
Corporate influences
How being a limited company can affect
decision-making
Fundamental internal factors affecting business decision-making have a
tremendous impact on the way a business is run. These corporate influences
have such a deep-rooted effect because they are likely to influence most
major decisions made within the business.
Corporate timescales r REVISED

□
When using data to help make decisions, or considering the targets that are
important to decision-makers, some companies find it hard to look beyond
next month or this year. Others will be willing to overlook short-term
problems, and be able to look further into the future to assess what effect
decisions will have in the long term. They will show patience.
Causes of short-termism
There are four main causes of short-termism within the UK:
Short-termism is when
+ The relationship between pics and financial markets: City investors control
the actions of managers
far more shares in UK pics than private investors. The performance of over-prioritise immediate
these investors, running pension funds and similar investment vehicles, issues, ignoring long-term
tends to be judged quarterly. This encourages them to look for companies ones.
whose performance is strong now, not in a few years’ time.
+ The use of short-term performance measures, such as earnings per share,
to award bonuses: If bonuses for pic bosses are based on indicators which
can be quickly affected by short-term action, the personal temptation will
be to look to enhance bonuses through actions such as buying back shares.
+ The threat of takeover: Boosting short-term profit tends to push a
company’s share price higher. This means that anyone sniffing around
with a takeover in mind will find the business more expensive to buy,
perhaps dissuading them from bidding. Exam tip
+ The functional background of many UK bosses: Many UK pic bosses have
Look for evidence of one
risen through the finance department. Managers from other functional
or more of these causes
areas, such as engineering or marketing, have a far better understanding
of short-termism when
of the need for a long-term perspective when making decisions.
analysing a business case
study. If the evidence is
Now test yourself there, you can build a chain
of logic to explain how
List three main causes of short-termism. these causes can lead to
Answers available online the effects covered below.
Effects of short-termism
As a focus on the short term takes hold in a business, many indicators may
arise, which frequently intensify the focus on the short term, such as:
+ inadequate expenditure on research and development
+ accounting adjustments that inflate current earnings
+ a bias towards using profit for high dividend payments or to buy back
shares, at the expense of investment

+ adopting pay schemes for directors that focus on achieving short-term
financial objectives
+ a willingness to cut the workforce quickly, leading to high labour turnover
and a loss of experience and skills that may be needed in the future
14 influences on business decisions

+ ignoring long-term risks with products and services, such as shifts in
consumer habits or potential obsolescence
+ a focus on takeovers to grow rather than the use of organic growth
+ a shortage of investment in image-building advertising
+ minimal training budgets.
Making links
At the very beginning of Chapter 4 is a section called 'staff as an asset versus staff as
a cost'. This encapsulates the tension between a long-term (staff as an asset) and a
short-term (staff as a cost) way of thinking.
• Long-term thinking
+ Companies willing to show more patience will often find themselves in a
better position competitively in the long term.
+ However, to do this requires the removal of many of the pressures that
lead to short-termism.
+ A great example of long-term thinking can be found in Germany. Major
pics play a far smaller role in the German economy, which is dominated,
instead, by medium-sized private limited companies, often family owned.
These companies are collectively referred to as the Mittelstand.
Common features of a Mittelstand company are:
Figure 14.1 Features of a Mittelstand company
This focus allows a firm to specialise in that one thing: an example of

Porter’s focused differentiation strategy. The result is that Germany has
a disproportionately high number of world market leaders, admittedly in
specialised niche markets. However, market leadership offers excellent
prospects for long-term profitability.
A comparison of a typical UK pic and a typical Mittelstand company is shown
in Table 14.1.

Table 14.1 The short-termist pic versus the long-termist Mittelstand
Pic Mittelstand
Typical financial structure Strong base of share capital with Strong base of share capital with
moderate gearing moderate gearing
Typical ownership structure Owned by many relatively small Family owned or majority family owned
shareholders with some shares listed on the stock
market
Typical approach to spending on Varies, but many will look for a Desire for very long-term success and a
R&Dand staff training low-spend model with high levels sense of moral duty creates a culture of
of outsourcing (and low investment investment in people and technology
in staff)
Typical business objectives Maximise short-term share price to Maintain a world-leading position to
keep the market happy, and to enjoy a hand over a continuingly successful
big bonus due to the high share price business to the next generation
Now test yourself
State three likely consequences of short-termism within a business.

Evidence-based versus subjective

decision-making REVISED
□
Evidence-based decision-making
+ Large businesses, with access to sophisticated computer systems, make
many routine decisions automatically.
+ A sales forecast, based on recent trends and figures for the same time last
year, can automatically generate decisions on issues such as how much
stock to order or how many staff need to be at work on a given day.
+ This type of decision-making - evidence-based or scientific decision
making - dates back at least as far as F.W. Taylor, who advocated managers
finding the one best way to do tasks.
+ Taylor used time and motion study - a method of experimenting with
processes - to identify the best way to complete a task. This approach
generated the desire to measure performance and use the data offered by
measurement to manage the business.
+ The weakness of evidence-based decision-making is its basis in
extrapolation. The expectation that the future will be similar to the past
can prevent revolutionary thinking and decisions.
+ As a result, evidence-based decision-making is less effective when facing
strategic decisions, for which limited data may be available.
Making links
All of the previous chapter on decision-making techniques comes from a way of
thinking that seeks to make decisions based on evidence, even when that evidence
consists of forecasts that may or may not be particularly accurate.
Subjective decision-making
+ Subjective decision-making - or the use of intuition by managers - allows
human judgement to take precedence over data.
+ It can be thought of as the artistic side of business decision-making, in
contrast to the scientific approach.
+ Of course, sometimes intuitive decision-makers have the wrong hunch,
but, without demoting the importance of data, many great business
decisions would never have been made.

+ Table 14.2 shows examples of good and bad decisions that would have
been made more on the basis of intuition than data.
Table 14.2 Some good and some awful real-life business decisions

Good business decisions Bad business decisions
When Google bought a small start-up software company for Waterstones bookshop decided to stop selling books online,
£50m in 2005, few had heard of Android software. By 2019, because 'online will never be more than 10 per cent of the
that £50m investment had 2.3 billion users worldwide market'
In June 2000, Nick Robertson and Quentin Griffiths launched Malcolm Walker, owner of Iceland Frozen Foods, took
'As Seen on Screen'; first year sales were £3.6 million. By 2019, the business upmarket, focusing on organic products; it
ASOS had sales of £2.73 billion didn't last
Unloved Mondelez (owner of Cadbury) launched Belvita Rupert Murdoch, media mogul, sold MySpace website
Breakfast Biscuits in 2010. The grocery trade laughed at the for $35 million, having bought it for $580 million six years
idea, but by 2019 Belvita sales had grown to £83 million - before
that is more than Jaffa Cakes
With recession biting, Waitrose launched its Essentials Google+ was launched in 2011. It was not welcomed,
range of lower-priced groceries. By 2020, sales of Essentials likened to a poorer version of Facebook. Even when Google
exceeded £1 billion a year and waitrose extended the range sought to require users of other google products to create
to over 1500 more items a Google+ account, things did not improve. Google+ was
finally withdrawn in 2018
Typical mistake
There is not a right or wrong way to make decisions. Although routine decisions are
better suited to evidence-based decision-making and strategic decisions may be hard
to make in an evidence-based way, much effective decision-making involves elements
of both approaches.
For which type of decisions is evidence-based decision-making most useful?

Corporate culture
How people in an organisation tend Making links
to behave Note here the reference

back to recruitment and
Easiest thought of as ‘the way we do things round here’, corporate culture training covered in Chapter 4,
impacts on the way businesses behave, as it strongly influences the way the and their role in shaping
people working for the business behave. Culture will be determined by several something as fundamental
key factors, including: as corporate culture.
+ the aims or mission of the business
+ the behaviour of company directors and senior staff Corporate culture sums
+ the attitude of senior managers to risk and enterprising behaviour up the spirit, attitudes,
+ recruitment and training procedures. behaviours and the ethos of
an organisation.
Strong and weak cultures REVISED
Where a clear sense of shared beliefs and behaviours exists, a company can Making links
be said to have a strong culture. The difference between a strong and a weak
culture can be summarised in the following two issues: Chapter 11 introduced
+ Is there a ‘can-do’ attitude or a ‘must we?’ attitude? the concept of mission. A
+ Is there a conviction among staff that the organisation is a force for good, company with a clear sense
of mission is more likely to
rather than just a money-making machine?
develop a strong, positive
culture.

Table 14.3 Strong versus weak corporate culture
Signs of a strong culture Signs of a weak culture

+ Focusing on customers' real needs, allowing staff to + Staff follow a script when dealing with customers (not
make decisions, e.g. refunds trusted to know what is right)
+ Staff show a real feeling for the organisation as 'us', as a + 'Us' tends to be a department, not the business as a
long-term commitment whole; and there may even be a feeling of 'them and us'
+ A united view among staff that the organisation is a + A cynical view among many staff, doubting the
force for good, e.g. staff at Greggs taking pride in the company's supposed principles and ethos; suspecting
company's support for school breakfast clubs that there is too much PR spin; too little commitment
+ Sticking together and working together at a time of crisis + When things look bad, better qualified staff look to find
another job
4 If senior leaders do not follow some of the rules that most staff have to follow,
will corporate culture become stronger or weaker?
Handy’s classification of cultures REVISED

□
Charles Handy classified business culture into four types. Identifying the
underlying cultural type of a business can help to explain its actions. Exam tip
if you can use case study
Power culture information to decide what
type of culture is evident
A power culture will occur when there is one or a small group of extremely
within a business, you can
powerful people leading an organisation. Characteristics include:
use Handy's cultural types
+ Everything goes through the boss.
to explain how culture
+ Few rules or procedures are laid down.
affects issues such as
+ Communication is through personal contact.
speed of decision-making,
+ Decision-making is likely to be governed by the desire to please the boss.
responsiveness to change
+ There is an autocratic leadership style. and motivation.
Power cultures can work effectively under great leaders, but too often can lead
to unethical behaviour as the desire to please the boss drives staff to make
poor decisions.
Making links
This culture is frequently found in small businesses where the founder still dominates.
Adjusting the culture is likely to depend on whether the entrepreneur can adjust to
becoming a leader - as explored in Chapter 5.
Role culture
This is likely to exist in an established organisation dominated by rules and
procedures. Characteristics include:
+ Power depends on the position held within the organisational structure.
+ All employees are expected to follow the rules.
+ Career progress will be predictable and based on who follows procedure
best.
+ The culture is bureaucratic, focused on avoiding mistakes.
in a bureaucratic
+ The organisation will struggle to cope with rapid change, especially
organisation initiative is
problematic if there is rapid change in the market. stifled by paperwork and
+ Leadership style is likely to be autocratic or paternalistic. checking and re-checking of
Role culture can be an effective culture for maintaining a company’s current actions.
position but really struggles in dynamic environments.

Making links
The organisational structure (explored in Chapter 4) is absolutely fundamental to how an
organisation operates if it has a role culture. Structures are likely to be tall with many layers.

Explain why companies with a role culture are rarely innovative.
Task culture
In a task culture, the project being worked on is the central focus. Senior
managers allocate projects to teams of employees from different functional
areas. Project teams become the normal working environment for staff.
Characteristics of a task culture include:
+ Each project team is formed for a single project, then disbanded once the
project is complete.
+ An individual’s power depends on their expertise rather than their status
within the organisational structure.
+ Employees become used to working with staff from other
departments - helping employees to understand the different
perspectives of each functional area.
This culture works when dealing with rapid change. However, a potential
drawback is the chance of project teams developing their own objectives
rather than sticking to the corporate objectives.
Person culture
Operating in organisations with highly skilled, professional staff, a person
culture sees individuals form groups in which they share their knowledge
and expertise. In this way, individuals can develop new skills and knowledge.
Characteristics include:
+ Staff are well paid and well treated.
+ Leadership style is democratic.
+ Staff feel a sense of personal development, which is likely to be highly
motivating.

□
6 List Handy's four cultural types.
How corporate culture is formed REVISED

□
Several factors will affect the formation of a company’s culture: leadership style,
type of ownership and recruitment policies. These are explained in Table 14.4.
Table 14.4 Factors affecting corporate culture
Factor Explanation
Leadership style Organisations formed by an entrepreneur with a strong character who is still in charge, or who led
the organisation for a long time, may reflect that leader's personality, such as Richard Branson's
unfailing entrepreneurial urge at Virgin
Type of ownership Pics are likely to place the need to satisfy stock markets above all else. This can create a culture
where short-term returns are encouraged, unlike privately owned family firms where a longer-term
perspective can emerge
Recruitment policies Where recruitment policies end up appointing 'identikit' versions of existing senior staff, a workforce
can begin to lack diversity. Even worse is when this creates a workforce that is dissimilar to customers.
Policies and procedures can develop which actively harm a business's success in the market

Making links
Note how the key influences on formation of culture were all covered in the first half
of this book, with recruitment and leadership style in Chapter 4 and type of ownership
detailed in Chapter 5.
Difficulties in changing corporate culture REVISED
Typical mistake
Students looking to explain that a company needs to change the way it operates
can too often throw in the phrase 'change the corporate culture' without fully
acknowledging just how difficult cultural change is to achieve. References to changing
culture should always be accompanied by an explanation of the difficulties in so doing.
Most humans have an aversion to changing firmly established routines. The

problem of organisational change in general is detailed in Chapter 16 (see
page 202). However, changing the way people do things is not easy. Reasons
why people will resist attempts to change culture include:
+ self-interest
+ low tolerance to change
+ misunderstanding of the proposed change
+ different assessments of the need to change.
Making links
Much resistance to change can be explained through a recognition that change may
threaten an employee's security needs - the second layer of Maslow's hierarchy (see
Chapter 4).
Cultural change, if it is to be successful, needs a combination of several key

factors:
+ a clear purpose
+ education and training
+ consistency of communication methods and messages
+ effective communication that change is going to happen.
State three factors that will influence the formation of corporate culture.
State three reasons why changing culture may be hard to achieve.
Shareholders versus
stakeholders
The frequent tension between shareholders
and other groups affected by a business
Stakeholders are dealt with by businesses on a daily basis:
Stakeholders are groups
+ Customers, suppliers and staff are all affected by and have an effect on
that are influenced by and
businesses. influence the operations of
+ It therefore seems sensible, when making decisions, to try to meet the a business.
needs of all stakeholder groups, in order to ensure their continued positive
relationship with the business.
+ This approach to running a business is known as the stakeholder
approach.

In contrast, some believe that the sole, or at least dominant, responsibility a
Shareholders are the
business has is to its shareholders: the owners of the business.
owners of a limited
+ This philosophy - the shareholder approach - places increasing
company.
shareholder value, through increased profit and share price, above all

other responsibilities.
+ Under the shareholder approach, other stakeholder groups can have their
interests ignored.
Internal and external stakeholders REVISED

□
Typical mistake
Small shareholders, especially in large pics, have little real influence over the business
and take no major part in its day-to-day decision-making. They should therefore be
considered as external stakeholders. Where a major shareholder is actively involved in
the business as its owner, they should be considered as an internal stakeholder.
+ A business is more likely to keep stakeholders happy if it draws them

towards the category of internal stakeholders, since these groups are more
likely to feel a part of the business.
+ An example here is franchisees of a business such as Subway, where if
the organisation makes franchisees feel valued as internal stakeholders,
the franchises are far more likely to be run along the lines the franchisor
wants.
State three internal stakeholders and three external stakeholders of a pic.
Internal
stakeholders
Employees
Managers
Owners
Figure 14.2 internal and external stakeholders

Stakeholder objectives REVISED
Each stakeholder group is likely to have their own objectives that they want
the firm to achieve, which will suit their own interests. Several stakeholder
groups and their main objectives are listed in Table 14.5:
Table 14.5 Stakeholder objectives
Group Objective
staff Growth (preferably organic), new technology products, not
processes, introduced, and rising profit (if profit sharing takes place)
Managers/ Growth (organic or inorganic), new products and processes, rising
directors profits (especially if bonuses are paid)
Shareholders Rising profits in the short and long term
Suppliers Growth
Customers Quality of product/service, innovative new products
Bankers Stable profits
Local residents Clean, green production with few deliveries or dispatches
Stakeholder and shareholder influences ' REVISED

□
+ Where stakeholder views are listened to and acted upon, a business can
operate as a force for good for most stakeholders most of the time.
+ Some businesses, such as John Lewis, recognise that treating all
stakeholders well has benefits for the whole business, including its owners.
+ Committed suppliers, loyal customers, motivated staff and positive local
residents are more likely to add up to long-term, sustained profitability.
+ However, where shareholder influence dominates, businesses may be
forced into actions that prioritise the short-term needs of shareholders to
the detriment of the business’s long-term success.
+ For example, treating suppliers poorly may boost cash flow or profitability
but does not create a relationship where suppliers will be willing to go out
of their way to make emergency deliveries when stocks are running low.
Conflict between shareholder and

stakeholder objectives REVISED
□
+ By their nature, different stakeholder groups have different priorities when
it comes to what they want from a business.
+ It is therefore no surprise that conflict exists between shareholder
objectives and those of other stakeholder groups.
+ Some businesses manage to balance the needs of these groups effectively
in certain situations.
+ For others, conflict can result in poor performance. Examples of shared
and conflicting stakeholder objectives are shown in Table 14.6.
Table 14.6 Stakeholder needs in different business circumstances
Situation Shared stakeholder interests/ Conflicting stakeholder interests/

needs needs
Productivity advance - perhaps coming Shareholders, managers and Managers and employees (threats of
from a staff suggestion scheme customers redundancy)
Fashion or weather turns in your favour Shareholders, managers, suppliers and Green campaigners may object to
employees increased resource use
Consumer demand switches from Shareholders and customers Managers and employees
shops to e- and m-commerce
High and rising inflation Shareholders and managers Employees, suppliers and customers

Exam tip
When considering which stakeholder group is likely to win out in a situation of
conflicting objectives, look for evidence elsewhere within the case study as to

whether the business seems to follow the stakeholder or shareholder approach.
Now test yourself
Briefly explain how satisfying stakeholder needs helps a business.

TESTED
□
Give two examples of business decisions where shareholders' needs may conflict
with those of staff.
Business ethics
The role of morality in business decisions
What are business ethics? REVISED
Making an ethical decision means taking a course of action which is morally Business ethics are
right. The extent to which business decisions consider the moral dimension the moral principles that
will be determined by two key aspects: underpin decision-making.
1 The personal moral beliefs of the individual making the decision - what
they consider to be morally justifiable.
2 The corporate culture, which will influence the beliefs of the decision
maker as to what would be considered morally acceptable by the company
as a whole.
Ethical considerations can be found throughout the operations of a business.
A few examples include:
+ dealing fairly and honestly with customers and suppliers
+ protecting the natural environment
+ dealing effectively with bullying, harassment and discrimination in the
workplace
+ providing accurate and transparent financial information
+ anticompetitive actions
+ not testing products on animals
+ whistleblowing of unethical actions by members of staff.
The ethics of strategic decisions REVISED
Given the importance of strategic decisions - defined as decisions that affect

the whole firm and are hard to reverse - the morality of these decisions
should be carefully considered.
Two key aspects of ethics in strategic decision-making arise regularly:
1 Whether the moral aspects of a decision have been fully considered. Some
simple decisions such as selling off part of a business to a new owner may
seem logical financially, but have the owners thought through the effect
on their soon-to-be former employees, and the communities that rely
on their incomes if the division may be closed down quickly by its new
owners?

2 The level of risk and who bears the risk. In the scenario above, where part
of a business is sold to new owners, the new owners may be confident that
they can close the division, sell its assets and fully cover the costs of the
purchase. In this case, the deal carries little risk to the new owners. The
risk is borne by the staff and their dependents - if the deal does not work
well, they will have lost their jobs. In many cases, those that stand to profit
from business decisions bear only a small part of the consequences of any
possible downside. This is morally wrong.
Now test yourself I
12 What two key factors will influence the ethics of any business decision?
in strategic decision-making, unethical decisions may be taken if what two features
are unfairly shared by different stakeholder groups?
Trade-offs between ethics and profit REVISED

□
+ Perhaps the truest test of ethical behaviour from a business is its
willingness to sacrifice profit in order to do what is right.
+ In the short term at least, ethical behaviour often means paying a little
more or making a little less on a business transaction.
+ Alternatively, ethical behaviour may involve spending money on workers’
conditions without expecting any financial return. There is almost always
a clear trade-off between what is morally right and what is most profitable.
+ That is not to suggest that profit is unethical. Without profit, businesses
would fail, creating redundancies and financial hardship.
+ The grey area tends to be how much profit is made. Firms that behave
unethically do so in order to maximise the possible profit they can receive.
Ethically run businesses aim to behave well in making a level of profit that
represents a satisfactory return on the risks they take.
Making links
Ethics by themselves present few problems to businesses. However, no business can
afford to ignore the impact of its decisions on its profit margins (as covered in
Chapter 8) and it is the question of balancing ethical behaviour with profitability that
makes this area so challenging.
Typical mistake
Don't confuse a company that paints itself as being 'ethically concerned' - merely
as a marketing ploy to try to add value or differentiate its products - with one that
considers the morality of its decisions, it is rare to find that genuine ethical behaviour
has a positive effect on profit. It is not unheard of, but it certainly doesn't happen as
often as companies launching 'ethically branded' products or services.
Pay and rewards 1 REVISED

□
+ The major ethical issue related to pay and rewards is the disparity between
the pay of bosses and workers.
+ When CEOs of pics total up the value of their salary, pension contributions,
share options and bonuses, these will be many times higher than the
pay received by those who work for their business and allow it to keep
functioning.
+ Of course, executives probably should be paid more given the level of
responsibility, need for major decision-making and the likely rarity of the
skills and experience they need to get the job done.
81

+ For example, John Lewis’s constitution - the rules of how the business is
run - limits the Chief Executive’s pay to no more than 75 times the average
salary. Although that sounds a lot, there is general acceptance that this is a
fair pay multiple; if the average worker gets £20,000 a year, the boss should

not be paid more than £1.5 million a year.
+ If that sounds a lot, a study of the pay of other CEOs would reveal much
higher pay multiples. The question is whether the extra pay offered to top
bosses has outstripped the extra risk involved in doing their jobs.
Making links
There is a clear link here
back to the topic of financial
reward systems covered
first in Chapter 4.
Corporate social responsibility REVISED

□
CSR could be a phenomenal way of self-regulating business activity. If
Corporate social
businesses commit to behaving responsibly so that their actions contribute
responsibility (CSR)
positively to the societies in which they operate, perhaps our world would be
describes the desire to
better. However, although some businesses take their social responsibilities
run a business in a morally
seriously, some will use the CSR label merely as a marketing tool without fully
correct way, attempting
committing to behaving in a socially responsible manner. to balance the needs of all
stakeholder groups.
Table 14.7 Advantages and disadvantages of CSR
Companies that behave, or seem to behave, in a Shareholders and other stakeholders reject the usefulness
responsible way towards their stakeholders can gain from of CSR for reasons that include:
doing so:
Marketing advantages: Consumers who have enough Reduced profitability: Genuinely embracing CSR is likely
disposable income will often pay a premium so that they to mean higher costs and perhaps lower revenues, with
can buy with a clear conscience from businesses that suppliers paid a fair price and selling prices set at a
behave in a socially responsible way. CSR can be a point of reasonable rather than a rip-off level
differentiation for some businesses Reduced growth prospects: Some business opportunities
may need to be turned down if they involve compromising
the morality needed to be socially responsible
Positive effects on the workforce: Recruiting high-flying Rejection of CSR as a PR tool: There is plenty of evidence to
staff may be easier if they do not wish to work for a morally suggest that CSR is often treated as a marketing tool rather
corrupt enterprise. Meanwhile, staff motivation may than an inherent shift in corporate culture: in which case, it
be enhanced as they feel happier working for a socially serves no valid purpose
responsible business with a clear sense of moral purpose If social responsibility means hiking up the price of food
that low income consumers need to eat healthily, perhaps
it is better to sacrifice the needs of suppliers to ensure
that even those on low incomes can access fresh fruit and
vegetables
Typical mistake
Please get your spelling right - moral relates to right and wrong. Morale is the sense
of togetherness that a group of people have. When discussing the effects of a moral
approach to decision-making it is right to suggest this can have a positive effect on
staff morale. It is wrong to say that staff morals can be enhanced by good morale in
decision-making.

Exam practice
Each year the Reputation institute publishes its Global The business has a much-admired corporate culture,
Study of 'The world's Most Reputable Companies'. This based on openness and trust in the core values of:
influences on business decisions

measures perceptions such as innovation, products, + creativity
financial performance and how they behave as a business + imagination
in wider society. In 2019, the Lego Group topped the poll + fun
for the fourth consecutive year. + learning
+ quality and care.
The family-owned Danish toy company, nearly 100
years old and still a private limited company, has seen 1 a) Assess the likely reasons for the Lego Group's
exceptional financial performance over the past 15 years, reputation for ethical behaviour. [10]
during which time it has also doubled its market share. b) Assess why the Lego Group is likely to take a
Lego has shown a strong commitment to corporate social long-term approach to decision-making. [10]
responsibility, including a pledge to use 100 per cent 2 ‘Creating the right corporate culture is the single
sustainably sourced materials by 2030 - quite a challenge most important part of a leader's job.' Assess the
for a company whose core business is manufacturing validity of this statement. [20]
plastic bricks. Plant-based alternatives are already being
introduced to the Lego range.
74
Summary
+ Key influences on decision-making within organisations + Key influences on corporate culture include:
include: + ownership type
+ the timescales considered when making decisions: + the founder's personal philosophy
short-termism versus long-term thinking + recruitment procedures.
+ whether decisions are made in an evidence-based + Corporate culture is hard to change.
or intuitive or subjective manner. + The stakeholder approach and the shareholder
+ Strategic decisions tend to involve more subjectivity, approach represent differing attitudes regarding to
while routine decisions are better suited to evidence whom a business is responsible.
based decision-making. + Different stakeholder groups have different objectives.
+ Pics are naturally more likely to consider the short-term + The objectives of different stakeholder groups are likely
effects of decisions. Long-term thinking is more likely to to conflict.
be found in private limited companies. + Business ethics are the moral principles underpinning
+ Corporate culture affects every aspect of business business decision-making.
activity. + There is usually a trade-off between ethics and profits.
+ Handy proposed four common types of corporate
culture to explain how most businesses do things.
Exam skills
This chapter on the influences on business decisions is a + Recognition of context - what is the business in the
good place to explore the importance of inference when question really like - is a sure-fire way to impress an
tackling exam questions with any kind of case study examiner with your ability to give mature and reasoned
stimulus: answers to business questions, instead of simply
+ Reading between the lines of case study materials, and churning out a string of uncontextualised business
this can mean numerical information as well as purely knowledge which fails to recognise the fundamental
verbal text, allows a far greater understanding of the importance to the subject of the context in which a
context within which you are answering a question. question is asked.
+ in a simple sense, noticing that a business seems + Each type of influence on decisions may be implied
to display a certain cultural type means that any within a case study, without being clearly stated.
suggested actions you recommend, or consideration of Culture, long-term or short-term time frames, relative
a suggestion in the question, must be viewed through importance of ethics in decision-making and even the
the prism of that organisational culture. Getting staff relative importance of stakeholders other than major
used to operating in a role culture to take risks and shareholders are all likely to be written into a business
make quick decisions may be doomed to failure - case study without being explicitly stated. Look for the
not because the strategy is wrong, but because the clues to these, and then recognise that they form a vital
organisation is unlikely to be able to implement the part of the context within which you are answering the
strategy. question.

Interpretation of financial
statements
How to read and understand balance sheets
and profit and loss accounts
Accounts are produced to provide information on the finances of a business
to its stakeholders. Shareholders, managers, bankers and suppliers will all be
interested to know one or more of the following about the business they are
dealing with:
+ The amount of cash available to the business
+ How that cash compares with the amount of short-term debt owed by the
business
+ How much of the firm’s long-term finance is borrowed A profit and loss account
+ How profitable the business is. shows a firm's revenue for
a time period along with all
The two major documents that all companies are required, by law, to publish the costs associated with
each year can provide this information. They are: generating that revenue.
+ The statement of comprehensive income, usually called the profit and loss
A balance sheet is a
account. This shows the revenue generated by the business this year and
financial document showing
the costs that were incurred in generating that revenue.
a business's assets and
+ The statement of financial position, usually called the balance sheet. This
liabilities ata point in time.
details what the business owns, owes and where the money came from.
Balance sheets (statement of financial

position) REVISED
□
Balance sheets show how wealthy a business is. They do this by listing
everything the business owns.
In addition, a balance sheet lists the money owed by the business - its
liabilities. The final part of a balance sheet details the shareholders’
contribution to the business - the capital they have provided.
Table 15.1 An example of a simplified balance sheet
Simplified balance sheet

£
Long-term (non-current) assets 300,000
Short-term (current) assets 100,000
Total assets 400,000
Balancing with: Total capital 400,000
1 Why might a bank be interested in seeing the balance sheet of a company applying
for a loan?

Types of asset
Long-term (non-current) assets are used over and over again by a business to
An asset is any item owned
generate profit. Examples include:
by a business.
+ land and buildings
+ machinery and equipment Liquidity is the term used
+ vehicles to describe a firm's ability to
+ patents or copyright. pay its bills and to finance
short-term spending.
Current assets are short-term assets that change regularly. There are three
main types:
Table 15.2 Current assets
Type of asset Description

Stock This is the value of any stocks or inventories of raw materials,
partially finished goods or finished products owned by the
business.
Receivables This is money owed to the business, usually by customers who
have bought on credit.
Cash This is money available in the bank that can be immediately
accessed along with physical cash.
Capital on the balance sheet

There are three sources of capital shown on a balance sheet:
+ Banks: Loans from banks carry interest payments and must be repaid.
+ Shareholders: When the company sells shares, it receives share capital in Typical mistake
return. This is theoretically owed to shareholders but is very rarely ever Note that reserves are not
repaid. money that the firm has
+ Profits: The reserves figure on a balance sheet shows the total amount of available to spend. This
retained profit that has been kept in the business as a source of finance. simply shows where money
has come from; it is likely
A final version of a balance sheet is shown in Table 15.3. Note that the column
that most has already been
to the right shows sub-totals from figures in the other column.
spent on assets, shown on
the top part of the balance
Table 15.3 An example of the final version of a balance sheet
sheet.
Balance sheet for 31 December last year
£ £
Making links
Property 180,000
Notice that the capital on
Machinery and vehicles 120,000 300,000 the balance sheet section
Stock 80,000 is the part of the balance
sheet that will detail the
Receivables and cash 60,000
long-term sources of
Current liabilities (40,000) finance (see Chapter 6) for a
Total assets less current liabilities 400,000 business.
Loan capital (250,000)

Net assets 150,000
Share capital 50,000
Reserves 100,000
Total equity 150,000
Which three long-term methods of finance are shown on a typical balance sheet?
85

Key information: assessing financial
performance using a balance sheet 1 REVISED
□
+ Typically, a business’s financial performance is measured by profit, as
shown on the profit and loss account.
+ However, longer-term performance can be assessed using the balance
sheet by seeing the movements in reserves over time.
+ Reserves build up over time (for a successful firm) because any profit the
firm makes after tax that is not paid out in dividends is retained in the
business.
+ This annual retained profit is added to the reserves figure on the balance
sheet. If the firm makes a loss for the year, this figure is deducted from
reserves on the balance sheet. This means that if the reserves figure is
consistently rising over time, the firm has been consistently profitable.
Stakeholder interest in balance sheets REVISED
Published accounts exist in order to ensure that stakeholders have access to

the information that helps them make informed dealings with a business.
Different stakeholders will be interested in a company’s balance sheet for
different reasons as shown in Table 15.4.
Table 15.4 Different interests in the balance sheet
Stakeholder interest in the balance sheet

Bankers Keen to understand a business's reliance on debt for its long-term
finance, bankerswill study the relationship between long-term
borrowings and total equity
Suppliers More interested in the short-term financial health of the business,
suppliers considering offering credit will want to see the relationship
between the company's available cash and its existing short-term debt
Staff May be looking at reserves to assess whether the 'wealth' of the Making links
business has gone up or down over time, perhaps wondering whether
they are receiving a fair reward for their efforts if reserves have Given the last chapter's
rocketed exploration of how different
stakeholders often have
conflicting aims, it is not
Now test yourself a surprise to note that
different groups will be
Using 140 characters or less, what does a balance sheet show?
interested in different
Using 140 characters or less, what is meant by reserves? sections of the balance
Answers available online sheet for different reasons.
Profit and loss (P&L) accounts (statement of

comprehensive income) REVISED
The profit and loss account is the record of how well a firm has done
financially in a given period of time. The financial measure of performance is
profit, therefore the profit and loss account shows a variety of different types
of profit to help stakeholders studying the account understand the business’s
performance.

How a P&L account shows profit or loss REVISED
□
In simple terms, a profit and loss account starts with annual revenue, then
deducts different costs and expenses to calculate different types of profit. A
basic profit and loss account is shown in Table 15.5.
Table 15.5 The basic structure of a profit and loss account
£m
Revenue 26.0
Less Cost of sales (17.0)
Gives Gross profit 9.0
Less Overheads (4.0)
Gives Operating profit 5.0
Less Financing costs 1.5*
Gives Profit before taxation 6.5
Less Tax (2.0)
Gives Profit after taxation for the year 4.5 Cost of sales is the cost
*ln this case more interest was earned than was paid out of buying or making the
products sold to generate
the revenue for the year.
Gross profit
Overheads, or expenses,
Gross profit is a raw measure of basic trading profit. It shows what is left from
or overhead expenses
revenue once the cost of making or buying the goods sold (cost of sales) has
are payments for something
been deducted.
that is of immediate use to
Revenue - cost of sales = gross profit the business, other than the
actual products they sell.
Operating profit
To move from gross to operating profit, overhead expenses are deducted.
Gross profit - expenses = operating profit
Expenses include items such as wages and salaries, rent and rates, heat and
light, and distribution and marketing costs. Therefore, operating profit shows
the amount of profit left after deducting the normal costs of operating the
business for the year.
Briefly explain why operating profit shows most clearly how well a business has
been run in any given year.
Profit before and after tax

Beneath operating profit, the profit and loss account deals with issues such as
the cost of financing the business, taxation and how profits are used. First, an
entry is made for net financing costs. This is simply:
Interest earned on money - interest on money borrowed
held by the business by the business
+ A negative figure is typical as many businesses borrow greater sums

than they keep at any time in the bank (and interest rates on loans will be
higher than those paid out on money in the bank).

+ This figure is deducted from operating profit to calculate the profit before
tax is deducted. With corporation tax taken away, the business is left with
profit after tax - also referred to as net profit for the year.
+ This is the profit that ‘belongs’ to the shareholders.
Table 15.6 shows the profit and loss account for SuperClothes pic for the year
ending 31 March 2020, with equivalent 2019 figures also shown.
Table 15.6 Summarised profit and loss account for SuperClothes pic (year ended
31 March 2020)
2020 (£m) 2019 (£m)

Revenue (sales excluding vat) 486 431
Cost of sales (190) (174)
Gross profit 296 257
Administrative and other expenses (236) (212)
Operating profit 60 45
Net finance expense (0.5) -
Profit before tax 59.9 45
Taxation (13.5) (17.5)
Net profit for the year 46 27.5
Making links
These different types of profit were introduced in Chapter 8. This now shows how
these types of profit appear in formal company accounts.
Using profit
Shareholders are left with a simple choice: should they withdraw profit after
tax for their own benefit, or leave that money in the business to finance
extra spending by the firm? It is directors who will recommend the balance
between these two uses of profit. They are likely to consider:
+ how much money the firm needs to finance future plans
+ how much dividend shareholders have received in the past
+ shareholders’ expectations for this year’s dividend.
If the majority of shareholders are unhappy with the recommendation, they
can vote against this at the annual general meeting (AGM).
Key information: assessing financial

performance using a P&L account REVISED
□
+ Sadly, company law does not require companies to publish a lot of detail in
the profit and loss account. That shown above complies with the law.
+ However, assessment of financial performance can be made by checking
which direction profits are headed. Increasing profits suggest improving
financial performance. However, before making a final decision on
performance, ratios should be calculated, as explained in the next topic.
+ Shareholders will be particularly interested in levels of net profit. Those
more concerned with the operating performance of the business will
consider operating profit all important.
+ Few will see gross profit as the most important profit figure, yet it does
reveal information on the basic profitability of the business that will be of
interest to competitors.

Exam tip
Look out for profit and loss accounts where different profit figures move in different
directions. These can provide great opportunities to show insight. If gross profit rises but
operating profit falls, the firm has probably struggled to control its expenses for the year.
A company whose gross and operating profits rise, but net profit falls, may have taken
on significant extra borrowings, pushing up the net financing cost of the business.
Using 140 characters or less, what does a profit and loss account show?
State three stakeholders who will be interested in seeing a company's accounts
and, for each, briefly explain why.
Ratio analysis
Using calculations to analyse balance sheets
and profit and loss accounts
Financial accounting statements provide useful data that can be helpful
in assessing the performance and health of a business. However, the raw
data itself can only tell the reader so much. More powerful analysis can be
achieved by looking at financial variables in relation to others - calculating
financial ratios.
Types of ratio REVISED

□
The three main classifications of ratio are profitability, liquidity and gearing.
Table 15.7 Aspects of company finance assessed by ratios
Aspect of financial performance Explanation

Profitability This shows the relationship between gross/
operating/net profit and revenue, assets and capital
Liquidity This shows the ability of a firm to meet its short
term debts with cash or near cash assets
Gearing This shows the proportion of the long-term
finance in a business that has come from loans
Each ratio provides information about a different aspect of the company’s

performance (profitability) and financial health (liquidity and gearing). Taken
together, they can really unveil some of the secrets of the financial statements.
Liquidity ratios F REVISED

□
The concept of liquidity first arose in Chapter 8. The current ratio shows how it is If either liquidity ratio goes
measured from the data on a balance sheet. too high, the firm may have
too much money tied up in
Both liquidity ratios are calculated in order to understand the balance stock, debtors or cash. This
between the company’s short-term debt and the assets it can use to meet that money could generate a far
debt: cash or other current assets that can be speedily turned into cash. greater return if invested in
non-current assets. Holding
excessive current assets may
Current ratio feel safe but is likely to damage
current assets
Current ratio =----------------------- a company's return on capital
employed (ROCE) ratio. 189
current liabilities

+ The ideal value for the current ratio is 1.5, meaning that a business would
have £1.50 of current assets for every £1 of short-term debt, which is
deemed enough to be able to cover the debts comfortably without holding
too many resources in unproductive forms, where they could be better
invested elsewhere.
+ If the ratio falls too low, this may indicate that the firm is suffering from Typical mistake
a liquidity crisis, so is unable to find enough cash to settle debts as they
become due. Low liquidity ratios, an
acid test well below 1 or
a current ratio close to
Acid test ratio or below 1, can indicate
A stiffer test of liquidity than the current ratio, the acid test ratio discounts financial problems.
inventories as something that can be quickly converted to cash. However, for many
current assets (excluding inventories/stock) companies, getting hold of
Acid test ratio =------------------------------------------------------------ extra cash in the short term
current liabilities is not a problem, so they
The ideal value for this ratio is 1. This would mean a company has £1 of cash do not need to maintain a
high cash balance to cover
or receivables to cover every £1 of short-term debt.
short-term debt. For a
Now test yourself TESTED supermarket such as Tesco
(with an acid test usually
For a company with current liabilities of £50,000, stock of £50,000 and other around 0.5), millions of
current assets worth £70,000, calculate pounds of cash enter the
a) current ratio business every single day -
b) acid test ratio. cash that can be diverted
to meet short-term debt
Answers available online should the need arise.
Gearing r REVISED
□
Measuring the long-term financial health of a business, the gearing ratio
Capital employed adds
expresses long-term liabilities as a percentage of the total amount of long
shareholders' capital (total
term capital (capital employed) in the business.
equity) to loan capital (long
long-term liabilities term liabilities) to work out
Gearing ratio =--------------------------- x 100 the total long-term finance
capital employed in the business.
+ In other words, if a business is financed by £50m of loans and £50m of
equity, the gearing ratio would be 50%. Indeed, 50% is regarded as the
Typical mistake
danger level over which it is normally inadvisable to pass.
+ The problem with a high gearing is the cash drain it represents: with Sometimes a balance sheet
interest payments to make, as well as loan repayments, high levels of debt will use brackets around a
can suck the lifeblood from a business rapidly. figure for liabilities to remind
the user that this is a debt.
To reduce an unhealthily high gearing ratio, several options are open: When using a bracketed
+ Issue more shares. liability figure to calculate
+ Retain more profits. a ratio (acid test, current or
+ Repay some loans. gearing) you should ignore
the minus sign.
A business has long-term liabilities of £250,000. Their capital employed is Making links
£400,000. The business is considering taking out an extra £100,000 bank loan.
Calculate their gearing ratio: The gearing ratio is clearly
directly influenced by
a) before taking out the extra loan
decisions over which
b) after taking out the extra loan.
sources of finance are
Answers available online used - as explored in
Chapter 6.

Profitability ratios F REVISED
+ Assessing how profitable a business has been can be done using the actual
figures for profit over several years.
+ However, more powerfully, profitability can be assessed by calculating
profit margins. These show profit as a percentage of revenue.
+ The most profitable firms are able to ensure that a greater proportion of
every £1 in revenue is left over as profit once costs have been deducted.
+ Profit margins were covered in more detail in Chapter 8 (see page 100). A
summary is provided in Table 15.8.
Table 15.8 Summary of profit margins and profitability
Gross profit margin Operating profit margin Net profit margin

Formula Net profit Operating profit Profit after tax
-------------------- x 100 ------------------------x 100 ------------------------x 100
Sales revenue Sales revenue Sales revenue
What it shows Gross profit per £ of sales Operating profit per £ of sales Net profit per £ of sales
How to improve it Price up Boost gross margin Boost operating profit margins
Unit variable costs down Cut overheads per £ of sales Cut corporation tax bill
(legally!)
increase sales
Problem if it is too low May not be enough gross May not be enough operating May be too low to provide
profit to cover overhead profit to reinvest into the shareholders with acceptable
expenses business and so get growth annual dividends
Return on capital employed (ROCE)

Another measure of profitability is the ROCE ratio. This expresses operating
profit as a percentage of the capital that has been invested in the business.
Therefore it shows a return on that capital that is comparable with other
potential uses of capital, such as simply leaving money in the bank to earn
interest.
operating profit
Return on capital employed =------------------------- x 100
capital employed
+ Higher is better for this ratio, since a higher return means the money
invested in the business is generating a higher return on that investment.
+ Where ROCE falls below current interest rates, a business may question
whether it would be better off closing, liquidating its assets and putting all
the money in the risk-free bank for a higher return than the risky option of
running a business.
Table 15.9 shows ROCE figures for several pics; notice how significant the
variations are.
Table 15.9 The return on capital employed (ROCE) achieved by a selection of public
limited companies in 2019/2020
Company Annual operating profit Capital employed ROCE

Games Workshop (hobby manufacture £81,199,000 £108,327,000 75.0%
and retail)
Ted Baker (retailing) £18,434,000 £284,100,000 6.5%
Moneysupermarket.com group £108,000,000 £215,300,000 50.2%
(online price-comparison services)
Severn Trent (utilities) £573,600,000 £9,945,900,000 5.7%
In order to boost the ROCE ratio, two options are available:

1 Find a way to increase operating profit.
2 Reduce capital employed without damaging operating profit.

Exam tip
improving capital employed can be achieved by buying back shares from
shareholders. It is this fact that explains the strange sounding notion of returning cash
to shareholders; if share capital is reduced, capital employed falls, yet the transaction
has no impact on operating profit.
A company has total equity of £5m and long-term liabilities of £Wm. Calculate its
return on capital employed if operating profit for the year was £3m.
Interpreting ratios to make business

decisions REVISED
□
Ratios can help to make key business decisions. Gearing and liquidity
ratios help to identify whether a business can afford to invest money in
new projects. Meanwhile, return on capital employed can help to assess
the attractiveness of a new investment (alongside ARR), or identify
underperforming parts of a business.
Table 15.10 shows how ratios can be useful.
Table 15.10 interpreting ratios to make decisions
Decision Ratios Evaluation

Can we afford to spend £50 Acid test 0.95 Finance can come from extra borrowing (to a 50% gearing
million on launching in China? maximum) plus some use of working capital (to an acid test
Gearing 24.5%
minimum of 0.6)
Do we need to put our prices up? Gross margin The problem should be addressed, but price elasticity of
demand must also be considered before proceeding
This year: 8.7%
Last year: 10.2%
Should we focus on Divisions A ROCE figures for: Unless Division c produces something of value to Division A
and B and sell off Division C? or B, there is a strong case for selling it off and focusing on
Division A 22.6%
the strongest areas of the business
Division B 31.4%
Division C 5.7%
Limitations of ratio analysis

+ Ratio analysis is a very helpful tool. Yet there are limits to its ability to tell
us the whole story of a business.
+ The major issue is the lack of detail provided within financial accounts.
Often the true story of a firm’s receivables or stock cannot be seen. If
money owed by customers is mainly owed by reliable, regular customers,
this should turn into cash, which will be received on time.
+ However, if much of the receivables figure on the balance sheet consists
of bad debts from failing customers, acid test and current ratio results will
paint a misleadingly healthy picture.
+ If stock is about to go out of fashion and become virtually worthless, the
current ratio will again present a misleading picture of health.
+ On the profit and loss account, net profit can be affected by one-off
transactions such as selling a piece of property at a profit.
+ Boosting net profit, this will improve the net margin for this year, but this
will simply be a blip, perhaps misleading those who do not investigate
further than a ratio result.

11 which ratio would be most useful to use when:

a) deciding whether prices are too low
b) deciding whether to borrow to buy new machinery
c) assessing whether to offer credit to a new customer?
12 State two actions a business can take to reduce its gearing ratio.
13 What are the ideal values for the
a) current
b) acid test ratios?
1/ What is considered the danger level for the gearing ratio?
15 State two ways to boost a company's ROCE ratio.
Human resources
Measuring and improving the performance
of the people in the business
Managing people ' REVISED
□
The department responsible for making the most of the business’s human
resources - their staff - is the HR (Human Resources) department. They have
a major role to play in boosting the competitiveness of a business. Major
elements of HR management carried out by the department include:
+ Designing jobs: The process of deciding what a particular job entails can be
critical in determining whether the job holder is motivated and effective.
Poor job design can lead to demotivation, poor performance and high
labour turnover.
+ Designing and implementing reward systems: Rewarding staff can be
a complex affair. Not only is it necessary to choose how to pay people -
salary, hourly rate + commission, etc. - but also many companies will
offer a range of fringe benefits. A good reward system will ensure staff are
content with the way they are treated by their employer, and should be
helpful in ensuring effective recruitment takes place.
+ Developing communication systems that work: Choosing appropriate media
and channels by which to relay company-wide information and ensure an
appropriate level of consultation through meetings or other methods.
The emphasis of the HR department’s role will change depending on
corporate objectives and strategy as shown in Table 15.11.
Table 15.11 Objectives and focus of the HR department
Corporate objective Key focus for HR department

Growth Recruiting the right number of extra staff with the right skills in the right places
Adjusting products and services Using training to help staff develop appropriate new skills and expertise and topping
sold this up via recruitment, while perhaps letting some staff go whose skills are no longer
needed
Cost reduction Combining jobs, boosting productivity, redeployment of staff, redundancy
programmes, reducing training budgets
Making links
Clearly quantifying and monitoring HR performance is a natural extension of the basic
roles of the HR department explored in Chapter 4.
93

Monitoring the effectiveness of human
resources REVISED
□
Just as effective management of any business resource involves assessing how
effectively it is being used, so HR management must find ways to assess the
effectiveness of the way that people are managed in the business. As a result,
a number of important HR indicators will be regularly monitored, especially:
+ labour productivity
+ labour turnover
+ absenteeism.
Labour productivity
Perhaps the single most important measure of the effectiveness of staff is
labour productivity:
Output per period
Number of employees per period
A business that is able to boost labour productivity without increasing

pay will enjoy lower labour costs per unit. This should boost their
competitiveness, allowing prices to be cut if needed, or a higher profit margin.
Labour turnover Labour retention is

Measuring the percentage of the workforce that have left during a year, the opposite of labour
this indicator can indicate staff discontent with how they are treated if it turnover - a measurement
increases. of the number of staff that
stay at a business during
Number of staff leaving the firm in a year
----------------------------------------------------------- x 100 a year, it is calculated by
Average number of staff during the year expressing the number of
staff that have stayed with a
Causes of increasing labour turnover could include those shown in Table 15.12.
business during the year as
Table 15.12 Some internal and external causes of increasing labour turnover a percentage of the average
number of staff employed in
internal causes External causes the year.
Poor recruitment and selection, resulting More local vacancies arising, tempting
in the wrong people being appointed staff to look for better opportunities
Poor motivation or leadership Better transport links allowing staff to look
Wage rates below the local norms for alternative jobs further away
High labour turnover has, on the whole, negative effects in most cases.
However, some positives can be found in the right circumstances.
Table 15.13 implications of a high labour turnover
Negatives of a high labour turnover Potential positives of a high labour turnover

Extra recruitment costs to find replacements New workers with new ideas and enthusiasm
Extra training costs for replacements New workers with appropriate skills may be brought in
to prevent the need to re-train existing staff where skill
requirements have changed
Time taken for replacements to settle in and become A new way of looking at problems in the business could
productive bring solutions to long-standing issues
Loss of productivity while replacements are found, trained
and finding their feet
Absenteeism
Measuring the amount of time missed by workers who do not come to
work when they are supposed to can indicate discontent in the workplace.
However, the weakness of this measure is that it fails to distinguish between
19
avoidable and unavoidable absences.

Total days (or hours) of absence in a period
----------------------------------------------------------------------------------x 100 Typical mistake
Possible total days (or hours) that could have been worked
Be careful with both
There is no doubt that a high level of absenteeism causes extra costs and lost absenteeism and labour
productivity that damages a firm’s competitiveness. turnover. They are both
indicators where high
Now test yourself numbers are bad: beware
interpreting rising levels of
16 Briefly explain why higher productivity leads to lower cost per unit. everything in business as
Briefly explain why high labour turnover may cause cash flow problems. good.
Why might Herzberg suggest that new company rules may lead to increased
absenteeism?
Answers available onlinex
Using employee performance data to help

make business decisions 1 REVISED
□
+ As with most data gathered by businesses, employee performance data
can highlight areas where problems exist. Making links
+ The data is unlikely to pin down the cause, or provide the solution.
+ However, analysis of data in this way can uncover major areas where If there is one absolutely clear
improvements need to be made. link to be made for all three
+ This is especially true where comparative data for rivals is available. of these hr measures, it is to
Where a business’s HR data shows it is lagging behind rivals, the topic of motivation that
competitiveness will suffer. we first explored in Chapter
4. Getting motivation right
Exam tip will improve each variable;
getting it wrong will cause
The context may determine the importance of employee performance data. During them to slide.
periods of rapid growth for a business, ideas and solutions, which are virtually
unmeasurable, may be critical to ensuring that a business successfully moves to
a new stage in its development. It is in mature businesses that indicators such as
productivity can be crucial, since productivity gains may represent the best chance to
increase profits - by boosting margins.
Human resource strategies to improve

employee performance REVISED
To improve employee performance, a range of strategies is available. Each

may be appropriate in different circumstances.
Financial rewards
+ Using financial rewards such as performance-related bonuses can be
hazardous. As Herzberg would point out, trying to use a hygiene factor
such as pay to motivate staff will only create a temporary improvement in
performance, which will disappear if the reward disappears.
+ A further problem is in deciding how performance will be measured,
before awarding a bonus.
+ Measure performance in the wrong way and employees may adapt what
they do simply in order to boost their bonus, perhaps in an unexpected
and harmful way.
Employee share ownership

+ Though hypothetically logical, employee share ownership is more likely to
work in small businesses than large ones, where staff may feel their own
performance has no serious impact on the overall profits of the business. 195

+ Share ownership should work by aligning the goals of the business with
those of staff.
+ If staff work better, the company will make more profit, allowing higher
dividends to be paid to shareholders, including the employees.
Consultation strategies
+ Finding an appropriate way to gather employees’ views and, even harder,
show that they are being genuinely considered, can boost employee
engagement and performance.
+ In small businesses, consultation can be a doddle - the boss chats things Consultation means
through with all five members of staff. However, if the business has 50,000 seeking and listening to
staff in 50 countries, this method is not viable. the views of employees as
+ The use of technology can help - by setting up internal chat rooms or a part of a decision-making
forum where staff can have their say - but the challenge of consultation process.
grows as a business grows.
Empowerment means
giving staff the authority
Empowerment strategies not just to decide how to do
Harnessing the theoretical ideas of Maslow and Herzberg, genuinely a task, but to decide what
empowering staff can bring significant increases in employee performance. tasks need doing in the first
However, empowerment can be terrifying to managers, who will still be held place.
accountable for the work of subordinates but cannot even tell them what to
do, let alone how to do it. The key conditions required if empowerment is to
be effective are: Making links
+ clear corporate aims and objectives
Notice how each of these
+ a strong culture of trust
strategies for improving
+ a skilled and talented workforce. employee performance
can be clearly linked to one
Now test yourself or more of the motivation
Briefly explain what the data shows is happening at this business: theorists whose work was
detailed in Chapter 4.
HR indicator 2 years ago 1 year ago This year
Labour productivity 100 105 115
(units per worker per week)
Labour turnover (%) 3% 8% 16%
Absenteeism (%) 6% 12% 20%
identify two strategies the firm could use to improve employee performance.
1 State two possible reasons why the rise in labour turnover could be causing the
increase in productivity.
Exam practice
Use the following information to answer the question about assessing this business's performance.
Extracts from profit and loss account
This year (£m) Last year (£m)

Revenue 3,500 3,200
Cost of sales 2,500 2,000
Gross profit 1,000 1,200
Expenses 800 700
Operating profit 200 500
Net cost of finance 50 20
Tax 30 25
Net profit 120 455

Summary of current balance sheet
£m £m
Non-current assets 250
Inventories 50
Receivables and cash 20
Current liabilities (40)
Total assets less current liabilities 280
Long-term liabilities (180)
Net assets 100
Share capital 25
Reserves 75
Total equity 100
HR data
This business Industry average

Labour productivity (units per 45 58
worker per week)
Labour turnover (annual %) 23 15
Absenteeism (annual %) 8 5
1 Analyse the information provided to evaluate whether the business should invest in new automated production
machinery to replace staff on their production line. [20]
2 Assessing a business's competitiveness should not solely rely on basic financial and HR data. Evaluate this view. [20]
Summary
+ A balance sheet (statement of financial position) + liquidity
shows what a business owns, owes and how much + gearing.
shareholders have invested. + Key measures of the effectiveness of HR management
+ A profit and loss account (statement of comprehensive in a business are:
income) shows revenues and costs for a time period. + labour productivity
+ Published financial statements provide useful insight + labour turnover
for a range of stakeholders. + absenteeism.
+ Calculating financial ratios helps to uncover what a + Strategies to improve HR effectiveness include:
business's accounts show. + financial rewards
+ The ratios you need to know focus on assessing three + employee share ownership
areas: + consultation strategies
+ profitability + empowerment strategies.
Exam skills
The results of the calculations outlined in this chapter, both company with a high gearing again will face financial
financial and HR, can provide excellent context to business constraints on its actions, with cash draining out of the
exam answers. firm on interest payments and loan repayments.
+ in an exam where the information to calculate gearing + The simple advice here is: if the examiner offers you
or either liquidity ratio is provided, doing the sums will the information needed, it is always worth calculating
enable you to offer justification or evaluation within a these financial ratios, even if you are not directly asked
range of different questions. to do so by a question. Their power in highlighting a
+ A business with low current and/or acid test ratios will businesses situation will allow you to score exceptionally
really struggle to implement any expensive solutions well for application marks on many questions that do
to problems - due to the likely shortage of cash. A not seem to be about these ratios at all.

16 Managing change
Causes and effects of change

What creates the need for businesses to
change?
The value of change r REVISED
□
Though continuity may bring comfort, change brings opportunities.
Competition that forces innovation or drives prices down can lead to pressure
for change from shareholders, customers and other stakeholder groups. It is
change that forces progress - which is generally positive.
Internal causes of change REVISED

□
Typical mistake
Do not assume that it is only external factors that lead to businesses needing to make
major changes. There are several internal factors that can lead to the introduction of
major change programmes.
A number of internally controllable issues can bring about the need to change.
Table 16.1 internal causes of change
issue Description
Changes in organisational size As a business grows, or shrinks, internal change is inevitable. Expansion can lead to
the need to adjust budgets and add extra supervisory layers to the structure to prevent
spans of control becoming too wide. Contraction is likely to lead to redundancies and the
damaging impacts that can have on staff morale
Poor business performance When profit, profitability or revenue growth are consistently below par, change is often
made at the top of an organisation. The need to change a senior decision-maker is
implied, since they have the ultimate responsibility for underperformance of the business
New ownership Following a takeover, aims, objectives, policies and procedures may well change in order
to satisfy the vision that the new owners have for the firm. Even when a successful
business has new owners, some change is likely since without the expectation that new
owners can improve a business, takeover is unlikely to take place
Transformational leadership For businesses that are struggling to survive, a new 'transformational leader' may be
appointed to radically adjust almost everything the business does and how it does it, in
the hope that they can find a new mission or purpose and thus revive performance
Making links
Notice how this list of internal factors causing change can all be linked in with
previously covered topics, from mergers and takeovers, through leadership and
growth to measuring business performance.
External causes of change REVISED
Frequently, it is changes in the external environment in which the business

operates that will cause change to take place. These causes focus on the
acronym PESTLE, while adding changes to the market as a seventh cause:

Table 16.2 External causes of change
issue Description
Political change Changes in the political party in government can have significant impacts, especially in
Managing change
businesses providing services at least partially financed by government spending. Less broadly,
even a change of policy from a political party can bring about the need for a change in approach
from a business, which perhaps will now need to adjust its approach to selling
Economic change Changes in economic growth, as the economy follows its cycle of expansion and slowdown,
affect most businesses depending on their income elasticity. The major impact is likely to be on
demand, and therefore an element of business change will be required to adjust capacity to suit
current demand
Social change How society expects to live - lifestyle changes - can create huge forces for change for
76
businesses, which may need to adjust what they sell, how they deliver products and services
or what alternative functions consumers may expect from existing products. Anticipating social
change can be a tremendous way to steal market share from rivals, if change can be spotted
and acted upon rapidly
Technological change New technologies can create whole new markets for products that may not have existed a few
years earlier, in addition, technology can make new processes possible, allowing new ways to
manufacture or deliver products and services
Legal change Government legislation, such as the introduction of tighter controls on advertising unhealthy
foods to children, can force a business to adapt its ways of working
Environmental change For business, perhaps the most important aspect of environmental change to consider is
consumers' attitudes to the environment. No doubt many consumers care enough about the
environment to factor this into their buying decisions. The trick for businesses is to react to the
shifting environmental concerns of their consumers
Changes in the market The emergence of new competitors, or radical change in relative market shares, can lead to
major change being required within an organisation in order to counter threats. On the other
hand, rapid growth in demand caused by fashion or trends may require swift changes in order
to capitalise on this demand
Exam tip
Making links
when multiple causes of
These external factors causing change were first explored in Chapters 10 and 11. change hit a business at the
in this section, their impact on a business's strategy is examined. same time, this can explain
why the business struggles
to deal with these scenarios
Now test yourself TESTED effectively. Revising for one
exam can be hard enough;
In addition to PESTLE factors, what is the other major external cause of change?
the problems become far
2 State three internal causes of change. greater when you have
Answers available online several papers in several
subjects to revise for at the
same time.
Possible effects of change REVISED
Changes internally and externally can have a number of different effects on a

business:
+ Effect of change on competitiveness: Much change is focused on the need to
improve a firm’s ability to compete in the market with its rivals. Following
Porter’s advice, cost leadership or differentiation are the only two viable
long-term routes to improved competitiveness (see Table 16.3).
Table 16.3 Possible changes designed to boost competitiveness through cost

leadership and differentiation
Possible changes designed to boost competitiveness Possible changes to boost competitiveness

through cost leadership through differentiation
Finding new suppliers Redesigning the product
Redesigning the product to reduce the cost of making it Re-branding the product or service
Boosting capacity utilisation through branch closures Adding extra features to the product or service

+ Effect of change on productivity: In a manufacturing context, change that
is focused on processes is likely to have as a fundamental goal the desire
to increase productivity, thus reducing unit costs. This may come from
automation or simply updating the technology already being used. In the
16 Managing change
service sector, productivity improvements are harder to find, with generally
more labour-intensive processes meaning that it is improvements in motivation
that can make a difference, but perhaps only marginal improvements.
+ Effect of change on financial performance: Change generally means
short-term pain for long-term gain (see Table 16.4).
Table 16.4 Long-term financial improvement and short-term pain
Long-term financial improvement Short-term pain

Reducing labour costs Redundancy payments
Lower unit costs Investment in new production robots
improved revenue growth increased advertising budget
Better profit margins through increased price Cost of redesigning product
+ Effect of change on stakeholders: Change brought on by an external threat

or negative internal aspects is likely to have painful impacts on several
stakeholder groups. To deal with poor financial performance, cost-cutting
may well hurt staff, suppliers and customers.
How might the need to cope with a surge in demand caused by a social change
affect a) suppliers and b) staff of a food manufacturer?
Key factors in change__________

What determines the success of planned
changes in a business?
Successful change REVISED
□
Many change initiatives fail. Key reasons for this include:
+ What motivates leaders does not motivate most of their staff.
+ Leaders can believe that they themselves are the change.
+ Money is the most expensive way to motivate people.
+ The change process and the outcome of the change must be fair.
Therefore, to make sure that a change initiative, such as a quality initiative,
a new customer service approach or a management reorganisation succeeds,
managers need to ensure that:
+ All staff understand the need for change.
+ All staff understand in advance what the new changed world will be like.
+ All staff understand the plan for moving from A to B.
Key issues in the likely success of change are dealt with in more detail below.
Organisational culture REVISED

□
Organisational culture affects the success of change in two main ways:
+ Some organisations have cultures that welcome change as a chance
to improve and to enhance the way the business strives to achieve its
mission. Successfully managing change in these organisations is far easier
[ill] than in those where the culture is wary of any change to the current way
of doing things.

+ Major change can require a change in culture within the organisation.
Success comes when change managers find ways to subtly adjust the
culture, without trying to radically move it in an opposite direction.
Attempts to change culture that try to shift perspective on ‘how we do
things’ through 180 degrees are unlikely to succeed, generating far more
resistance to proposed changes.
Making links
The concept of culture was first introduced in Chapter 14. The prevailing culture has a
huge impact on a company's ability to cope with change.
Size of the organisation ' REVISED

□
Instinctively, many believe that successful change is easier in a small
organisation than in a large one. Little evidence exists to support this view.
Issues faced by managers of small- to medium-sized firms include:
+ Smaller firms may have fewer financial resources to help to move the
change forward and ensure a smooth transition.
+ Often dominated by one person or family, the alternative perspectives
needed to understand the need for change and method of change may be
lacking.
+ With a smaller workforce, the range of skills available may be limited,
reducing the flexibility of the workforce to adjust to new ways of working.
In larger firms, problems are still likely to exist: Typical mistake
+ Senior managers may struggle to get a real feel for the views of their
thousands or tens of thousands of staff. Avoid lazy assertions that
+ Different parts of the business may need different approaches from the change is easier in a large
change programme; these differences can be hard to accommodate in a or small organisation. Use
coherent plan. the issues raised here to
+ Explaining change to staff can be hard. Even if the CEO can passionately recognise that managing
explain the change to her underlings, they are likely to explain the change change is tough in both
in a slightly less effective way to their subordinates, and so on, until junior large and small firms, but
managers struggle to generate any enthusiasm explaining the changes to for different reasons.
staff.
+ Changing the way the organisation functions creates chances for
co-ordination problems as different departments must adjust to different
working relationships.
Now test yourself
4 State the three basic challenges that successful change management must meet.
Briefly explain why change may be easier to manage in a young technology
business than in a long-established DIY retailer.
Time and speed of change REVISED
+ External change factors can lead to a changed environment over an

incremental change
extended period of time, perhaps a decade or two. This is incremental
occurs when change is slow
change.
and happens in small steps.
+ The result is that a business can manage the internal changes needed
more easily, making small adjustments over a period of time that are more Disruptive change occurs
easily introduced. suddenly, unpredictably,
+ When change happens more rapidly, perhaps through the release of a new and has a major effect on
technology, radical adjustments are required. entire markets.
+ These disruptive changes force major internal shifts which may well be
difficult to pull off effectively for managers.

Managing resistance to change REVISED
Kotter and Schlesinger suggested three successful approaches to managing

the resistance to change generally experienced by firms looking to make
16 Managing change
Table 16.5 Kotter and Schlesinger's three successful approaches to managing
resistance to change
Approach Explanation
Education and Effectively explaining to staff why change is needed, then how the proposed changes will address the
communication problems causing the need to change, can work well. If much resistance to change is caused by staff
not understanding exactly why the current status quo is not good enough, enlightening them as to
what makes change necessary can break this barrier
Participation and if unofficial leaders are consulted on how to make changes, allowing them to feed colleagues' views
involvement into a change process, the changes are more likely to be successful. The reason is that if people feel
they 'own' the changes, they will try hard to make them work, instead of dragging their feet if change
is imposed
Negotiation and Sometimes resistors may need to be 'bribed' to accept changes, perhaps with a pay rise or
agreement adjustment to working conditions. Trade unions may often be involved in this process, with the union
negotiating on behalf of their members to reach an agreeable solution to the problems preventing
successful change
Exam tip
When trying to explain why a change has not succeeded, if there is little evidence of
Kotter and Schlesinger's suggested approaches, perhaps their least favoured method
has been used. Kotter and Schlesinger were clear that using force and coercion is the
least likely method to successfully overcome resistance to change.
State the three main successful ways to overcome resistance to change.
Scenario planning___________________________________
How to prepare for unexpected negative
events through planning
Planning ahead allows better decision-making. This is because:
Scenario planning means
+ time can be taken to analyse possible actions
visualising possible future
+ resources needed can be secured. situations for a business
In order to plan ahead, it is necessary to imagine the future. Scenario and then devising plans
planning looks to harness the benefits of planning ahead. It does so by for how to exploit likely
regularly imagining issues that may affect the business in the future. The opportunities and minimise
most common purpose of scenario planning is in preparing for threats, the effects of likely threats.
though it can be used to plan future growth paths.
Identifying key risks through risk

assessment REVISED
□
The first stage to scenario planning is risk assessment. This involves: A risk assessment is a
+ identifying possible major risks or threats faced by the business process used to identify,
+ quantifying the possible cost to the business if the event occurs quantify and decide on the
+ attaching a probability to the chance of the risk occurring. likelihood of negative future
events occurring.

This allows a firm to make a considered judgement as to which risks to
prioritise preparing to handle, by combining the magnitude of their effect
with the probability of the risk occurring.
Common risks that many businesses identify include: natural disasters, IT
systems failure and loss of key staff
Table 16.6 Common business risks
Risk Explanation
Natural disasters Floods, storms, earthquakes and other natural disasters can cause havoc, especially for
manufacturers whose supply chains can be disrupted. Suppliers may be unable to harvest, mine,
produce or deliver materials and components. The company's own manufacturing facilities may be
disrupted if the disaster strikes locally, while onward distribution can be hampered by damage to
infrastructure
IT systems failure The trouble with computerising operations systems, such as ordering and replenishment, automated
banking and online sales, is that an extra area of significant vulnerability is added to businesses. From
an internal system malfunction, to viruses and malware, to major hacking events, companies whose
IT systems fail to function effectively may find the consequences are a failure to deliver their product
or service. This is likely to lead to reputational damage
Loss of key staff While more staff than you may expect can be replaced with relative ease, some businesses have
'superstars' who are so special at their role that they may be irreplaceable. Alibaba's Jack Ma or
Tesla's Elon Musk may be irreplaceable. The business would need to find a way to try to work around
their loss, often by bringing in several people who can each do part of what their superstar once
did. Following 2020's coronavirus pandemic, most businesses will be planning to cope with a similar
scenario in the future
Now test yourself
What three-step process is involved in risk assessment?

Typical mistake Making links

Do not assume that a natural disaster only represents a problem to businesses local There is a link to be noted
to the site of the disaster. Perhaps the most significant business problem of natural here to the section early
disasters is the disruption they can cause to a well-oiled supply chain, potentially in Chapter 1 on risk and
messing up the entire chain of production. This could be true even if the disaster uncertainty.
occurred on the other side of the world if that is where the supplies come from.
Planning for risk mitigation REVISED

□
The whole point of scenario planning is to give decision-makers time to
consider how they might deal with the effects of a major risk occurring.
Mitigation involves lessening the impact of the risk, generally through laying
out plans in advance showing what will be done if a crisis strikes.
Table 16.7 Examples of risk mitigation planning
Potential crisis Risk mitigation

Natural disaster Have relationships in place with alternative suppliers
Organise potential outsourcing of production
Figure out alternative transport routes for major items within the
supply chain
IT systems failure Have a back-up system ready to switch on
Loss of key staff Succession planning

Succession planning and business continuity REVISED
□
Identifying and training potential replacements for key personnel - succession
Succession planning
planning - allows a business to gain the benefits of internal recruitment for
means preparing
key positions. Knowing the logic behind existing business strategies can
replacements for key
really help a new leader seamlessly take over the helm of a business, in a way
personnel in advance of
that an external replacement would find impossible.
their departure.
Business continuity relies on a number of components:
Business continuity
+ A secure financial position that will enable a firm to spend the cash means getting a crisis
required to deal with an emergency without threatening their long-term hit business back to
financial stability. functioning normality as
+ Clearly defined responsibilities laid out in advance, confirming who will quickly as possible after a
deal with what aspects of possible problems. This allows training to be major disruption.
provided in crisis management to these personnel.
+ Effective communication systems prepared, perhaps including special
emergency numbers to call for stakeholders who want to contact the
business and also methods for the business to contact the media to begin Exam tip
handling the marketing and PR implications of a crisis.
Management in scenario
planning and crisis
management illustrate
List three common risks for which businesses can prepare in advance. how there is no one
right management style.
Briefly explain why scenario planning is a better alternative than dealing with a
Preparing for a disaster
crisis once it has happened.
relies on consultation in
Answers available online order to get a rounded
perspective on likely risks
and possible mitigating
Exam practice actions. Once a crisis
strikes, however, speed of
1 Evaluate the view that 'The ability to effectively manage change is the key to decision-making is key, for
long-term financial success in all markets in the twenty-first century'. [20] which autocratic decision
2 Evaluate the view that 2020's global pandemic showed that all businesses should making is the best way.
invest more time and money into scenario planning. [20] This illustrates nicely how
different styles suit different
Answers and quick quiz 16 online situations.
Summary
+ internal causes of change include: + Successful change management relies on:
+ changes in organisational size + all staff understanding the need for change
+ poor business performance + all staff understanding, in advance, what the new
+ new ownership changed world will be like
+ transformational leadership. + all staff understanding the plan for moving from
+ External causes of change include: AtoB.
+ changes in the market + Managing change is influenced by:
+ political change + corporate culture
+ economic change + time and speed of change
+ social change + size of the organisation.
+ technological change + Managing resistance to change is best done through:
+ legal change + education and communication
+ environmental change. + participation and involvement or
+ Change is likely to have significant effects on: + negotiation and agreement.
+ competitiveness + Scenario planning starts with risk assessment.
+ productivity + Scenario planning helps businesses deal with major
+ financial performance. crises by preparing in advance.
+ Preparing in advance means risk mitigation can take
place.

Exam skills
This chapter on managing change reminds us that + If you can explain why a plan may not be implemented
evaluation can be shown in an answer by exploring the effectively, you will be showing an awareness of the
relationship between plans and reality. real-life struggles of organisations, which will impress
+ The need for a new plan is a common scenario in an examiner.
business exams, and therefore firmly places business + Scenario planning rarely gets things exactly right,
in a dynamic context, where change happens - the so the plan will need adjusting, while, as previously
future is uncertain. mentioned, change will often be resisted.
+ Making change is a complex process where plans may + Furthermore, in dynamic business environments, even
become derailed through resistance by staff. a successfully implemented plan may be out of date
+ Meanwhile scenario planning stresses the benefits by the time it is in action if the world around it has
of having a plan in place in case something goes changed in the meantime.
wrong. The theme of planning for an uncertain
This central theme of planning shows clearly why running
future is therefore central within this section of your
a business is hard, needs a dose of luck along with a great
specification and doing the planning is hard enough
understanding of business theory, and can therefore
and presents many challenges for business.
enable you to show in an answer to a business question
+ The plan itself is nothing until it leads to action and it is
that grasp of reality which is lacking in so many students'
in the difference between plans and reality that scope
answers.
for evaluation is great.

17 Globalisation
Growing economies_______________
Where, why and how some countries are
experiencing rapid economic growth
Economic development is happening: a greater proportion of the
world’s population is now living above the poverty line. The cause is not
redistribution of the world’s wealth; it is the development of economies
which had previously been relatively inefficient and unproductive. The key
drivers behind economic development for the countries that have developed
significantly in recent years have been:
+ willingness to accept inward investment from multinationals
+ more enterprising behaviour from local businesses
+ more stable government
+ easier access to export markets due to improvements in communication
and transport: globalisation.
Growth of the UK economy compared to

emerging economies REVISED
□
To contextualise the term emerging economies, it is worth comparing growth
Making links
rates around the world with the economy of the UK. For the past 200 years,
economic growth in the UK has averaged 2.25 per cent per year. That means The idea of economic
the size of the economy doubles every 30 years or so. Other economies that growth has been covered
would be classified as emerging economies have recently been experiencing in both Chapters 10 and 11
more rapid growth (see Table 17.1). already.
Table 17.1 Economic growth of selected developing countries
Country Average annual growth in real GDP Typical mistake

per head 1990-2019 (%)
Do not underestimate the
Bangladesh 4.23
growth rates of countries
China 8.48 such as Bangladesh.
India 5.00 As growth rates are
cumulative, Bangladesh's
Bolivia 2.33
growth rate means its
Nigeria 2.01 economy will double in size
every 17 years. This level
of economic development
Now test yourself TESTED makes a significant impact
on life in developing
State four key drivers of economic development.
economies-just 4.23
Answers available online per cent per year.
Growing economic power of countries within

Asia and Africa REVISED
□
+ The next two topics will cover China, India and Africa in more detail. What
needs to be raised here is the broader impact of development in wider
South East Asia. China has acted as something of a hub.
IB + Manufacturers in China are looking for suppliers from whom transport
costs will not be great. As a result, other Asian economies, notably

Vietnam, Indonesia and Cambodia, have seen rapid growth in the last two
decades.
+ Not only do these countries represent a viable source of supply for China,
they are also building their own manufacturing base. They offer lower cost
production than China, where increases in real wages and other costs are
putting off some companies looking for cheap production locations.
Implications of economic growth

for businesses REVISED
□
New export opportunities
As developing countries see incomes rising, UK businesses may discover new
markets to which they can export. The UK is particularly good at providing
services, including:
+ fashion design
+ design engineering and architecture
+ culture (books and entertainment)
+ financial and other business services.
As economies reach the latter stages of development, the demand for services
grows, meaning that UK exporters should be targeting China right now.
Offshoring production
+ Many UK manufacturers have closed their UK manufacturing facilities and
offshoring means moving
re-opened them in developing countries. a business function to
+ For example, Dyson moved to Malaysia more than 20 years ago. another country, generally
+ The goal of offshoring is to exploit the lower production costs, boosting in order to lower costs.
profit margins, even if transport costs rise as a result. In recent years, more
service businesses have found ways to offshore their work, with jobs as
diverse as call-centre enquiry and complaint handling, to basic analysis of
medical x-rays being shifted to lower cost economies.
Increased domestic competition

As countries develop, entrepreneurs, increasingly able to access capital and
credit, will start up businesses that may be so successful that they can start
exporting to countries such as the UK. This leads to increased competition for
UK businesses, both globally and in their own home markets.
Implications of economic growth for

individuals REVISED
□
As an economy grows, the types of jobs done change. Initial stages see those
employed in agriculture moving into manufacturing jobs. This shift is both
cause and effect of development, as manufacturing processes add more
value than primary sector jobs, stimulating growth. However, the change in
employment patterns will have a variety of impacts:
+ rural to urban migration
+ increased need for managers, expanding the middle class
+ increasing skill levels within the economy.
In addition, developing economies represent opportunities for entrepreneurs
to start up and grow businesses that depend on increasing disposable incomes.

| Indicators of growth REVISED
■ GDP per capita
17 Globalisation
• Rising levels of income per person should be a clear indicator of economic
GDP per capita, or strictly
• development. If, on average, the people of a country are earning more, they
gross domestic product
• will spend more, creating a virtuous circle. Therefore, watching GDP per
(GDP) per head of population
• capita over time provides an excellent indicator as to the level of purely
at purchasing power
• economic development taking place within a country. parity (PPP), needs a little
• unpicking. Gross Domestic
• Literacy Product (GDP) is a measure
e Although money is a component, there is more to economic development ofthe total output of a
country's economy. Dividing
e than just rising incomes.
this by the population
• Illiteracy rates - the number of people who cannot read or write - should adjusts for countries with
• see a dramatic improvement as an economy passes through the stages of much larger populations.
• economic development. A literate workforce will be more productive, capable Purchasing Power Parity is
• of performing tasks that add more value to production, thus hastening further a further adjustment that
• economic development. factors in differences in the
cost of living.
• Health The Human Development

• Levels of health should improve as an economy develops. Key ways to Index (HDI) is an attempt
to provide a single measure
• measure health focus on the start and end of life. Simply measuring
of economic development
• life expectancy gives a good clue as to the health of a nation; economic
encompassing income,
• development leads to healthier living along with better treatment of later-life
education and health.
• diseases.
•
• Human Development Index (HDI)
• Championed by the United Nations, the HDI combines measures of economic
• progress with health and education to try to provide a well-rounded picture of
• a country’s economic development. The figures in Table 17.2 illustrate HDI for
selected countries.
Table 17.2 HDI ranking and scores, selected countries 2018
Rank (out of 180 countries) HDI score (out of 1.0)

Norway 1 0.954
UK 15 0.920
Cuba 72 0.778
Mexico 76 0.767
China 85 0.758
India 129 0.647
Kenya 147 0.579
Nigeria 158 0.534
Source: United Nations
These figures help to illustrate that, as with any weighted average, there
will often be debate over the relative importance of different factors.
Cuba has relatively low GDP per capita, but the government prioritises
both health and education, perhaps nudging the country higher than
expected. Mexico’s performance reflects what is not there; crime rates
are not included.
What three factors does the HDI combine to assess economic development?

China versus India
A snapshot of what is happening economically
77 Globalisation
in the world’s two most populous countries
and what this means for UK businesses
+ China and India matter because of their populations.
+ Both are home to almost 1.4 billion people: two countries, each with nearly
20 times the population of the UK.
+ Neither country has reached the level of development of the UK, however
both are catching up.
+ China is further down the path of development than India, but both will be
enormous features of the global economy for the foreseeable future.
China? REVISED
□
Not only does China have a huge population, it has also undergone an
incredible period of economic growth over the past 30 years. A growth rate
that has averaged around 10 per cent per year in that period has transformed
the country. That 10 per cent growth means the economy doubled in size
every eight years or so. The result has been an explosion in markets for a
range of consumer goods.
As GDP per head grows in China, and total GDP continues to grow at around
7 per cent per year, China’s economy seems likely to wrestle the title of global
economic superpower from the USA.
Or India? REVISED
□
India has one major advantage over China in the race to be the twenty-second
century’s dominant economic power: its population. India’s population is
growing faster than China’s. In addition, its population is younger, the result
of Chinese attempts to limit their population over the past 20 years.
Making links
The idea of population changes as an external influence on businesses was introduced
in Chapter 11. Nowhere is the issue of population change more significant than in
China and India.
Which economy has been growing faster? REVISED

□
China. Largely as a result of investment in construction and infrastructure,
allied with huge export growth, China is well ahead. The investment has
come from two main sources:
+ Government spending: This focused first on infrastructure (roads and
dams, for power and water). Subsequently, the focus has turned to housing,
railways, schools and hospitals. Spending on these areas helps to reinforce
the growth path on which the Chinese economy continues to travel.
+ Foreign direct investment (FDI): Western companies have been building
factories in China for the past 30 years to take advantage of low wage costs.
India has lagged behind on this kind of fixed capital formation, although its
Fixed capital formation
performance has improved in the last ten years or so.
is the term used to describe
China’s export growth was originally built on incredibly low-cost labour. investment in long-term
However, as wage rates have risen, China has retained its place as the world’s assets from roads to
largest exporter of manufactured goods. Notably, these exports contain a buildings.
huge proportion of high-technology products: higher than India, the UK or
even the USA.

India’s exports are less obvious. Its major export successes have been
‘invisibles’ such as software engineering and running call centres. Its export
advantages over China are:
+ English (the global language) is widely spoken.
+ The outstanding top end of the education system turns out world-class
managers and software engineers.
Now test yourself
To the nearest 100 million, what is the population of both China and India?
State three key drivers of Chinese growth over the past 25 years.
Can India grow rapidly and consistently? 1 REVISED

□
The three key weaknesses facing the Indian economy listed in Table 17.3
below.
Table 17.3 Weaknesses in the Indian economy
Weakness Explanation
Poor infrastructure India's democratic system of government (China is not a democracy) means that if the voters
don't agree with a policy, the government cannot ultimately force it on the population. China's
government can dictate that over 40% of spending will be on investment: in improving
infrastructure, notably motorways and utilities such as water and electricity supply. India's road
system is far worse than China's and undoubtedly a drag factor on attempts to grow the economy
Narrow education Despite the very top end of India's education system being excellent, education for the masses is
system poor, with 29% of the population being unable to read and write. These illiterate individuals will not
be able to effectively take on the more highly skilled jobs needed as the economy looks to grow, in
China, 96.5% of the population is literate
Balance of Compared to China's current account surplus of $136 billion in 2019, India's deficit of $9.7 billion
payments deficit shows that Indian consumers are buying more imports than foreigners want to buy Indian
exports. Without a fall in the value of the rupee (which will prompt even more inflation), this
problem will be hard to fix
A further issue is the tendency of the Indian economy to ‘overheat’ when

industrial production accelerates. This overheating shows as inflation,
which the Bank of India curbs by increasing interest rates, thus halting
growth. India’s inflation rate has been consistently higher than China’s.
Can China outstrip America?

+ Wages present the key challenge to China sustaining its remarkable
Typical mistake
growth. As the economy develops, wage rates rise. This is already evident
in China. Although China's GDP will
+ The problem is that much of China’s growth has come because it offers outstrip America's, it may
low-wage manufacturing. As multinationals interested only in low-wage be more interesting to ask
locations pull out, the question is whether enough higher-added-value whether GDP per capita will
manufacturing can be attracted to sustain the overall growth. get close in the foreseeable
+ China’s GDP has overtaken the USA if measured at PPP. Of course, this future. With a population
adjustment for the cost of living is significant: prices in the USA are over four times the size of
significantly higher for many items than in China. the USA's, China's economy
+ As China’s economy, especially its manufacturing sector, continues would need to be over four
to steam ahead, emissions present a major concern. Environmental times the size of America's
legislation and regulation has only recently been taken seriously for that to happen. Make
by China. sure you state clearly
whether you are discussing
+ Although the Chinese government is now taking active steps to ensure
total GDP or GDP per capita.
better environmental standards, particularly regarding air pollution,
scenes of smog in Chinese cities are all too common.

What are the opportunities for British
business? 1 REVISED
□
Export opportunities, along with scope to directly invest in China and India,
exist. However, British firms have not yet shown significant levels of success
in either country, despite the odd one-off hit, such as Jaguar Land Rover in
China (though it is Indian-owned).
Table 17.4 issues for UK businesses considering exporting to India or China
Potential problems for UK businesses Key opportunities for UK businesses

Short-termism in UK pics: Cracking such major India may be a more comfortable market for UK businesses, given
markets will take time. Shareholders have often the countries’ shared past (India was a British colony for some
shown themselves unwilling to wait 150 years). With more cultural similarities than with China, British
firms may stand more chance in India, which continues to offer
opportunities that have already been missed in China
Underestimating market potential: Over the past As China's economy continues to develop, its service sector is likely
30 years, during which China has seen such to show higher growth rates. Of course, much of the UK's global
astounding growth, many British commentators success stories can be found in the service sector. There may still
have continually predicted that its economy would be time for British financial services companies, designers and
implode; it's still going strong musicians to establish themselves in a rapidly growing sector of the
Chinese economy
Ponderous decision-making: Some UK firms have
dithered over China and India. Waiting for too
long to commit has allowed foreign competitors,
notably Germany, to get into China, and to a lesser
extent India, and establish themselves securely

□ Making links
State two factors that have held the Indian economy back relative to China. It was Ansoff, in his
Strategic Matrix, who
7 Why do UK businesses have reason to be optimistic about a) China and b) India?
highlighted the significant
Answers available online challenges of entering a
new market - see Chapter
11 for a reminder.
Business potential in Africa

How attractive is the continent of Africa for
business investment?
What is Africa like? REVISED
□
Although some generalities can be made about ‘all’ African countries, vast
Typical mistake
differences exist: there is wealth and development (South Africa, Nigeria) as
well as great poverty and underdevelopment (Malawi). Meanwhile, Africa is Africa is a continent. Never
frequently split along economic, religious and social lines, and between North refer to it as a country.
Africa (Egypt, Tunisia, etc.) and sub-Saharan Africa.
The focus of this topic is mainly sub-Saharan Africa. North African countries
are further along the path to development, and represent a smaller population
than the part of the continent that lies south of the Sahara desert. Some
generalities include:
+ It is less economically developed than most other parts of the world.
+ Huge reserves of natural resources are yet to be exploited.
+ There are difficulties in maintaining reliable, stable government (not true
for all countries).
+ Corruption represents a significant disincentive to foreign investment.

However, other, less ‘known’ common threads are developing:
Making links
+ Many countries are experiencing strong economic growth around the 5 per
cent per year mark. The effects of foreign direct
+ There is major foreign direct investment, especially from China and Japan. investment are explored in
17 Globalisation
+ There is a broad improvement in governance, with fewer civil wars and a more detail in a later section
slow growth in democracy. of this chapter.
Getting trade right? REVISED
Although trading blocs exist within Africa, they have historically been
small. In 2015, the East African trading bloc signed a free trade deal with
the Common Market for Eastern and Southern Africa (which includes South
Africa), creating a potential market of 600 million consumers.
Promoting trade between African countries is vital because:
+ Historically, African nations have seen neighbouring countries as rivals
rather than partners.
+ International trade has been proven to be critical in achieving economic
growth (see the next section of this chapter).
Given that many African countries have trade deals with the EU and/or the
USA, it seems perverse that they struggle to trade with one another.
Now test yourself
Which two countries have already made significant investment in many

sub-Saharan African countries?
Opportunities for UK business in Africa r REVISED

□
+ In Africa’s richest nations, especially oil-rich Nigeria, there is tremendous
Making links
wealth in the very top few per cent of the population.
+ This wealth can be attracted by British retailers, hotels and public schools Some of the very real
and, perhaps in the future, a broader range of high-end UK businesses. challenges of marketing in
+ As countries like Nigeria lead the continent in economic development, new, international markets
middle classes will emerge. Indeed, soft drink sales in Nigeria and are explored in more detail
Cameroon have rocketed in recent years. in Chapter 19.
+ Consumer goods markets are beginning to mature, with international
brands starting to make their mark.
+ Britain’s Unilever has made strong inroads into the continent. Other
multinationals to have invested directly in Africa in a major way are
US companies Wal-Mart and Microsoft.
Problems doing business in Africa REVISED

□
Corruption
Corruption is a problem in most African countries (similarly in many less
economically developed countries globally). Its prevalence offers businesses
two major headaches:
+ Costs can rise as local or national officials expect payment to allow a firm
to receive the necessary licences and permissions to do business.
+ Companies that value CSR (corporate social responsibility) cannot condone
conducting business in a corrupt manner.
Poor infrastructure
Issues relating to infrastructure include substandard:
+ electricity supply
+ road networks

+ rail networks
+ waste disposal facilities.
These all play a vital role in enabling a business to function. Even when
there is infrastructure in place, a lack of co-ordination between nations
can hamper this, for example, if a motorway finishes at a border with
no corresponding road link available in the neighbouring country. This
infrastructure should be provided by governments, and the lack of
coherent and stable government prevents this perhaps as much as a lack of
government income.
Making links
Investor concern about stability Entering new markets is
+ Health epidemics, government collapse and inconsistent application of a costly business and will
the rule of law create instability in many African nations. For example, often require extra sources
of finance (see Chapter
Nigeria has not managed to effectively deal with terrorist insurgents in the
6). If finance providers
north-east of the country.
are worried about a new
+ These concerns over stability represent a major obstacle to investment -
market, the move might fail
which by its nature takes time to pay back - during which investors are
due to a lack of finance.
more likely to meet major disruption.
Now test yourself TESTED Exam tip
Following agreement between the East African trading bloc and the Common If exploring problems of
Market for Eastern and Southern Africa to form a single free trade area, how many investing in Africa, consider
consumers live in these blocs? the length of time most major
investments take to pay off:
1C List three major problems of doing business in Africa.
years rather than months.
Answers available online The continent is changing
so rapidly this brings
uncertainty, which investors
hate. Meanwhile, it is often
International trade and not a single problem, but

instead several problematic
business growth________ factors working together.
Why countries trade goods and services and

how this allows businesses to grow
The logic behind foreign trade: international
specialisation r REVISED
□
Trade is necessary because economic history has taught the world that if each
country specialises in the things it does best, then trades with others to get
products and services it does not produce domestically, the global economy is
more productive as a whole.
Distinguishing between imports and exports REVISED

□
Imports
Britain imports goods and services worth over £40 billion per month. These
imports are products
imports may be:
and services produced
+ foreign brands that add to the choice available to UK consumers
abroad and consumed
+ goods or services that Britain no longer mass produces
domestically.
+ materials and components used by British businesses, especially
manufacturers, which may be produced far more cheaply, perhaps at
better quality, abroad
+ services, such as tourism, which involve importing services from foreign
hotels.

Exports
In June 2019, the value of UK exports was £29.8 billion per month.
Exports are products and
+ Exporting offers businesses the chance to increase sales and to achieve
services that are produced
growth, which enables them to enjoy economies of scale.
17 Globalisation
domestically and consumed
+ Another major reason for exporting is to avoid reliance on the domestic
overseas.
market.
+ If a firm’s home economy enters recession, there may be a drastic
fall in sales, but if the firm can export to a country unaffected by Making links
recession, the damage caused by the fall in domestic sales is less As soon as we start to think
significant. about imports and exports,
consideration must be given
to movements in exchange
rates - a subject first
1 Why does international specialisation create the need for countries to trade with covered in Chapter 10.
one another?
2 When you pay for a hotel room in Ayia Napa for a week, does that count as an Exam tip
export or an import for the UK? Remember that for imports,
Answers available online goods and services arrive
and cash flows out of the UK.
For exports, it is goods and
services that flow out, and
The link between business specialisation and cash that flows in to the UK.
competitive advantage REVISED

□
Business specialisation
Choosing to produce only one product, or products for a single market,
is a common strategy used by businesses. Porter’s focused differentiation
or focused cost leadership are examples of strategies based on
specialisation.
How specialisation can boost efficiency

+ For a business choosing to produce just one product, fewer machines will
be needed than by a multi-product firm. Therefore, the cost associated
with purchasing or funding those machines will be lower.
+ There is a similar effect with training costs pushing down total costs; there
is no need to provide training to help multi-skill staff working in a single
product firm.
+ F.W. Taylor believed that specialisation enhanced efficiency on the basis
that ‘practice makes perfect’. An employee who repeats one simple task
over and over gets quicker and quicker at that task, boosting the efficiency
of the process in which they are involved.
Exam tip
How efficiency gains created by specialisation can Perhaps the key

determinant of which route
create competitive advantage to choose is price elasticity.
Increased efficiency has one simple but substantial benefit: lower unit costs. For a firm selling a price
If specialisation can be used to lower unit costs, a business finds itself with an elastic product, the former
ideal choice of two attractive options: option should lead to a
+ Lower selling price by the same amount as unit costs have been significant increase in sales,
reduced. This preserves the profit margin on each unit, but lowering boosting total revenues. For
prices boosts competitiveness of the business within its market, thus a company whose product
boosting sales. is price inelastic, cutting
+ Alternatively, a company may simply decide not to adjust prices or its price price makes no sense, since
competitiveness and settle for a higher profit margin on every unit it sells the increase in unit sales
as a result of lower unit costs. will be relatively small.

Briefly explain how specialisation can lead to a cost-based competitive advantage.

77 Globalisation
Foreign direct investment (FDI) and business
growth r REVISED
□
+ Outward foreign direct investment occurs when a British business buys
assets abroad.
+ Typically this may involve building production facilities or buying retail
Foreign direct
outlets, although takeovers of foreign businesses are also considered as
investment (FDI) occurs
outward FDI.
when a business purchases
+ FDI can also flow inwards. When foreign companies buy British assets - non-current assets in
buying property or building factories in the UK - money flows into another country.
Britain.
+ It is important to note that subsequent earnings from these investments
will flow out of the UK, so rent on a foreign-owned UK property leaves
the UK.
Outward FDI offers businesses opportunities to grow abroad. The key
benefits of actual FDI, rather than simply exporting products made in the
UK, are listed in Table 17.5 below.
Table 17.5 Benefits of FDI
Benefit Explanation
Avoiding problems The administration and bureaucracy involved in moving
involved in exporting goods around the world, such as organising onwards
transport when it arrives in the destination country, can be
avoided if the product is made in the country in which it is to
be sold
Avoiding transport The shipping costs of exporting products can be significant,
costs even more so when products are large and bulky
Avoiding trade Tariffs and quotas imposed by countries on any imports are
barriers bypassed if the product is made in the country in which it is to Typical mistake
be sold
Too many simplistic
Access to natural Some FDI will focus on extractive industries such as mining. responses to questions
resources If extracting uranium from the limited sites where it can be about the benefits of fdi
found around the world, FDI is the only way; the business never make it past lower
must go to where the uranium is, and build extraction facilities operating costs. Note that
there several other benefits exist,
Lower operating Many businesses will look to build production facilities in some of which may be of
costs countries where land or labour costs less, meaning that particular relevance in the
manufacturing abroad reduces the costs of production context provided.
14 List three potential benefits of FDI instead of exporting domestically produced

products.

Factors contributing to
increased globalisation____________________________
Why have the world’s economies become
increasingly inter-dependent?
It is the growth in international trade that best illustrates the concept of
Globalisation is the trend
globalisation. Figure 17.1 shows 25 years of strong growth, then raises
towards closer ties between
the interesting question of whether the pace of globalisation has slowed,
economies and businesses
especially with the USA moving towards a more isolationist stance.
within the global economy.
Isolationism refers to a
Export volume nation whose trade policies
Forecast
Trend (1990-2008) are designed to put the
interests of domestic
businesses first by imposing
trade barriers to hamper
imports.
Figure 17.1 The volume of world merchandise exports, 1990-2015 (index 1990 = 100)
Source: WTO
Trade liberalisation r REVISED

□
Trade liberalisation involves removing trade barriers, such as:
+ Tariffs: These are taxes imposed on imports that raise the price of
imported products, aiding sales of domestic rivals.
+ Quotas: These are physical limits on the quantity of a type of good that can
be imported in a year. Once the limit is reached, consumers must buy from
domestic producers.
+ Regulations: Rules, paperwork and systems can be put in place to make it
harder for imports to enter a country.
Liberalisation will generally follow a new trade agreement between
two countries, on the basis that both remove trade barriers between
one another.
Table 17.6 Opportunities and threats caused by trade liberalisation
Opportunities from trade liberalisation Threats caused by trade

liberalisation
Companies that rely on imported materials and Allowing imports into a domestic
components will enjoy lower costs, enabling market does increase competition
them to reduce prices to compete with cheaper for domestic firms. The most
imported rivals efficient should survive; those
Due to the bilateral nature of trade agreements, who could only survive due to the
liberalisation can lead to increased export barriers will lose that protection
opportunities with the removal of barriers in the and possibly face closure
other direction

Political change REVISED
+ The key political change prompting the wave of globalisation shown above
is political change in China.
+ Following the death of Chairman Mao, the 1980s and 1990s saw a move Making links
away from hard-line communism, with private ownership of business
allowed. These political changes are
+ Then, in 2001, China joined the WTO (World Trade Organization), giving just the type of things that
PESTLE analysis (detailed
it access to rich western markets and offering the country the chance to
in Chapter 11) should help
enjoy an amazing export-led boom.
a business to identify as
+ Britain’s decision to leave the EU, along with the election of Donald Trump
giving rise to opportunities
as US president since 2016, offer hints that political changes may now slow
or threats.
down the march of globalisation.
Reduced cost of transport and communication F REVISED

□
The extra costs involved in moving goods around the world can prevent trade
by lowering profit margins. However, the last 50 years have seen significant
reductions in the cost of transport for three main reasons:
+ Oil prices have remained stable or fallen contrary to fears that the supply
of oil may run low, driving costs up.
+ Technological developments have led to the development of more efficient
engines, reducing fuel consumption and therefore cost.
+ Technology has also enabled the building of bigger trains, boats and
planes, which allow container economies of scale.
Communication’s major revolution has been the arrival of the internet as
a technology. Hard as it may be to imagine a world before the internet (or
email), organising trade through phone lines and possibly fax machines
lacked efficiency. Now, linked with the hardware involved, especially high-
capacity fibre-optic cable, immediate worldwide communication of complex
data is normal.
Now test yourself
5 State three barriers to trade that a government can use to hamper imports.
Briefly explain two potential benefits to domestic businesses of agreements to
liberalise trade.
Increased significance of transnational

corporations REVISED
□
+ Global giants, selling in hundreds of markets, seek growth by entering new
markets in order to boost sales year by year and keep shareholders happy.
+ Whenever a transnational corporation enters a new market, local
businesses face an incredibly powerful new competitor, one that will
benefit from enormous economies of scale.
+ These, of course, are companies that will be transferring resources and
products from one country to another, boosting international trade.
+ In addition, when major global transnationals are able to sell their
products in so many markets, consumer choice from nation to nation
declines: different national markets become less different.
Increased investment REVISED

□
+ Communication and trade liberalisation have both driven increased
trans-border capital flows.
+ As financial markets are more willing to invest capital in businesses based
elsewhere in the world, so the world seems to become a smaller place.

+ The downside to this globalisation of financial markets is the
interconnectedness that has evolved.
+ With banks in one country investing elsewhere in the world and lending
to foreign customers, a financial crisis in one part of the world can spread
rapidly throughout the whole global financial system, as seen in 2008.
Migration REVISED
□
Many people who migrate to other countries do so for economic
Typical mistake
reasons. The vast majority of these migrants tend to share two key
characteristics: There is a huge amount of
+ They are proactive and determined, willing to uproot and move to an well-researched evidence to
entirely new country to work and live. show that inward migration
+ They tend to be relatively well-educated. has a strong positive effect
on the success of UK
These traits help to explain why increased migration can stimulate economic businesses. Do not ignore this
growth. by stating that immigration
harms the UK economy.
Growth of the global labour force REVISED
+ Companies have managed to reduce their labour costs by seeing the

market for labour as global, rather than local or national.
+ Many UK businesses have offshored production in order to benefit from
cheaper labour elsewhere in the world.
+ Meanwhile, other UK businesses facing shortages of skilled staff have
recognised the benefits of recruiting from abroad in order to fill jobs that
would otherwise have to be offshored, or left undone - losing sales.
Structural change REVISED

□
+ All economies that experience economic development see structural
change, with reduced reliance on agriculture as economic activity shifts
first to manufacturing, and then into services.
+ Major economies that have experienced rapid development in the past 40
years have increasingly specialised in order to improve their international
competitiveness. They have been able to find export markets that have
enabled the acceleration of development and the related trade to sustain
the rise of globalisation.
List three technological developments that have encouraged globalisation.
Protectionism
How some countries seek to give domestic
businesses and advantage over foreign rivals
The goal of protectionism is to increase a nation’s prosperity by increasing the
Protectionism means
amount exported and/or decreasing the amount imported to the country. It
giving preference to
is the opposite of free trade. Protectionism usually features the use of trade
domestic producers by
barriers to make it harder for foreign firms to import their goods. The three
making it harder for foreign
major forms of trade barrier are:
companies to export to
+ tariffs your country.
+ quotas
+ legislation and regulation.

Tariffs REVISED
Imposing a tax on a product being imported automatically reduces its

A tariff is a tax imposed
competitiveness, as the tariff will drive up the price. This reduces the ability
on an imported product to
of the product to compete with domestically produced rivals.
allow it to enter a country.
The two main scenarios in which governments tend to use tariffs are:
+ To protect a declining industry: When entire industries decline, major
problems can arise with structural unemployment. Finding a way to slow
this decline allows governments more time to deal with this problem.
+ To protect ‘infant’ industries: If a new industry is in its infancy, the
domestic firms that make up the industry may still be too small to benefit
from economies of scale. If foreign rivals have already grown, they may
be able to kill the domestic industry before it has the chance to mature.
Logically, once domestic producers have matured, tariffs can be removed.
Table 17.7 Benefits and drawbacks of tariffs
Benefits of tariffs Drawbacks of tariffs

As tariffs help firms to survive, they protect jobs of firms Imposing tariffs pushes up prices, reducing consumers'
whose rivals are being taxed ability to buy the product, reducing standards of living
Tariffs also indirectly protect the other businesses that Tariffs help inefficient firms to survive, potentially harming
rely on these firms for trade: suppliers and local firms that competitiveness. Without tariffs there is far greater
would suffer if unemployment rose incentive for these firms to improve what they do
Tariffs raise tax revenues, allowing governments to increase
spending on public services
Import quotas ' REVISED

□
+ The effects of quotas are almost identical to those of tariffs.
+ The mechanism differs since, instead of directly manipulating the price of A quota is a physical limit
imports, this control happens indirectly, through the market mechanism. on the volume of a product
+ Quotas are designed to protect and encourage domestic producers. If that can be imported in
imports are limited, this is likely to push prices up. a year. Once the quota is
+ This should encourage domestic producers to increase the amount they used up, only domestically
are willing to supply. produced goods will be
+ In addition, quotas are likely to improve the current account of a country’s available.
------------------------------- s
balance of payments.
Table 17.8 Benefits and drawbacks of quotas
Benefits of quotas Drawbacks of quotas

Domestic firms face less competition, improving their No extra tax revenue is gained
competitiveness. This improves profit for shareholders by the government
and job security for workers
Preventing unemployment theoretically reduces They push up prices
government spending on benefits domestically for consumers
Government legislation
+ Legislation relating to consumer protection and environmental protection
REVISED
□
can act as a barrier to imports. If a government imposes new, stronger
standards of safety or emissions in certain industries, importers may find
their products become illegal. This necessitates design change, which
takes a significant period of time, before importing can resume.
+ In trading blocs, such as the EU, where one goal is the harmonisation
of laws within the bloc, these problems are less likely since the same
standards apply across the whole trading bloc.
+ Passing legislation that hampers imports may only do so as an indirect
consequence of the new laws. If some domestic producers fall foul of the
new laws, the effect on imports could be incidental.

+ However, many governments deliberately introduce laws directly aimed at
blocking imports, such as preventing foreign firms providing internal air
travel in Russia. Making links
17 Globalisation
Now test yourself TESTED Legislation was identified
in Chapter 10 as an
in what two types of industry are governments most likely to use tariffs? external influence on
Explain why Brexit makes it more likely that the UK's government might use business activity. Here is an
legislation to protect UK producers. examination of how it can be
used as a protectionist tool.
Domestic subsidies REVISED

□
+ Instead of acting to make importing harder, domestic subsidies are a
A subsidy is a payment
protectionist measure that look to actively support domestic firms.
made by government to
+ The government pays a figure, usually per unit of output, to sustain firms
a business producing a
that would otherwise be unable to compete. certain product or located
+ The subsidy can be thought of as reducing the unit costs by the amount in a particular area that
of the subsidy, thus boosting margins or allowing companies to cut their the government wishes to
selling price. support.
+ Boosting margins may keep some businesses operating in markets from
which they would otherwise withdraw, protecting jobs and domestic
supply of that product.
+ The other consequence is to make it easier to export these products, as with
a lower selling price they may be more price competitive in foreign markets.
Table 17.9 Benefits and drawbacks of paying subsidies
Exam tip
The USA has clearly shifted
Benefits of paying subsidies Drawbacks of paying subsidies
to a protectionist outlook
Subsidies in effect stimulate demand, Artificially inflating profit margins of under the presidency of
perhaps allowing struggling businesses to inefficient businesses can prevent them Donald Trump. This gives
boost order books, allowing investment in pushing for efficiency gains that would allow you a great opportunity to
more efficient production them to compete without the subsidies bring in current examples
Subsidies have a positive effect on the Subsidies must be funded, meaning the from your reading of
balance of payments by reducing imports government must increase taxation - in a business news stories to
and boosting exports from firms receiving sense punishing firms in industries where help illustrate answers to
the subsidies no subsidies are provided questions on protectionism.^
The four major policies followed by protectionist governments are

summarised in Figure 17.2.
Figure 17.2 Logic chain: the key factors relating to protectionism
State one protectionist measure designed to cut imports and one that also
stimulates exports.
1 List three stakeholder groups who would support paying subsidies to a struggling
manufacturer.

Trading blocs
How and why some countries agree to allow
free trade between themselves
The latter half of the twentieth century saw a move away from protectionism
A trading bloc is a group
in favour of free trade. One result has been the creation of a number of major
of countries that sign up
trading blocs allowing free trade between member states.
to free trade between
In addition to free trade, some trading blocs have, or are working towards: them, protected by a tariff
+ harmonisation of laws (all members have the same legal standards wall against imports from
governing business operations) outside.
+ free movement of labour.
The attractions of trading blocs r REVISED

□
Despite Britain’s departure from the EU trading bloc, attractions of belonging
Dumping is a term used
to a trading bloc remain. These include:
to describe the practice of
+ Harmonisation of laws allows one product to be made that meets legal
selling off excess production
requirements in all member countries. This allows companies to benefit in a foreign market at an
from economies of scale. exceptionally low price,
+ Countries working together within a trading bloc have more power than which destroys sales for local
individual nations to stand up to non-member countries using techniques producers. China is frequently
such as dumping. accused of dumping excess
+ Competing in a larger ‘home’ market incentivises the boosting of efficiency products, such as steel,
for firms in member states. elsewhere in the world.
Expansion of trading blocs REVISED
The expansion of trading blocs has happened in two ways in the last 60 years:
+ New trading blocs have been created.
+ New countries have joined existing trading blocs.
Table 17.10 shows a selection of the biggest trading blocs around the world.
Table 17.10 Expansion of trading blocs
Starting Main members Total GDP Total population

date 2019 (bn) 2019 (m)
European Union (EU) 1958 Germany, France (27 in total) $18,290 446
Association of South-East Asian Nations 1967 Indonesia, Thailand, Vietnam $9,340 622
(ASEAN) (10 in total)
MERCOSUR (Spanish for South 1991 Brazil, Argentina, Uruguay $3,396 295
American Common Market) (6 in total)
USMCA (formerly called NAFTA) 1994 USA, Canada, Mexico (3 in total) $22,293 489
East African Community (EAC) 2000 Kenya, Tanzania (5 in total) £194 177
The EU and the single market Making links

+ Although Britain has now left the EU, the post-Brexit EU still has
27 members and a total population of around 445 million consumers. A single currency such as
the euro eradicates any
+ These consumers, in global terms, are relatively affluent. The EU’s single
concerns that businesses
market remains an incredibly attractive market for EU companies to
may have over exchange
access.
rate fluctuations (see
+ What the EU has achieved, which other trading blocs have yet to do, is to
Chapter 10).
introduce a single currency (though not among all members).

The ASEAN trading bloc
The ten full members of ASEAN (see Table 17.11) operate in an Asia dominated
by the economic success of China, Japan and South Korea. ASEAN’s members
try to work constructively alongside these giant neighbours. After all, much
of ASEAN’s success has been in feeding the might of their bigger neighbours’
manufacturing machines.
Table 17.11 ASEAN's full member states
ASEAN's full member states

Brunei Cambodia Myanmar (Burma) Laos Malaysia
Thailand Vietnam Philippines Indonesia Singapore
USMCA (formerly NAFTA) trading bloc

+ With only three members - Canada, Mexico and the USA - the USMCA
(formerly called NAFTA) is a tense trading bloc.
+ At the heart of the tension is Mexico’s ability to attract companies looking
for a low-cost manufacturing base from which they can import freely to
the world’s largest domestic market: the USA.
+ Resentment of this aspect of NAFTA’s existence was probably the
underpinning reason behind the election of Donald Trump to the US
presidency in 2016.
+ In 2020, the USMCA bloc came into force after Trump threatened to quit
the North American bloc unless its terms were adjusted to better suit the
USA’s requirements.
Now test yourself Typical mistake
22 State three major trading blocs and in which part of the world they can be found. A mistake made by some
students is to try to
23 State two possible features of a trading bloc apart from free movement of goods
generalise about the impact
and services.
of trading bloc membership
Answers available online on all businesses in a
country. Factors such
as whether they import
Impact on businesses of trading blocs supplies or export finished
+ It is impossible to generalise about whether membership of a trading bloc products, whether they
are a manufacturer or
is overall beneficial or negative to businesses in any country.
service provider, or whether
+ Different industries will benefit more from free trade than others. In
suitably skilled staff are
general, it tends to be manufacturing firms that benefit more than others
available domestically mean
from membership of a trading bloc.
that generalisations about
+ However, even within an economic sector, the balance of benefits to the positivity of trading bloc
drawbacks can vary widely. membership should never
The key impacts on business of being located in a country within a trading be made.
bloc are summarised in Table 17.12.
Table 17.12 Advantages and drawbacks of trading blocs to businesses
Advantages of trading blocs Drawbacks of trading blocs

+ Free movement of goods between members gives + Competition increases due to freer trade, so those with
the potential to create a large 'single market' monopoly power may find it competed away
+ External tariff walls insulate the business from + To create a single market, new rules and regulations may
competition from another part of the world be agreed, including minimum wage rates
+ As trade grows between neighbours, it becomes + The availability of easily accessed neighbouring markets
economic (and necessary) for governments to may reduce enterprise in relation to distant but dynamic
provide infrastructure support ones such as China
+ The advantages become much greater if there is + Within a geographically close bloc, there may be
free movement of labour as well as free movement common factors that together become common
of goods problems, e.g. low commodity prices

24 Briefly explain how being based in a free trade area helps to make economies of
scale available.
Exam practice
Keith Glazebrook, owner of Lamination station Ltd, a successful chain of high street printing and copying stores
throughout the UK, decided that the time was right for expansion. With contacts all over the world, Keith, an entrepreneur
who valued networking, had figured out that, in order to grow his business, he wanted to enter a rapidly growing market.
He had narrowed down his choices to just two potential markets: India and Kenya. His research had discovered the
following information:
India Kenya
Population (million 2019) 1,326 54
GDP per capita at PPP $7,200 $3,500
Economic growth % change 2019 5.7% 4.9%
% of GDP from agriculture 15.4% 34.5%
% of population working in agriculture 47% 61%
Adult literacy (as % of population) 74.4% 81.5%
Keith knew that much of his custom would come from people who would have no copying or printing facilities at home.
Some trade would come from entrepreneurs looking to produce promotional materials. Much of the rest would come
from normal householders looking to copy legal or other important documents, in order to grow his business, Keith
wanted to find the market with the most growth potential. With healthy profits from his UK operations, he is willing to wait
for his investment to pay off, but his goal is to double the size of his business in the next 15 years.
1 a) Assess two potential problems that Keith may face doing business in either country. [8]
b) The current Indian government has launched a number of protectionist measures. Assess two possible
protectionist measures and the effect they may have on Keith if he opens branches in India. [8]
c) Assess whether Keith should choose to expand to India or Kenya. Justify your decision. [12]
2 An increasing trend to protectionism, led by Donald Trump's US government, will inevitably lead to negative
consequences for a UK business that exports 50 per cent of its output to the USA.' To what extent do you agree? [20]
Summary
+ Economic growth can be measured in several ways: + Problems doing business in Africa include:
+ GDP per capita at ppp + corruption
+ literacy + poor infrastructure
+ health + lack of stability.
+ HDI. + International trade allows international specialisation.
+ Major economic growth has been evident in several + International trade consists of:
countries within Asia and Africa in the last 20-30 years. + imports
+ China is now arguably the world's largest, or at least + exports
second largest, economy. + foreign direct investment (FDl).
+ China and India have roughly similarly sized + Eight major factors have contributed to increased
populations, and thus markets. globalisation in the last 30-40 years:
+ China has grown more rapidly than India for the last + trade liberalisation
25 years. + political change
+ China is more developed as an economy than India. + reduced cost of transport and communication
+ Factors holding India back include: + increased significance of transnational
+ poor infrastructure corporations
+ narrow education system + increased investment flows
+ balance of payments deficit. + migration
+ Africa may be the last major opportunity for massive + growth of global labour force
growth available to multinationals. + structural change.

+ Protectionism is the opposite of free trade. + Protectionism seeks to take action to discourage
+ Protectionist measures include: imports and encourage exports.
+ tariffs + Major global trading blocs include USMCA, EU, ASEAN.
+ quotas + Membership of a trading bloc allows significant benefits
17 Globalisation
+ government legislation and regulations to businesses located within them, especially a much
+ domestic subsidies. larger market to sell to without any barriers to trade.
Exam skills
You are likely to have learned about globalisation in the African countries - your answers must show that you
early years of secondary school. Your challenge is to show have studied the content of this chapter at an A-level
an A-level standard understanding of what globalisation standard, not relied upon old knowledge copied into
means, how it impacts on business activity and the your Year 7 Geography book.
realities of the commercial side of globalisation in various + Further to this is the need to pay particular attention
parts of the world. to the effects of globalisation on business strategy.
+ The key is accuracy of knowledge. From a real grasp Throughout this chapter, each topic has a clear section
of the differences between China and India as export assessing the implications for businesses. This is
markets and production bases for UK firms, to an ability the perspective from which you should be viewing
to recognise the vast economic differences in different globalisation.
22

18 Global markets and business
expansion
Conditions that prompt trade

What are the forces encouraging businesses
to operate in other countries?
Trade between businesses in different countries, or a business in one
country and consumers in another, tends to be prompted by one or more
of a number of common factors. These factors can be grouped into two
categories:
+ Push factors: These are reasons driving a firm away from its domestic
market.
+ Pull factors: These are reasons attracting a business to a new foreign
market.
Although the desire to trade internationally is often driven by a corporate
objective of growth, other goals may be survival, cost minimisation or
reduction of risk.
Push factors F REVISED

□
Reasons why a firm may wish to leave its domestic market, or at least remove
a sole reliance on it, include:
Saturated markets
Where a firm is keen to grow, new customers must be found. If everyone in a
domestic market that wants the product has already bought it, especially in
the case of consumer durables such as TVs, growth can only come in one of
two ways:
+ Widen the range of products being sold. Exam tip
+ Sell to new markets. Don't forget to use Ansoff's
For a business that does not feel it has the talent or assets to broaden its Matrix when assessing
the risk and causes of risk
product range, new markets must be found.
involved in entering a new
international market. The
Making links lack of understanding of
the market is what causes
Back in Chapter 3, it was noted that the product life cycle model can apply to an entire this strategy to be higher
market, not just a single product. Saturation is likely to occur at the end of the maturity risk than simple market
phase. penetration.
Competition
+ Particularly if a giant new competitor enters a market, existing businesses
may recognise that, in the long term, their survival lies in fleeing the
competition.
+ A huge new player entering a market could call upon tremendous financial
and distributive strengths to quickly eliminate smaller rivals.
+ Those smaller rivals may decide to leave the market and seek their fortune
in new international markets as a route to survival.

Extending product life cycle
+ As a product nears the decline phase of its life cycle, entering new
international markets may represent a viable extension strategy.
+ Sustaining a high level of sales ensures the product continues to generate a
positive cash flow which can be invested in new product development.
+ In some cases, entering new markets may be a way of prolonging the
growth stage of the life cycle.
State three push factors encouraging international trade.

Pull factors r REVISED

□
The pull factors are features of international trade which operate as a force
Exam tip
attracting a business into foreign markets and include:
Generally speaking, push
Economies of scale factors are threats which
drive a business to trade
+ The opportunity to boost unit sales through successfully entering new internationally, while pull
international markets brings with it the opportunity to benefit from factors are more likely
economies of scale. to be opportunities a
+ Economies of scale will be accentuated if production is concentrated business recognises are
in a few locations globally. Not only will purchasing economies of available through trading
scale be likely, but also managerial and technical economies of scale internationally.
may arise.
+ With economies of scale comes a reduction in unit costs, boosting profit
margins.
+ Therefore, a business may experience the blissful scenario of increasing
revenues while reducing unit costs at the same time. Offshoring means moving
one or more business
functions to a foreign
Making links
country, usually to take
First identified as a motive for growth in Chapter 12, the economies of scale available advantage of lower labour
by operating on a global scale are immense in some industries. costs.
Outsourcing means
contracting another
Possibility of offshoring and outsourcing business to perform a
business function on your
+ The lure of lower costs is great, especially when the differentials between
behalf. Frequently that
the costs of land, labour and support services are so great between the UK
function will be production,
and many developing economies.
often performed by a
+ Therefore, this opportunity to significantly reduce costs can act as
business located in a lower
a very strong pull factor to UK-based businesses to shift production
cost country.
abroad.
+ This may be by directly investing in facilities in foreign countries
(offshoring), or by outsourcing production to low labour cost locations.
Typical mistake
Risk spreading Do not use the terms
+ Selling in only one country is a little like putting all your eggs in one outsourcing and offshoring
basket. interchangeably. While
+ Entering more international markets is an effective way of spreading they may both be actions
risk. If sales fail in one country, there are other markets where sales may designed to reduce costs,
remain stable. they are distinctly different
+ Although the process of entering a new market may carry an element of and examiners expect to
risk, as Ansoff pointed out, if that entry is successful, the overall risk faced see the best students use
by the business is reduced. terminology with accuracy. y

Now test yourself
2 List three pull factors that encourage international trade.

List three possible corporate objectives that may be behind a business's decision
to begin to trade internationally.
Assessment of or not a country

as a market
How to judge whether or not a country is
right to start selling in
Once a business has decided to pursue a strategy involving overseas
expansion, it must choose carefully which markets to enter. This decision
making process will focus on a range of factors that determine the
attractiveness of a market.
Market attractiveness REVISED
+ Assessing a market’s attractiveness should be done in the most objective

Exam tip
manner possible.
+ The result is that companies considering overseas expansion are likely to Many businesses will add
set a range of criteria that will apply across potential markets. a level of sophistication
+ The country that scores best when assessed against all the criteria will be to this type of analysis
chosen as the market most likely to offer success. by weighting some of
the factors more heavily
Common criteria are shown in Table 18.1.
than others. So, a bank
Table 18.1 Common factors determining market attractiveness considering entering a new
market may place greater
Common factors determining market attractiveness weight on the scores for
Levels of disposable income Growth of disposable income Ease of doing business political stability and ease of
Quality of infrastructure Political stability Exchange rates doing business than would
a chain of coffee shops.
Levels and growth of disposable income r REVISED
+ The level of disposable income is a key reflection of standards of

Disposable income is the
living in a country. Thus, low disposable income countries will be
money a household has
unattractive markets for companies selling expensive luxuries such as
available to spend from
VR headsets.
income after income tax
+ However, it is not only the level of disposable income that matters, it is the
has been deducted.
direction and size of changes in disposable income that suggest what the
future holds.
+ Growing levels of disposable income represent an opportunity for
business. As people earn more, they spend more.
+ In addition, they spend differently. As disposable incomes rise, new
niche markets emerge, satisfying consumer wants rather than needs.
Getting into these niches early can be a major step to success in a new
country.
+ Countries with growing levels of disposable income represent
opportunities to firms looking to expand abroad. The crucial judgement
for a business looking to enter these markets is timing. Enter too early and
there may not be a large enough market to break even. Enter too late and
rivals may have established brand loyalties already.

4 For what type of products might levels of disposable income be a more important
factor than growth in disposable income?
Ease of doing business REVISED

□
The World Bank (among others), regularly produces statistics on the ease
of doing business in different countries. The way ‘ease of doing business’ is
measured is typically via an assessment of the time taken by many common
business activities such as:
+ days to start a business
+ days to wait for a construction permit
+ days to get electricity
+ total tax rate as a percentage of profit
+ days to import an item
+ days to enforce a contract.
Several of these will only be relevant when a business first enters a new
market. For those expecting to stay a long time, factors such as time taken to
export and, especially, tax rates are likely to be more important.
Making links
To a large extent, the ease of doing business in a country will be greatly affected by
the legislation (introduced in Chapter 10) in place covering business activity.
Quality of infrastructure REVISED
Infrastructure describes the services needed to make modern life function,

including:
Figure 18.1 Aspects of infrastructure
Transport networks and basic services matter for businesses looking to

enter a market. The speed with which goods can be transported has a major
operational impact, while for service providers as well as manufacturers,
basic utilities are crucial.

Political stability REVISED
□
Figure 18.2 Issues considered as contributing to political stability
The level of political stability is vital in the planning process for any business.
The more stable a potential market, the more confident a business will feel
about forecasts of its future performance in that market. Some firms will
favour stability over other factors, while more entrepreneurial businesses
may be willing to accept the risks involved in instability if other factors make
a market attractive.
Making links
The overall assessment of a new international market is likely to stick closely to the
PESTLE structure introduced in Chapter 11.
Exchange rates
+ Exchange rates fluctuate, meaning that any firm that expects them to
remain stable is being naive.
+ Although some currencies may gain or lose strength in the long term,
perhaps dependent upon long-term economic performance, the volatility
of exchange rates makes them seem a factor that is hard to assess usefully.
Indeed, exchange rates are unlikely to affect a decision as to whether to
enter a new market.
+ Rates will, however, be an important consideration in deciding when to
enter a new market.
+ If investing directly into the country, assets should be purchased when the
pound is relatively strong.
+ If exporting from the UK to the new market, lower prices can be charged
without harming revenues measured in pounds when the pound is
relatively weak.
Now test yourself
State three aspects considered when measuring the ease of doing business in a
new market.
List three components of infrastructure required by modern businesses.

Assessment of a country as a
production location
How to judge if a country is a suitable place
to manufacture products
As a company decides to expand, or shift production to another country,
several factors will be considered. For UK businesses moving abroad, costs of
production will play a key part in the decision. However, several other factors
that affect costs directly or indirectly will also play a part.
Costs of production ' REVISED

□
Given the fact that cost is often the key driver behind decisions to move
production to a new country, the costs of production in that country will
be assessed carefully. Table 18.2 shows costs of manufacturing in selected
countries relative to the USA. Perhaps most notable is the rise in the costs of
manufacturing in China between 2004 and 2018.
Table 18.2 Manufacturing costs in selected countries relative to the cost of
manufacturing in the USA
Country indexed manufacturing costs indexed manufacturing costs

2004 (USA = 100) 2018 (USA = 100)
China 87 94
Germany 117 118
Japan 107 104
UK 107 106
Indonesia 82 82
India 87 88
Mexico 92 86
Source: www.bcgperspectives.com
The assumed reason for lower costs in many countries is lower wage costs.
Labour intensive
However, this factor can be overstated. The key is to consider how labour
describes a business
intensive the production process is. For many products, even in a lower
process that relies more on
cost country, production will be capital intensive. This is shown well by the
people than machinery.
breakdown in Jaguar Land Rover’s costs in Figure 18.3.
Capital intensive
describes a business
process that relies more on
Key
machinery than people.
□ Materials & components
□ Employee costs
□ Other costs
Figure 18.3 Jaguar Land Rover cost breakdown, 2019

Source: JLR accounts; all figures in £ms; total costs: £24,057m
Often, the cost differential will be down to the ability to source materials
and components more cheaply abroad, along with lower costs of land and
business services.

Making links
Ultimately, to gauge the effect of producing abroad, it is important to consider not
just the impact of different costs on gross profit margins, but also on operating profit
margins. These were first considered in Chapter 8.
Skills and availability of workforce 1 REVISED

□
+ Producing abroad needs a skilled, or at least semi-skilled, workforce.
+ The skills required to operate machinery may not be available in many less
economically developed locations.
+ In addition, to function in a modern manufacturing plant, literacy will be
an important skill.
+ Chapter 17 showed literacy to be an important indicator of the level of
development of an economy. Without a strong education system to provide
literate staff with the necessary skills, some countries will struggle to be
seen as attractive locations for production.
Are low wages in a country more important for capital or labour intensive
businesses?
Based on Table 18.2, was production in India or China cheaper in 2018?
Infrastructure r REVISED
□
+ As it is for firms assessing the attractiveness of a new country as a market
(see above), so infrastructure will be an important consideration for those
looking for a production base.
+ Transport and utilities must be up to scratch for a modern manufacturing
facility to be able to reliably service the markets it is designed to serve.
+ This explains why some major multinationals will take responsibility
for improving local infrastructure in a location they choose, as well as
building their own production facilities.
Location in a trading bloc REVISED

□
+ Often, a vital pull factor for a location will be its presence within a trading
bloc.
+ When Britain was still a member of the EU, it became an extremely
attractive manufacturing base for non-European firms. The reason was
that for a company such as Toyota, seeking to serve the European market,
building their cars in the UK meant that they avoided tariffs that would
have been charged on cars imported from Japan, or indeed anywhere
outside the EU.
Making links
The benefits of locating in a trading bloc were covered in more detail in the last
chapter. Here we can see why these may affect a location decision.
Exam tip
With the UK outside the EU, its attractiveness as a production location for global
businesses will be reduced. Without tariff-free access to the single market, foreign
direct investment flows may fall considerably.

Government incentives REVISED
□
National governments may well be keen to attract foreign companies to set up
production facilities in their country. Reasons for this include:
18 Global markets and business expansion

+ job creation
+ extra tax revenues
+ a boost for local suppliers
+ increasing skill levels among local labour force
+ potential for a positive impact on the balance of payments.
In order to attract businesses to their country, governments will use a variety
of possible incentives, such as:
+ grants to help purchase land and machinery
+ tax breaks
+ investment in local infrastructure
+ investment in local training.
Ease of doing business REVISED

□
As explained in Chapter 17, a business planning to operate in a new country
will need to assess how much regulation, government interference and
bureaucratic inefficiency it may suffer from. Typical issues to consider
include:
Figure 18.4 issues affecting the ease of doing business in

another country
Political stability ' REVISED

□
+ As well as assessing a country as a potential market, it will also need to be
assessed as a production location.
+ Businesses expect to be able to plan for the future, something which is
made almost impossible if governments change frequently and make
drastic policy changes as a result.
+ This factor is likely to be more important when assessing a country as a
manufacturing base, rather than simply a market to sell to. This is because
the level of investment needed to start producing is likely to be higher,
thus these investments will take longer to pay back and generate a positive
return on investment.
Natural resources 1 REVISED

□
+ It is likely that the availability of natural resources will play a key role in
attractiveness for businesses further back along the supply chain.

+ Generally, companies that initially process raw materials at the start of a
supply chain will need large quantities of relatively bulky resources. These
will be expensive to transport over long distances.
+ This makes it logical for these firms to select locations near a plentiful
supply of natural resources.
Likely return on investment REVISED

□
+ Ultimately, the test of a production location will boil down to the likely
return on investment.
+ Cheaper locations will seem more attractive, since the initial investment
will be lower.
+ However, where a cheap location provides limitations to the likely future
revenues the location can earn, this may be a false economy.
+ A country where the investment will be 50 per cent higher than
another but that can generate revenues that are 100 per cent higher will
ultimately offer a better return on investment for firms willing to take a
long-term view.
Making links
There is a clear link to be made here to the investment appraisal methods introduced
in Chapter 13 - perhaps most notably when considering a return on investment, the
ARR method.

□
State three reasons why a country's government may offer incentives to
businesses setting up production facilities.
Reasons for global mergers or

joint ventures
Why large, international companies seek to A merger occurs when
two firms agree to come
work together together to create a new,
single business.
+ As we saw in Chapter 12, growth can occur organically or inorganically
A takeover occurs
through mergers and takeovers.
when one business buys
+ With speed of reaction to changing markets and technologies globally, a controlling interest in
inorganic growth, via merger or takeover, can represent a huge temptation another business.
to companies from different countries.
A joint venture is a formal
+ For those unwilling to make adjustments to the ownership structure
agreement between two
of their business, a joint venture represents an alternative approach to
separate businesses to
working with a business in another country.
work together for a fixed
time on a specific project.
Spreading risk REVISED

□
+ For a successful business selling in just one or two national markets, a
downturn in one or both markets can spell disaster.
+ It may therefore make sense to ensure that the business is selling across a
range of national markets, in order to ensure that some of its markets are
likely to remain buoyant, even if some fail.
+ Moving into foreign markets may be most easily achieved by merger or
takeover.

Exam tip
If spreading risk is the motive, it is most likely that getting into quite different markets
would do a better job of spreading risk, in these cases, it makes a lot more sense
to harness the expertise of another business, through inorganic growth or a joint
venture, instead of trying to break into a very different market on your own.

□
1C Briefly explain the difference between a merger and a joint venture.
Entering new markets/trade blocs REVISED
+ Having explored the benefits of operating in a trading bloc in Chapter 17,

the reasons for operating production facilities in a new country, especially
as a way of avoiding trade barriers such as tariffs, are clear.
+ Similarly, entering a new foreign market in order to boost sales is a
common strategic approach to achieving a growth objective. Exam tip
+ However, as Ansoff stressed, the danger of entering a new market is a lack
of understanding of that market, and a failure to comprehend how deep The Chinese government
the lack of understanding may be. does not allow foreigners
to take over large Chinese
+ Mergers or takeovers can be a smart way to overcome this problem; buying
businesses. This is why so
a business filled with local experts can be the route to buying that missing
many large western firms
local understanding.
have entered China using
+ Alternatively, joint ventures with domestic firms, without the
joint ventures with Chinese
permanence of a takeover or merger, can also overcome this initial lack of
partners.
understanding.
Acquiring national/international brand

names/patents REVISED
□
+ The opportunity to buy intellectual property - especially brands and
patents - can drive global mergers or takeovers. Buying up a strong
portfolio of brands offers a lower-risk way to penetrate new international
markets.
+ Though expensive, global players are likely to have access to the finance
needed to buy nationally dominant brands.
+ Thus, by using their substantial financial muscle, a large firm can enter
new international markets by buying up market leaders and harnessing
the power of their brand and distribution networks in each market.
+ Buying businesses that hold patents is a quick route to effective new
product development. Once an idea or new process has been patented, the
resources of a global firm may be able to bring that idea to market more
successfully than smaller, national businesses.
+ With design and marketing departments, along with distribution
networks, this can be clever strategy for international growth.
Making links
The benefits of branding were first introduced in Chapter 3. in some cases, these are
so great that a business may launch a takeover bid to acquire a global brand.
Securing resources and supplies REVISED

□
+ For companies using natural resources, especially minerals that can only
be found in far-flung corners of the world, ensuring secure, reliable and
reasonably priced supplies can represent a problem.

+ The solution can be setting up a joint venture with the company extracting
the resources. However, this can lead to problems if the joint venture
partner is not maintaining standards of quality or ethical treatment of
staff. Bad publicity would rub off on both partners.
+ To gain more control, a full takeover may be a better option. This gives full
control over how the former supplier operates in a way that a joint venture
does not. This form of backward vertical integration is increasingly
common in both Africa and South America.
Maintaining/increasing global
competitiveness REVISED
□
+ Boosting competitiveness by driving down unit costs may help to explain
many global mergers or takeovers.
+ It is the economies of scale that such deals promise that entices firms to
come together, as a means to drive costs down, ensuring that the business
can undercut any rivals they may need to.
+ Porter’s low cost strategy could be a perfectly viable route for one
business in each market. As Porter pointed out, there is only room Typical mistake
for one cost leader in any market. However, following Porter’s generic in the heat of an
strategies suggests that competitiveness can be maintained by ensuring examination, too many
differentiation. students forget Porter's
+ Buying similar businesses across the world, with similar points of truism: that there can
differentiation, can also explain a number of global mergers and takeovers. only be one cost leader
in any market. Using the
Making links phrase 'this could help
them become another cost
As explained here, there is a clear link between Porter's generic strategies, explained
leader' screams of a lack of
in Chapter 11, and attempts to grow on a global scale. understanding.
Now test yourself ■
1 Explain why a takeover may be preferable to a joint venture when a business

wants to work closely with a supplier in a low-wage country with minimal labour
laws.
2 How does a joint venture help to overcome Ansoff's concerns over market
development?
Global competitiveness
Issues affecting a firm’s ability to compete
with international rivals
If a business can achieve the ability to compete effectively on a global scale, Global competitiveness
the key benefits are likely to be: measures the ability of a
+ dominating its domestic markets with minimal penetration from imports business to succeed against
+ ease of entry and strong global competitiveness in foreign markets due to both domestic rivals and
global brand recognition. foreign competitors in
As Porter has pointed out, competitiveness can be achieved through cost international markets.
leadership, since the firm with the lowest costs should always be able to
undercut their rivals’ prices. Porter’s alternative strategy is to compete
through a high level of product differentiation. This is especially feasible in
wealthier markets where price is likely to be less important, with consumers
valuing other features such as design, branding and functionality.

The impact of movements in exchange rates
on competitiveness 1 REVISED
□
Movements in the relative values of currencies can have a major impact on
the competitiveness of global firms. The three major contexts to consider are:
+ companies which rely on export markets
+ companies whose domestic market is subject to competition from imports
+ companies which need to import significant quantities of raw materials or
components.
Impacts of a high exchange rate

Considering the case of a UK-based business, an appreciation in the value of
the pound is bad news in two of the three key scenarios.
For example, if £1 is worth $1.50, and the exchange rate changes to £1:$2, the
pound has strengthened against the dollar.
+ Companies which rely on export markets will find it harder to sell their
goods in foreign markets due to increased prices, or must accept lower
profit margins. For a company selling a product for which they need to
receive £10 of revenue, at the original exchange rate they would need to
charge $15 in the USA. Once the pound has appreciated in value, they will
need to charge $20 to achieve the same £10 of revenue, or accept a lower
revenue of £7.50 if they maintain the $15 selling price in the USA.
+ Companies whose domestic market is subject to competition from imports
will find their foreign rivals’ imported products seem cheaper to UK
consumers if the pound increases in value. An American product that sells
for $150 would have cost a UK consumer £100 at the £l:$1.50 exchange
rate. When the pound appreciates to £1:$2, the $150 item will now only
cost a UK consumer £75, giving imported goods a significant advantage
over domestic rivals.
+ Companies which need to import significant quantities of raw materials or
components may be the only ones to celebrate an appreciation in the value
of the pound. The stronger pound buys more foreign currency, meaning
that their imported materials will cost them less in pounds, lowering their
production costs.
Impacts of a low exchange rate

The effects of depreciation in the value of the pound will be the precise
opposite of those shown above when the pound rises in value, as shown in
Table 18.3.
Table 18.3 Effects of depreciation in the value of the pound
Context Effect of a falling pound

Companies which rely on export Products will seem cheaper in foreign markets,
markets boosting export sales
Companies whose domestic imported products will become more expensive in
market is subject to competition sterling terms, increasing the competitiveness of
from imports domestic producers in their home markets
Companies which need to import imported materials will now cost more, pushing
significant quantities of raw up production costs unless the same materials
materials or components can be sourced at home
Making links
Of course, exchange rate fluctuations make pricing decisions (first covered in
Chapter 3) far tougher. This challenge will also be discussed in Chapter 19.

Now test yourself
13 when considering exchange rate changes, what do the letters spiced stand for?
H What type of businesses will benefit from a strong pound?
markets and business expansion

Competitive advantage through cost

competitiveness REVISED
□
+ The ability to produce goods and deliver services more cheaply than
anyone else in the market provides a secure competitive position for a
business.
+ The ability to lower their prices below any rival’s yet still make a profit
when others are making a loss means the business can always rely on
value-seeking customers.
+ However, being the cheapest supplier in a market is a difficult and
relentless challenge. Three key strategies to achieving cost leadership are
18 Global
outlined below.
Raising productivity
+ Productivity gains will come from increasingly efficient use of resources.
+ Key resources from which more efficiency may be squeezed are human
resources and tangible non-current assets.
Making links
Finding a way to increase labour productivity is a fundamental principle behind
Chapters 4 and 9.
+ Clearly, motivated staff are likely to achieve higher levels of productivity.

+ However, it is important to consider that overall productivity within
a business may have just as much to do with how well planned and
organised processes are.
+ Therefore, management and organisation play a key role in the quest for
higher productivity, thus lower unit costs.
+ The assets that a business uses to generate revenue include property,
machinery and equipment. If a way can be found to gain more output or
revenue from the same assets, the unit cost will fall.
+ Some examples: Opening an automated car wash for longer hours can
generate higher revenues without adding too much to the costs. Finding
a way to ensure that a piece of machinery breaks down less often -
thus producing more output - will again reduce average cost per unit.
Meanwhile, keeping a vehicle operating for longer may add little to its costs
but increase its output significantly.
Outsourcing
One way to reduce costs is to find another business that can perform a
business function more efficiently than the business can ‘in-house’. This is
called outsourcing. Not only can this reduce running costs, it can also free up
capital and space to invest further in those processes which the business can
do cheaper than anyone else.
Offshoring
If a business can do something more efficiently than any other, but unit costs
are high simply because of the prevailing local rates of wages and land, the
solution may be offshoring: transferring the business’s successful methods
and expertise abroad.

5 List three potential strategies that a firm might follow to try to achieve cost
leadership.
Typical mistake
Remember that with offshoring, the original business still owns the facilities that have
been moved abroad. Outsourcing, which need not mean a change of country, means
paying another company to perform a process for the business.
Competitive advantage through product

differentiation REVISED
□
Businesses based in the UK (or other developed economies) will find it hard
to be cost competitive. Instead, they are far more likely to achieve global
competitiveness through effective and long-lasting product differentiation. As
outlined in Chapter 1, differentiation can come from several possible sources,
shown in Table 18.4.
Table 18.4 Possible sources of product differentiation
Actual product differentiation Perceived product differentiation

Design Branding
Different functions Advertising
Engineering Sponsorship
Performance Celebrity endorsement
Skill shortages and their impact on

international competitiveness r REVISED
□
+ If companies have failed to plan for future workforce needs or to provide Making links
appropriate training for staff, they may find themselves lacking in staff
with appropriate skills to cope with changes in the market. Once again, the importance
+ To overcome the problem of being unable to fill newly created positions to competitiveness
with appropriately skilled staff, the company may need to poach staff from of human resource
other businesses. management, notably
+ This will almost certainly require paying higher wages to coax staff from recruitment, first discussed
their existing employers. So, the failure to invest which may have been in Chapter 4, is clear when
seen as a way of boosting competitiveness by cutting costs may result in skills shortages exist.
damaging competitiveness by leaving roles unfilled or necessitating the
payment of higher wages in order to fill those gaps.
+ Where this failure to plan and invest is mirrored by that of the
government, a company may find itself unable to access any suitably
skilled staff to fill vacancies.
+ Where a national skills shortage exists, businesses may need to consider
outsourcing abroad, or even relocating a particular function to a country
where the required skills are more readily available.

Exam practice
1 'A company adopting a strategy of global cost leadership will always be more vulnerable to changes in
exchange rates than a company using differentiation as a strategy.' Evaluate this statement. [20]
markets and business expansion

2 Key issues that businesses usually consider when choosing an international market to enter are:
+ levels and growth of disposable income
+ ease of doing business
+ quality of infrastructure
+ political stability
+ exchange rates.
Evaluate which ONE is likely to be most important for a UK mobile phone network provider looking to build
new overseas markets.
Summary
+ Trading internationally is likely to be prompted by push + ease of doing business
18 Global
and/or pull factors. + natural resources
+ Push factors that prompt trade include: + likely return on investment.
+ saturated markets + Global expansion may be pursued through joint
+ competition ventures or mergers and takeovers.
+ extending the product life cycle. + Motives for global mergers or joint ventures include:
+ Pull factors that prompt trade include: + spreading risk
+ economies of scale + entering new markets or trading blocs
+ possibility of offshoring or outsourcing + acquiring brand names or patents
+ risk spreading. + securing resources or supplies
+ Key considerations when assessing new international + boosting global competitiveness.
markets include: + Global competitive advantage can come through cost
+ levels and growth of disposable income competitiveness or product differentiation.
+ ease of doing business + To boost competitiveness through cost
+ quality of infrastructure competitiveness, three clear strategies can be
+ political stability followed:
+ exchange rates. + raising productivity
+ Key considerations when assessing international + outsourcing
production locations include: + offshoring.
+ costs of production + Changes in exchange rates have an impact on global
+ skills and availability of workforce competitiveness.
+ infrastructure + Global competitiveness can be affected by skills
+ location in a trading bloc shortages.
+ government incentives
Exam skills
This chapter's content offers the opportunity to practise There are three key determinants of the relative
evaluative skills. With two sections entitled 'assessing importance in context:
the attractiveness', examiners will be looking to see + What type of business is facing the decision? What
whether you are able to make actual assessments of matters most to that type of business?
the attractiveness of countries as markets or production + Which countries is it looking at? Different issues are
locations: likely to become more or less important at different
+ when faced with questions such as these, ideally you stages of economic development.
will recall the major issues to be considered - as listed + What clues are given in the case study or stimulus
on the specification and in the preceding pages. materials? Look out for hints about what the boss is
+ If your memory fails you and you cannot remember especially concerned about.
every factor listed, that need not be the end of your + Having chosen the three or four most important issues
chances. that you can remember, explain their relevance in this
+ Extended answer questions will expect a discussion of case, assess how attractive each factor is, and then
a few factors. you can move on to making a judgement - probably
+ The key is to ensure that you prioritise those factors based on weighing up the relative importance of the
that are most important in the context of the question. factors you have chosen to analyse.

19 Global marketing
Global marketing____________________________________
What approach to marketing should be taken
by a firm selling in many markets?
Global marketing strategy and glocalisation REVISED
□
During the twentieth century, some brands were able to spread their sales
Glocalisation is a
worldwide through a consistent and unchanging product and promotional
term used to describe
approach. Coca-Cola’s success is unlikely to be repeated, as the nature of
an approach to global
global markets has changed. The need to adapt products to suit local market
marketing that maintains a
tastes has led to an approach to global marketing known as glocalisation. consistent brand and image
across the world, but makes
Exam tip adaptations, especially
to products, to suit local
It is only at the higher-priced end of markets where global consistency still pays. markets.
Luxury brands seem loved throughout the world without adaptations. It is in mass
markets where local changes tend to be needed.
A summary of the strengths of both approaches is shown in Table 19.1.

Table 19.1 Global versus glocal branding
Strengths of global brands Strengths of localising brands

(glocalisation)
+ Huge sales provide production + Tailoring to local tastes and habits
opportunities to enjoy significant should boost market share, e.g. green
economies of scale tea Magnums in Japan
+ Over 1.4 billion people travelled abroad + Local buyers can assume you are a
in 2018; global brands can be bought local producer, which may help sales
for reassurance and familiarity, i.e. (e.g. many British people believe
globalisation helps sales Ford to be a British car maker, not
American)
+ Many promotional tools are global (e.g. + An innovative product designed for
sponsoring Formula 1 or buying the local tastes may end up being a global
rights to Arsenal's shirt front) and can success, e.g. the Nissan Qashqai,
only be economic if the brands sell designed in Sunderland, but now an
globally (e.g. Emirates airline) important global brand
+ Global scale provides strong + Localising brands probably means
negotiating power with retailers localised production, which cuts costs
(helping those 'power brands' get and may help establish a greener
better display and distribution) image for the business
Different approaches REVISED
Domestic/ethnocentric
+ This approach to global marketing stays focused on the home country. The
attitudes of the company’s senior managers will be heavily influenced by
their national culture.
+ This leads to an approach that expects consumers in foreign markets to
welcome the company’s products as they are.

+ Ethnocentric attitudes can also be found among consumers, who are
sometimes unwilling to consider imported products worthy of their
attention. This gives domestic producers a competitive advantage in their
home markets.
+ However, when it comes to breaking into foreign markets, this could
breed an ethnocentric approach from managers, who will assume foreign
consumers will buy products just because they come from their country.
International/polycentric
+ A polycentric approach is founded in the belief that all markets are
different. Thus, decisions are made at a local level, specifically designed to
suit the needs of local customers.
+ The empowerment of local managers to develop new products and brands
with local tastes in mind can undo some of the advantages of operating on
a global scale.
+ However, the firm will still look to benefit from advantages of size, such as
purchasing economies of scale.
Mixed/geocentric
+ Perhaps the best approach, this combines ethnocentric and polycentric
perspectives. The approach is underpinned with the belief that people
all over the world share some characteristics, thus the creation of global
brands with a level of consistency worldwide is possible.
+ However, the approach also accepts that local differences exist,
necessitating localisation. The geocentric approach would empower local
managers, but on the understanding that where possible, global is best. So,
local managers can take decisions that suit their area where the company’s
global approach cannot be applied effectively.
Now test yourself
which approach to global marketing is founded on the belief that all international
markets have such significant differences that a global approach to marketing
will fail?
what name is given to the recognition that successful global marketing needs
some recognition of local differences?
Applying the marketing mix to global

markets 1 REVISED
□
Making links
The marketing mix was introduced in Chapter 3: product, price, promotion and place.
This section examines the issues raised when setting a global marketing mix.
The judgement of marketing managers will be crucial in deciding the

extent to which the four Ps should be adjusted to suit local needs. Although
consistency with the company’s global approach will generally be desired,
especially under an ethnocentric and a geocentric approach, different Ps may
need to be adjusted. Examples of local adjustments needed could include:
+ Product: Size, taste/flavour, packaging.
+ Promotion: Methods and content.
+ Place: Typical outlets may vary; a delivery service may be expected.
+ Price: Some local markets may need to see pricing strategies adjusted due
to local competition.

Applying Ansoff’s Matrix to global markets REVISED
□
+ Ansoff helps businesses assess the level of risk associated with their
Making links
choice of strategic direction.
19 Global marketing
+ Measuring markets and products on its two axes, as firms consider Remind yourself of
entering new foreign markets, they can assess how similar or different Ansoff by turning back
new markets are to their existing markets. to Chapter 11.
+ On the other axis, they can judge risk by the extent to which local market
conditions require them to change their product portfolio or enter the
market with existing products.
Applying the Boston Matrix to global markets REVISED

□
High
Making links
Cash Rising The Boston Matrix first
C cow B Star appeared in Chapter 3.
Market
growth
(%) Low High
Dog Problem
D • child
Low
Market
share
(%)
Figure 19.1 The Boston Matrix
+ As shown in Figure 19.1, the Boston Matrix is a helpful tool for firms to use
to assess their product portfolio.
+ Above all, it suggests how the marketing budget should be allocated,
indicating that cash cows can generate finance which can be used to
support an extra marketing push for rising stars and problem children.
+ The matrix can be adjusted to be used to assess the different international
markets that a business sells to. The axis showing market share should
be adjusted to show market wealth, so, in the example in Figure 19.2,
although the Ghanaian market is growing rapidly, the level of personal
wealth within the market may not be high enough yet to generate serious
revenue for a business.
+ However, it may be worth investing in the Ghanaian market now,
expecting market wealth to grow over time.
High Market wealth Low
High
China
£ Ghana
§ India
%
■if
s Brit ain
Afghanistan
and Gfsrmany
Low
Figure 19.2 Boston Matrix adjusted and applied to global market
if using the Boston Matrix to assess international markets, what should replace
market share on one axis?

Global niche markets
Key differences between markets
Making links
On the first page of Chapter 1, the benefits of niche marketing were covered. Now it is
time to consider a niche approach to international marketing.
Differences between different countries’ markets mean that from a global

perspective, each country could be seen as a niche within the global market.
As covered in Chapter 1, selling products to a niche market tends to allow
firms to take advantage of the following benefits:
+ benefits of successful niche market strategy
+ able to meet consumer needs more precisely
+ able to charge a higher price than for mass market products
+ less direct competition.
Cultural diversity 1 REVISED

□
Typical mistake
Do not confuse national cultures with corporate cultures, as covered in Chapter
14. Although both refer to common acceptable norms of behaviour, one refers to
behaviours acceptable in a country while the other refers, far more specifically, to
those behavioural norms found in a business.
Cultural diversity is caused by many factors, but predominantly driven by: Cultural diversity
+ Economic factors: Particularly differing levels of average disposable income describes the differing
in different countries. interests and values of
+ Weather: Particularly temperature, influences how and where people people from different
work, relax, eat or generally live their lives. national backgrounds.
+ History and tradition: These features of a country may have a wide-
ranging impact on so many issues relevant to business, including diet,
attitudes to religion, gender, racial diversity and lifestyle.
The impact of cultural diversity is to make the delivery of a single global
strategy very hard to pull off. With consumers in different niches sharing
different needs and wants, the pressure to adapt to local diversity is great.
Features of global niche markets F REVISED

□
+ Wealthy people tend to travel a lot, picking up tastes and habits that are
remarkably similar at the higher-income end of markets globally.
+ This explains why niches at the higher-income end of most luxury goods
markets, from perfume to cars, or champagne to designer clothes, tend to
develop as global niche markets.
+ For products that are not luxuries, or for luxury goods aimed at lower
income consumers, there is less commonality globally. Thus, these
markets tend to differ by country.
+ Therefore, it is safe to assume that most global niche markets cater to the
wealthy in supplying luxuries.
+ On the other hand, most mass markets tend to have local variations that
make a standardised, global, ethnocentric approach less likely to work.

Adapting the marketing mix to fit global
niche markets REVISED
□
19 Global marketing
Critical aspects of a successful global marketing mix vary according to the
type of market. For businesses aiming at those top-end luxury niches, key
features include:
+ aspirational price levels
+ products with a strong brand heritage
+ distribution through world-famous luxury stores such as Harrods and at
airports
+ promotion in glossy style and travel magazines and through glamorous PR
events. Exam tip
However, for companies attempting to compete in other global niche markets, Carrying out market
with less commonality, a deep understanding of local tastes is critical in research in a foreign
designing the marketing mix. Cultural diversity can affect each aspect of market may fail to uncover
the mix: every relevant aspect
+ Different features expected of the product. of consumer behaviour.
+ Different price expectations depending on the value placed on the product Market research exercises
or service locally as well as levels of income. tend to be limited in
+ Differences in traditional channels of distribution from country to country. scope: they only discover
+ Different expectations of how promotional messages are received from what they set out to ask.
country to country and market to market. Too often, a failure to
understand local markets
Without the availability of staff with a deep understanding and experience of
means that research fails to
local market differences, the marketing mix produced for a global brand may
ask the right questions.
fall victim to failing to appropriately read the conditions that would allow a
successful brand launch.
4 State three key sources of cultural diversity within markets.

Which niche markets are most likely to share common features globally?
What is likely to be the key for successfully marketing a product in a new country
in markets typified by cultural diversity?
• Cultural and social factors in

global marketing__________________________________
Some of the major challenges for companies
selling in many international markets
+ As discussed in the last few pages, there can be remarkable differences
between different national markets. This makes global marketing fraught
with possible problems.
+ The differences between national markets suggest that a deep
understanding of local conditions is likely to be the key to a successful
marketing mix.
+ This section summarises six common causes of marketing mistakes for
firms looking to market their products in different national markets.

Cultural differences r REVISED
□
+ Behavioural norms can be very different from country to country. The way
Culture describes normal,
people meet and greet one another in formal and informal settings can be
acceptable behaviours in a
19 Global marketing
vastly different.
certain context.
+ Similarly, typical behaviours within business meetings can vary. Even yes
and no can mean different things in different countries, with yes often
meaning perhaps in some environments.
+ Meanwhile, societies may have vastly different perceptions of certain
marketing methods; consider the use of singing and dancing cows, which
are amusing and brand-building in the UK, but likely to cause offence in
cultures where cows are sacred animals. Indeed, religious beliefs can form
a strong part of the set of values that influence cultural differences.
Exam tip
It is hard to overestimate how many businesses fail to fully grasp cultural differences
when entering new international markets. Linking this to the problems of carrying out
effective market research explains why so many firms get it wrong when trying to
break into an unfamiliar market.
Different tastes REVISED

□
+ Most obviously, tastes can vary in food and drink markets. Different
national cuisines, influenced by the types of food most commonly grown
locally, as well as historical factors, may dictate the likely success of
different flavours of food or drink. Global coffee shop brands have found
the need to feature far more tea on their menus in traditional tea-drinking
markets such as China and India.
+ Other markets, however, can be strongly influenced by local differences in
taste. Clothing, especially fashions, will see tastes varying depending on
local media as well as local climate.
+ Meanwhile, markets for products such as cars (different features or interior
designs), electronics (different ways of using them) or books (different
genres preferred) may be hugely influenced by local tastes.

□
List the six major causes of international marketing mistakes caused by cultural
and social factors.
List three markets in which different local tastes can lead to the need to make
adjustments to products.
Language REVISED
□
Assuming your level of English is close to fluent, you can consider yourself
lucky in a global business sense. Table 19.2 shows the popularity of English as
a language of international communication in a business environment.
Table 19.2 The five most popular second languages spoken around the world, 2019
Language Learners (million people)

English 898
Hindi 295
French 199
Mandarin Chinese 199
Indonesian 155
Source: https://www.ethnologue.com/guides/ethnologue200

It is clear which language many people want to be able to speak to ‘get on’
in the world. However, English is not the most commonly spoken language
globally. Table 19.3 shows it only features mid-way up the most commonly
spoken first languages in the world.
19 Global marketing
Table 19.3 The five most widely spoken languages in the world, 2019
Language Speakers (million people)

Mandarin Chinese 918
Spanish 480
English 379
Hindi 341
Bengali 228
Source: https://www.ethnologue.com/guides/ethnologue200
Typical mistake
Combining these facts with the widely recognised business practice that
speaking to a consumer in their own language helps hugely in successfully General references to
selling to them, should help you see why studying a foreign language can language barriers do not
increase your employability. Fluent linguists working for a business offer two impress examiners. Try to
key benefits in trying to sell to foreign markets: be specific as to the types
+ Customers will be impressed if spoken to in their own tongue. of language problems
+ Marketing errors caused by linguistic misunderstanding in product that can occur in global
naming, branding or promotion are likely to be avoided. marketing.
Unintended meanings REVISED

□
+ The problems with literal translation is that all languages have their own
idioms: phrases that should not be taken literally, such as English phrases
like ‘flogging a dead horse’ or ‘back in a second’.
+ At times, a literal translation can cause a significantly different meaning to
be understood by consumers in a local market, a meaning that may be far
from the intended meaning behind the promotion.
Inappropriate or inaccurate translations REVISED

□
The major causes of problems arising from translations include:
+ Wrong words: Choosing the wrong word to use in a local language can
confuse or obscure meaning.
+ Sounds like something else: A brand name that sounds like something else
in the local language can lead to problems.
+ Slang: Local slang can make some words used as brands or in advertising
slogans carry unexpected and inappropriate meanings.
Inappropriate branding or promotion REVISED

□
+ Wording and imagery used in branding may clash with local values and
cultures, causing negative publicity for a brand in a local market.
+ Carefully designing a TV advert that ‘works’ in Western Europe does not
mean that the advert’s message and content will be effective, or even
acceptable, in all global markets.
+ A major area for problems here is religious belief and cultural diversity.

Exam practice
Edwards and Edwards is a high street food retailer, specialising in high-end, luxury,
specialist food products, including caviar, champagne and specialist cold meats.
Edwards and Edwards have been successfully operating across a number of
European markets for the last ten years. In order to satisfy their shareholders' desire
for continued growth, the company has now decided to enter both the Japanese
and Chinese markets. With no previous experience of these markets, the firm has
commissioned local market research companies to gauge local consumers' reactions
to the likely success of the expansion. Results have been broadly positive and are
summarised below.
Question % of positive % of positive

responses in China responses in Japan
Would you like to be able to buy 46 32
high-end European food products?
Have you ever heard of Edwards 18 12
and Edwards?
Would you be willing to pay a price 55 12
premium for these products?
Would you expect to see premium, 12 67
locally sourced products in-store?
1 a) Evaluate whether the research data supports the use of an ethnocentric/

domestic marketing strategy. [20]
b) Evaluate the main marketing challenges that Edwards and Edwards may face in
entering these two new markets. [20]
2 Evaluate whether increased globalisation will inevitably lead to reduced differences
between national markets for consumer goods over the next 20 years. [20]
Summary
+ Glocalisation means thinking globally and acting locally. + The Boston Matrix can be used to help to assess the
+ There are three broadly different approaches to global attractiveness of new international markets.
marketing: + Cultural diversity means local markets can have major
+ ethnocentric/domestic differences, based especially on economic factors,
+ polycentric/international weather, and history and tradition.
+ geocentric/mixed. + Major causes of problems in operating in international
+ The marketing mix is likely to need adapting to suit local markets include cultural differences, different tastes
markets. and language issues.
Exam skills
This chapter offers the clearest example from the whole of marketing concepts such as mass versus niche
specification of getting context right. marketing, product portfolio analysis using the Boston
+ in re-visiting the marketing half of Theme 1, it is clear Matrix and the design mix.
that much of your knowledge of marketing studied + Make sure, however, that your answer to global
early on in your course is going to be relevant again. marketing questions is clearly different from an answer
+ However, when examining this final part of Theme 4 you would give to a domestic marketing question about
of your specification, and this chapter's content in a UK business examining the first part of Theme 1. Get
particular, the context in which you must use your the context right and you should be well on the way to
marketing knowledge will be global. In some ways achieving high marks.
this should allow you to deepen your understanding

20 Global industries and companies
(multinational corporations)
The impact of multinational

corporations
How do huge multinational companies affect
the places in which they operate?
The impact of MNCs on the local economy ' REVISED
□
Employment
Table 20.1 Positive and negative impacts of multinational companies
Positive impact of MNCs Negative impact of MNCs

Local + Western training methods may make the local + Western employers may attract over-qualified
labour workforce more productive/employable people - possibly stripping local businesses and
public services of skilled staff
Wages + MNCs usually pay higher wage rates than local + Some locals may feel bitter that they are paid less
firms, improving standards of living than westerners for doing exactly the same job
Working + MNCs have international reputations to maintain, + Conditions may be above-average, yet still quite
conditions so they will tend to provide above-average shocking to westerners
conditions + Some MNCs may have impressive policies in
+ Yum Foods has a 'Human and Labour Rights place, yet the workplace reality may be worse
Policy' and claims to employ it in all 125 countries than the paper theory
Job + Yum Foods employs 1.5 million people worldwide; + The success of MNCs may sometimes be at
creation in Africa it provides more than 20,000 jobs the expense of local independent firms; the key
measure is net job creation
Local businesses
+ When a multinational sets up operations in a new area, the impact on A multinational company
most local businesses is likely to be positive. is one that has branches
+ A new factory that creates hundreds of jobs will look to local businesses or manufacturing plants in
for some supplies, will create more spending power locally - to be spent several countries.
in local shops and restaurants - and will add income to the area that local
entrepreneurs can exploit.
+ However, if the operation started by a multinational provides direct
competition to an existing business, it may have too much power for local
rivals and put them out of business.
Local communities and the environment

+ The impact of multinationals on local communities and the environment
is too complex to be considered in absolute terms. Examples of
multinationals investing in local communities, raising standards of
healthcare, education and infrastructure can be found.
+ Alongside these are examples of multinationals whose approach can cause
damage to local communities, disrupting social structures and indirectly
bringing problems of crime that can be associated with sudden, newly
found wealth.

+ Likewise, although there are examples of multinationals that have had a
damaging effect on the physical environment, local businesses may be just
as, if not more, guilty of causing environmental damage.
+ This may be especially true where local environmental regulations are
minimal or non-existent: at least a multinational may need to stick to
globally laid down internal environmental standards.
1 State three negative impacts that a multinational may have on local labour
markets.
The impact of MNCs on the national

economy r REVISED
□
FDI flows
+ When multinationals choose to invest directly into other countries, they
are injecting cash into the national economy. That cash creates jobs and
injects extra money into the local economy.
+ However, there are concerns that the FDI flows may not entirely work in
that direction. Once a multinational is generating profit, the likelihood is
that the profit will be sent out of the country, back to the multinational’s
home country.
Balance of payments Making links

+ Countries that import more than they export run a current account deficit.
Thinking back to Chapter
This is likely to lead to a fall in the value of the currency, which creates a
17, the effects covered here
risk of inflation.
are occurring throughout
+ However, if the country attracts FDI, the inflow of cash from many growing economies,
multinationals cancels out the current account deficit. including China, India and
+ The potential problem with this occurs when a multinational decides across some parts of Africa.
to withdraw its FDI. This represents a further outflow from the country,
thus further damaging the balance of payments current account. One
company’s decision to withdraw FDI would have a minimal impact on a FDI (foreign direct
major economy, but the effect of a large multinational withdrawing from a investment) occurs when
smaller, less economically developed country can be significant. a business purchases non-
current assets in another
country.
Technology and skills transfer
+ When multinationals open facilities in a new host nation, they are likely to
Exam tip
introduce ideas and methods that may be new to the country.
+ This allows the local economy to copy or ‘borrow’ the techniques and The impact of multinationals
methods being used, improving the efficiency of local businesses. on consumers in host
+ Access to new technology can be the key to unlocking economic countries is a classic example
development. Skills can be developed among the local workforce, which of one where you should
sustains the ongoing development. be able to introduce ethical
concerns as a counter
argument against classic
Consumers benefits such as increased
As multinationals enter new countries, consumers within those countries choice. Introducing the
gain more choice. This is broadly seen as a good thing. However, problems ethical issues involved in the
may emerge if the competition from the multinational drives domestic firms operations of multinationals
out of business. Though this is the reality of capitalism, concerns over the can be a handy way to
fairness of the competition are often attached to the entry of multinationals produce counter-arguments
to foreign markets. or offer evaluative thoughts
within an exam answer.

Business culture
+ Multinational businesses are run in a professional and generally consistent
way. This consistency of operation may not be commonly found in host
countries.

+ In just the same way that technology and skills transfer helps domestic
businesses, so will the experience of seeing how a multinational operates.
+ As domestic suppliers deal with the multinational, they are likely to adapt
a more consistent and professional business culture.
Tax revenues and transfer pricing

+ Different countries charge different rates of tax on business profits.
As multinationals operate across several countries, it is logical for a
multinational to try to maximise their profits in countries where tax rates
are lowest, declaring minimal or no profits in high tax countries.
+ The mechanism that multinationals use to engineer this is transfer Transfer pricing is
pricing. A multinational will move products between its different locations, a technique used by
charging an ‘internal price’ for components or partially finished goods as multinationals to adjust the
they are transferred between the multinational’s locations. internal prices paid by one
+ This allows high prices (therefore low profits) to be charged by branches in branch of their operations
high-tax countries, with most profits engineered into the operations based to another as a way of
in low-tax countries. minimising the total tax bill
+ Laws on transfer pricing vary from country to country, but clever tax paid by the company.
accountants can generally ensure that multinationals using this technique
are not breaking any laws.
+ The implication for host countries is that multinationals are able to Typical mistake
minimise the tax they pay locally using transfer pricing.
+ This potentially places undue pressure on host countries’ governments to Most multinationals that
keep tax rates low. use transfer pricing, or base
themselves in tax havens,
are not actually breaking the
Now test yourself law. The term used for not
paying tax which is legally
Briefly explain why the reputation for environmental damage that tarnishes
due is tax evasion. The
multinationals may not be deserved.
multinationals are using tax
3 What global inconsistency makes transfer pricing possible? avoidance strategies: not
Answers available online illegal, but ethically dubious.
Ethics in global business__________________________

What particular ethical issues are raised by the
operation of huge multinational companies?
What are business ethics? r REVISED
□
First covered in Chapter 14, business ethics concerns the morality of
business decision-making and actions. The natural conflict between
operating in a morally acceptable way and boosting profit can be
intensified when a multinational begins operating in a less economically
developed country.
Stakeholder conflicts REVISED

□
Large businesses operating on a global scale are most likely to be pursuing an
objective of maximising profit, under pressure from their shareholders. Given
the power of large shareholders they are likely to be the dominant stakeholder
group, who get their way. Table 20.2 shows examples of stakeholder conflicts
and ethical solutions to them.

Table 20.2 Conflicting stakeholders - ethical solutions
Conflicting Example Ethical solution Making links

stakeholders
We first considered
Retailers and In 2020, Asda announced it would Price negotiations should be
stakeholders in Chapter
their suppliers only pay 50% of money owed tough, but once a price is agreed,
14, even exploring why
to manufacturers whose goods it is unethical to bully a small
stakeholders’ objectives can
they no longer needed due to the supplier into receiving less
conflict. For multinationals,
pandemic
the expectations of such a
Directors and In 2020, Tesco finally relented Staff understand that bosses vast range of stakeholders
staff to staff pressure on pension receive higher remuneration, but tend to be impossible to
contributions. Outgoing boss Dave unfairness such as this is quite satisfy.
Lewis had been getting 25% of his simply unethical
salary 'in lieu of pension', with the
wider workforce only receiving
7.5% of their salaries in pension
contributions. New boss, Ken
Murphy, will now only receive 7.5%
Management Bafflingly, owners of bank shares Ethics should apply in all cases;
and have allowed senior bank staff using negotiating power is fine;
shareholders to pay themselves bonuses but many bonuses were for things
that strip the banks of their that cost the bank in the long
profitability (Lloyds Bank shares: term, e.g. mis-selling payment
976p in 1999; 575p in 2007; 75p in protection insurance (PPI)
2015; 31p in 2020)
Pay and working conditions F REVISED

□
Before deciding on the morality of pay rates around the world, it is imperative
to view local pay rates in a local context. Paying a factory worker the same in
Vietnam as a factory worker in the UK fails to take account of differences in
the costs of living.
Ethical issues relating to pay and working conditions include:
+ Should wealthy consumers feel comfortable wearing clothes made by
factory workers paid pence, rather than pounds, per hour?
+ Should firms in less economically developed countries be allowed to
produce goods for developed economies in working conditions that would
be unacceptable in the markets being sold to, but which are legal in the
host country?
+ Should a multinational company that outsources some of its production
be responsible for the pay and working conditions in their suppliers’
factories?
Table 20.3 indicates how a line can be drawn between ethically acceptable and
unacceptable working conditions in developing economies.
Table 20.3 Working conditions and ethics
Working conditions that could be Working conditions that are

seen to be ethically acceptable unconditionally unacceptable
+ Cramped and hot, where profit + Dangerous conditions with machinery
margins are too low to allow more and fire risk - and perhaps chemical air
space and air conditioning pollution
+ Long working hours, perhaps up to 12 + Forcing people to work long hours,
hours a day perhaps by threats of dismissal
+ Agricultural workers planting rice - + Long back-breaking hours in
bending over for perhaps 12 hours a agriculture with little pay - while
day farmers and dealers get rich

Now test yourself
4 State one ethical issue relating to pay or working conditions that affects
multinationals.

Environmental considerations REVISED

□
Emissions
+ For products that produce emissions that are harmful to the environment -
perhaps most obviously cars - the emissions produced are regulated in all
developed countries.
+ In addition, consumers may be attracted by products with lower emissions.
+ Ethical issues arise when considering who measures emissions. Although
independent testing takes place, if the company itself has to pay an
independent tester, the company doing the testing may be tempted to
adjust results in the hope of securing a long-term customer.
+ A further issue can be seen if a company discovers an emissions problem
with a product. Failure to communicate this information externally,
perhaps in the hope of fixing it quickly without tarnishing the company’s
brand, is unethical.
Waste disposal
+ Many products produced by businesses pose problems of disposal when
their life is complete.
+ Getting rid of old consumer electronics products which often contain
poisonous elements presents problems with an ethical dimension.
In developed economies, disposal of hazardous substances is highly
regulated and thus expensive.
+ However, some businesses see less economically developed countries with
their weaker or non-existent regulations as a cheap solution. Dumping
hazardous products or by-products in less developed countries is unethical.
Supply chain considerations ' REVISED

□
The major ethical issues highlighted on the specification are the exploitation
of workers and child labour. Both of these practices are clearly wrong.
However, two interesting issues can be raised:
+ What is the alternative for the worker or the child? If this is the only job
available to the worker, no matter how exploitative, how else could they
feed their family? Should the job be withdrawn? If the child is working for
their parents, perhaps on a family farm or in a family factory, would the
removal of that extra pair of hands cause the business insurmountable
problems?
+ Should a business be responsible for the employment practices of their
suppliers, or their suppliers’ suppliers? Large businesses producing or
selling complex products may well be buying from suppliers who buy
materials from other suppliers. If one of the suppliers’ suppliers is using
child labour, does the original business deserve censure?
Marketing considerations r REVISED

□
Misleading product labelling
Although tight product labelling legislation is in place to ensure that labels
don’t lie, ethical issues still surround labelling. Many of these relate to food
products, but by no means all. Issues include:
+ implications of messages about the vague benefits of a product

+ inferences about a product’s ingredients or methods of production,
perhaps implying it is ‘all natural’ but without explicitly lying about the
level of highly processed ingredients used in it
+ unhelpful imagery on packaging or in adverts, which is designed to infer,
suggest or imply something untrue, without explicitly claiming an untruth.
Inappropriate promotional activities

A range of promotional activity that businesses undertake can be criticised
Making links
for being unethical. Examples include:
+ Promotions that encourage consumers to buy more than they need can When we first met
lead to food waste. promotional activities in
+ Food retailers have also received criticism for running Buy One Get Chapter 3, there was no
One Free promotions on sugary drinks and foods, encouraging over- real consideration of ethical
consumption of foods best consumed in small quantities. issues, in this context, of
+ Advertising has also been blamed for social issues, such as body image multinational activities, the
issues, especially among teens, by using touched-up images of models to 'ethical spotlight' is shone
set unattainable beauty goals. on some promotional
+ Companies offering credit to try to encourage people to buy products they activities.
really cannot afford can also be accused of unethical promotion.
The fundamental issue here is where to draw the line between a business
objective of maximising sales and consumers’ inability to resist the
bombardment of promotional messages they receive every day.
in what two ways do the operations of multinationals raise environmental issues?

6 Define business ethics.
Controlling multinational
corporations
Is it possible to control what huge
multinationals do?
Influence or control? REVISED
□
The subtle difference between influence and control can be illustrated
Exam tip
by considering a company’s stakeholders. While stakeholder groups such
as pressure groups and customers may influence a business, control lies Some argue that customers
with major shareholders and the directors they appoint, as well as with can exert control over
government (through laws and regulations). businesses, while many
would suggest that they
Figure 20.1 shows different stakeholder groups according to their level of
merely have influence
control or merely influence. over what businesses do.
Control Influence Examples can be found to
illustrate both, but, as the
Zone of
zone of uncertainty marked
uncertainty
on Figure 20.1 shows,
customer power can offer
Large Small Customers Pressure
shareholders shareholders groups
excellent opportunities to
Government explore the issue of control
versus influence.
Figure 20.1 The subtle boundary between influence and control

Notice the dotted arrow showing that pressure groups can influence
governments as well as businesses.

State two stakeholder groups that a) have some control over multinationals and
b) merely influence but do not control multinationals.
The need to control MNCs REVISED

□
Unlike most governments, the leaders of multinationals are not answerable
to the citizens of the countries in which they operate. Instead, multinationals
do the bidding of their directors, appointed by major shareholders. It is this
issue that lies behind the belief that the activities of multinational companies
need to be controlled to an extent by external agencies such as governments.
Specific situations raised are outlined below.
Safety concerns
Multinationals producing in less economically developed countries with
lax regulations on factory safety may be able to squeeze extra life out of
unsafe machinery that has had to be retired from plants elsewhere. If local
regulations cannot ensure safe equipment for workers, some other form of
control may be needed.
Short-term mineral extraction

+ By their nature, minerals can only be extracted once.
+ Where a multinational enters a host country to extract minerals, it is
therefore crucial that the country receives appropriate reward for its
irreplaceable natural resources. What an appropriate level of reward is can
be debated.
+ However, in circumstances like these, with vast sums of money changing
hands, it can be too easy for local politicians to benefit personally by
allowing the multinational in, rather than ensuring that rewards are
shared equitably within the host country.
Weakening local cultures

Using their marketing budgets and techniques, honed over many years,
multinationals can be highly adept at selling foreign products to locals.
Concerns are often raised when the success of a multinational’s marketing
leads to consumers changing their habits and lifestyles as a result. This can
lead to a loss of traditional local cultures, to be replaced by some kind of
global corporate consumerist culture.
Lack of commitment to the host country

A multinational lacks the strong bonds tying it to a country that characterises
domestic focused companies. As a result, multinationals may be willing
to leave a country, perhaps creating significant unemployment or social
problems, in the event of problems that a domestic producer may have the
commitment to work through, such as a recession.
MNCs and political influence REVISED

□
Lobbying key political decision-makers is something that multinationals tend
Lobbying describes the
to do exceptionally well. With money and power, multinationals can exert a
process of directly trying
worrying level of influence over politicians.
to influence key political
decision-makers to act in the
best interests of a business.

This influence can be used to achieve many things that aid the operations of
multinationals, including:
+ granting licenses to run phone, rail or electricity networks
+ granting licences to extract raw materials
+ encouraging changes in laws and regulations affecting the multinationals’
operations
+ offering tax breaks
+ overlooking instances where they fail to adhere to regulations.
Typical mistake
These actions, which multinationals can influence politicians to take, may all seem
to refer to less economically developed countries. Look more carefully and you can
see that all could apply to developed countries too. There are plenty of examples of
multinationals gaining political influence in countries such as the UK in order to get
their way; this is not simply a developing world phenomenon.
Legal control REVISED

□
+ Multinationals have to abide by the laws of each country in which
Making links
they operate. However, the two legal areas where multinationals cause
confusion are in takeover law and tax law. it is interesting to notice
+ Although takeover deals involving domestic companies will be dealt with how the concept of
by competition authorities in that country, who can stop a multinational legislation, first covered in
from one country taking over a multinational based in another country? Chapter 10 as simply laws
+ Though trading blocs such as the EU can exert control, cross-border takeover that businesses must follow,
involving multinationals can, in some ways seem ungoverned by any law. becomes more nuanced
+ As covered above, multinationals can use transfer pricing between the once considered in the
different countries in which they operate in order to avoid paying tax in context of multinationals.
countries where corporation tax rates are high. Without an effective global
body to police the operations of multinationals in areas such as this, there
is no clear legal control over this.
+ In developing economies the issue of legal control may be more
fundamental. In some countries, laws governing the operations of
companies, such as they exist, may not be effectively enforced. In some
ways, this allows businesses, especially large, powerful multinationals, to
operate beyond the law in some parts of the world.
Pressure groups REVISED

□
There is no doubt that powerful pressure groups can exert some influence
over multinationals. They can also influence governments in order to try
to curb business actions they do not support. However, pressure groups
certainly influence multinationals rather than controlling their actions. In
many cases, multinationals have stopped or adjusted activities that powerful
pressure groups objected to.
Social media 1 REVISED

□
Table 20.4 impact of social media on company behaviour
Why social media may impact on company behaviour Why social media may have little
impact on company behaviour
Social media's power is to be able to almost instantaneously shine a light on The speed with which issues appear
events to audiences of millions. Bosses of multinational businesses are aware of on social media is tremendous, but
the potential number of customers who may discover mistakes or malpractice they also disappear from social media
that cast their business in a poor light. If this publicity leads to customers going to quickly too. If a company can 'weather
rivals to buy, it is little surprise that multinational bosses will pay close attention the storm' for a week or so, Twitter
to how their businesses operate in order to avoid a potentially catastrophic social users are likely to have moved on to the
media storm. next issue.

Explain two examples of situations that illustrate the need to control multinationals.
What two areas of business operations does the law find it hard to deal with where

multinationals are involved?
Exam practice
1 'As multinationals operate across borders and have such huge financial resources, national governments now
lack the ability to control their operations.' Evaluate this statement. [20]
2 'The experience of China shows that inviting multinationals to set up in any developing economy brings more
positives than negatives.' Evaluate this statement. [20]
Summary
+ The major impacts of multinationals on local The operations of multinationals raise a number of
economies are: ethical issues, particularly relating to:
+ effects on local labour markets + stakeholder conflicts
+ effects on local businesses + pay and working conditions
+ effects on the local community and environment. + environmental impacts
+ These effects can be both positive and negative. + supply chains
+ Effects of multinationals on national economies of host + marketing methods.
countries include: The need to control multinationals' operations is
+ EDI flows highlighted by issues including:
+ balance of payments + safety concerns
+ technology and skills transfer + mineral extraction
+ effects on consumers + loss of traditional local cultures.
+ development of business culture Multinationals have proved capable of softening the
+ tax revenues. control exerted over them by:
+ Again, these impacts can be both positive and + laws
negative. + politicians
+ pressure groups.
Exam skills
+ With many sections of this chapter being quite the course of two years, and then through revision in
specialised, they are often likely to be examined the months and weeks leading up to your exams, that
through precise, quite tightly worded questions, such you are really aware of what the specification says.
as 'State two issues highlighting the need to control That's why this revision guide is written to closely
multinationals’, or, 'Explain how multinationals' choices mirror the specification. There should be some comfort
over supply chains raise ethical issues'. in knowing that you can only be asked about topics
+ For very precise questions such as these, there will on the specification - that limits the size of the task of
be an expectation that you have put in the hard work exam preparation.
and know what is on your specification, in the world Of course, there are no short-cuts to ensuring you have
of examining, the single biggest constraint faced a firm grasp of the specification, so, armed with this
by question paper writers is that they can only ask book, try to ensure that you are as familiar as possible
questions about what is shown on your specification. with the only things the examiner can ask you about.
You can use that to your advantage by ensuring, over

Glossary
Term Definition Page
Added value The difference between the cost of bought-in goods and services and the selling price 17
of a product.
Asset Any item owned by a business. 185
Automation Using machines to complete tasks within a process. 108
Balance sheet A financial document showing a business's assets and liabilities at a point in time. 184
Barriers to entry Factors in a market that can make it hard for new companies to break into the market. 142
Batch production Making a group of products to one specification at a time, allowing some variation in 107
products, yet some specialisation.
Brand A recognisable name or logo that helps to differentiate a product or business. 32
Breakeven A position where a business is selling just enough to cover its costs without making a 92
profit.
Budget A target for revenue or costs for a future time period. 95
Bureaucratic Where initiative is stifled by paperwork and checking and re-checking of actions. 175
organisation
Business angels Individuals who invest in the very early stages of a business taking a significant equity 79
(share) stake.
Business continuity Getting a crisis-hit business back to functioning normality as quickly as possible after 204
a major disruption.
Business ethics Moral principles that underpin decision-making. 180
Business functions The main departments working within a business. The traditional business functions 52
are marketing, finance, human resource management and operations management.
Business plan A document setting out a business idea and how it will be financed, marketed and put 84
into practice.
Capacity Used to describe the maximum possible output of a business. 110
Capacity utilisation The proportion of maximum capacity being used by the business. 111
Capital intensive Describes a business process that relies more on machinery than people. 230
Capital intensive Uses high levels of automation, reducing the role of humans as much as possible and 110
production replacing them with machines.
Cell production Organising workers into small groups or cells that can produce a range of different 108
products more quickly than job production allows.
Centralised An organisational structure where most major decisions are taken at the very top of 52
structure the organisation by the most senior managers.
Collateral Something of value that is used as security when a loan is offered, in the event of the 79
business being unable to pay the loan back, the asset is transferred to the bank and
sold in order to generate the money due for repayment.
Collusion When two or more rival businesses agree to fix supply or prices within their market. 127
This is illegal.
Commodities Basic goods, traded internationally, and are generally basic, unprocessed raw 137
materials such as oil, copper, wheat or cocoa.
Commodity markets Markets for undifferentiated products, generally raw materials such as gold, crude oil 22
or rice.
Competitive Refers not just to how many competitors they face, but how directly other firms' 125
environment products are in competition and how fierce rivalries are.
Complement A product whose use accompanies another, so petrol is a complementary product to 19
cars.
Consultation Seeking and listening to the views of employees as part of a decision-making process. 59, 196
Corporate culture Sums up the spirit, attitudes, behaviours and the ethos of an organisation. 174

Corporate Targets set for the whole firm to reach in a given time period. 128
objectives
Corporate social The desire to run a business in a morally correct way, attempting to balance the needs 182
responsibility (CSR) of all stakeholder groups.
Corporate strategy A medium- to long-term plan for achieving the corporate objectives. 129
Correlation Expresses a relationship between two variables. 158
Cost of sales The cost of buying or making the products sold to generate the revenue for the year. 99,187
Critical path The sequence of activities on which any delay will delay the whole project: the 167
activities with zero float time.
Critical path A technique used in planning the most time-efficient way to complete complex 166
analysis projects.
Crowdfunding Obtaining external finance from many small investments, usually through a web 79
based appeal for investors.
Cultural diversity Describes the differing interests and values of people from different national 243
backgrounds.
Culture Describes normal, acceptable behaviours in a certain context. 245
Current assets Items the business owns that are in the form of cash or can be easily turned into 102
cash quickly without a major loss in their value. There are three current assets: cash,
money owed by customers (receivables/debtors) and stock.
Current liabilities Debts owed by the business that are due to be paid within the next 12 months. The 102
two main current liabilities are trade creditors and overdrafts.
Decentralised The opposite of a centralised structure and is where decision-making is passed lower 52
structure down the organisation structure through the process of delegation.
Decision tree A diagram showing the options and possible outcomes involved in making a decision 163
along with the probabilities of outcomes occurring.
Delegation Passing decision-making power down the organisational structure to a lower level. 52
Demand The level of interest customers have in a product. 19
Diseconomies of inefficiencies related to growing as a business that can lead to upward pressure on 146
scale unit costs.
Disposable income The money a household has available to spend from income after income tax has 227
been deducted.
Disruptive change Occurs suddenly, unpredictable and has a major effect on entire markets. 201
Distribution channel The route a product takes from producer to consumer 37
Diversification As defined by Ansoff, means selling new products to new markets. 133
Dumping The practice of selling off excess production in a foreign market at an exceptionally 221
low price, which destroys sales for local producers. China is frequently accused of
dumping excess products, such as steel, elsewhere in the world.
Earliest start time The earliest possible date on which it is possible to begin the activity. 166
(EST)
Economies of scale Reductions in unit cost caused by the growth of a business. 145
Effective demand interest backed by the ability to pay. 19
Efficiency Measures the extent to which the resources used in a process generate output 109
without wastage.
Empowerment A slightly stronger form of delegation in which the subordinate is given some 59, 196
decision-making power over what tasks need to be done, not simply told when to
do them.
Equilibrium A situation in a market where supply and demand are balanced, making the price stable. 22
Exchange rate The value of one currency expressed in terms of another. 119
Expected value The average outcome expected following a chance event. 165
Exports Products and services that are produced domestically and consumed overseas. 214
Extension strategy A medium- to long-term plan for extending the life cycle of a product. 40
External Filling a job vacancy with somebody who does not currently work for the business. 50
recruitment

Extrapolation Predicting by projecting past trends into the future. 157
Fixed assets Items owned by the business which it intends to use over and over to generate profit. 103
Examples include property and machinery.
Fixed capital investment in long-term assets from roads to buildings. 209
formation
Fixed overheads The costs that have to be paid no matter how well the business is performing, such as 99
management salaries and rent on the head office.
Float time Describes any slack time available attached to an activity. The LFT minus the duration 167
of the activity minus the EST of the activity shows if there is float time.
Flow production Continuous production of a single, standardised product. 108
Foreign direct Occurs when a business purchases non-current assets in another country. 215, 249
investment (FDI)
Franchise A licence to use another business's name and business model in return for payment. 71
Franchisee An entrepreneur or company that buys a licence to use another business's name and 71
business model.
Franchisor A business that sells the right to use its name logo and business model to other 71
businesses or entrepreneurs.
GDP Gross Domestic Product (GDP) is a measure of the total output of a country's 208
economy. Dividing this by the population adjusts for countries with much larger
populations. Purchasing Power Parity is a further adjustment that factors in
differences in the cost of living.
Global Measures the ability of a business to succeed against both domestic rivals and foreign 235
competitiveness competitors in international markets.
Globalisation The trend towards closer ties between economies and businesses within the global 216
economy.
Glocalisation An approach to global marketing that maintains a consistent brand and image across 240
the world, but makes adaptations, especially to products, to suit local markets.
Human An attempt to provide a single measure of economic development encompassing 208
development index income, education and health.
(HDI)
imports Products and services produced abroad and consumed domestically. 213
incremental change Occurs when change is slow and happens in small steps. 201
Indirect taxes Taxes that the government imposes on goods and services, for example VAT. 22
Induction training Initial training when an employee begins a job that is designed to familiarise them with 51
the workplace and the business.
Inflation The percentage rate at which average prices rise during a year within the whole UK 118
economy.
Inorganic growth Growth that occurs as a result of taking over or merging with another business. 147
intermediaries Businesses between the producer and the consumer in a distribution channel, such 37
as retailers.
internal recruitment Filling a job vacancy with somebody who already works for the business. 50
intrapreneurship The name given to the encouragement of entrepreneurial behaviour within larger 65
businesses.
investment The process of using forecast cash flows to assess the financial attractiveness of an 159
appraisal investment decision, linked with a consideration of non-financial factors.
Isolationism A nation whose trade policies are designed to put the interests of domestic 216
businesses first by imposing trade barriers to hamper imports.
Job enlargement The term used to describe any increase in the scope of a job and this describes both 59
job rotation and job enrichment.
Job enrichment Used by Herzberg to describe designing jobs that include the motivators. These 57
include: a complete unit of work, direct feedback on performance and the ability to
communicate directly with any other member of staff.
Job production Making one-off items to suit each customer's individual requirements. 107

Joint venture A formal agreement between two separate businesses to work together for a fixed 233
time on a specific project.
Just-in-time stock A Japanese-rooted approach to stock management that aims to eliminate buffer stock 114
management completely.
Key performance Quantifiable measures of aspects of a business's performance that the business 135
indicators (KPIs) considers to be the main determinants of its commercial success.
Labour intensive Describes a business process that relies more on people than machinery. 110, 230
Labour retention A measurement of the number of staff that stay at a business during a year. It is 194
calculated by expressing the number of staff that have stayed with a business during
the year as a percentage of the average number of staff employed in the year.
Latest finish time The last possible date by which it must be complete to avoid delaying the overall 166
(LFT) project.
Leader The role of a leader is to identify key issues to be addressed, set objectives and decide 60
what should be done to address those issues and who should do it.
Lean production A collective term for a range of Japanese techniques designed to eliminate waste from 115
business processes.
Leasing An alternative to buying the asset outright. Instead, the asset is rented for a monthly 80
fee for a set period of time.
Liability The extent to which the ownerfs) of the business must repay debts incurred in the 69
running of the business.
Limited liability A form of legal protection for business owners which ensures that owners of a limited 70
company can only lose the money they have invested in the business.
Line manager A single boss for each member of staff, from whom orders must be taken, advice can 52
be sought and to whom actions must be explained where necessary.
Liquidation When a company's owners close down the company, selling off its assets to generate 82
cash to pay off the debts of the business.
Liquidity A firm's ability to pay its bills and to finance short-term spending. 102,185
Lobbying The process of directly trying to influence key political decision-makers to act in the 254
best interests of a business.
Manager A person fulfilling a role whose major job is to oversee putting plans into action, 60
getting the details right and ensuring that the resources allocated are used correctly.
Market positioning Deciding exactly what image you are trying to create for your product, relative to 16
its rivals.
Market segment A subsection of a larger market in which consumers share similar needs and wants. 10
Market Discovering useful ways to split up a market into different groups of consumers who 15
segmentation share similar characteristics, wants and needs.
Marketing strategy The general approach to marketing used by a business. 43
Merger When two firms agree to come together to create a new, single business. 233
Method of finance The process through which a source of finance provides money to a business. 80
Mission The underpinning purpose behind the existence of a business. 128
Mission statement A catchy summary of the reason why a business exists. 128
Monopoly A single business that dominates supply in a given market. 125
Moving average A quantitative method used to identify underlying trends in a set of raw data. 155
Multinational A company that has branches or manufacturing plants in several countries. 248
company
Net financing cost The income from interest on bank deposits minus the interest charges from overdrafts 99
and loans. It will usually be a negative number.
Niche market A small segment of a larger market. 10
Objective A specific target set by a business. 67
Offshoring Moving one or more business functions to a foreign country, usually to take advantage 207, 226
of lower labour costs.
Oligopoly The name given to a market dominated by just a few major suppliers. 126
Opportunity cost The value of the next best option foregone when a business decision is made. 72

Organic growth Growth which takes place without any merger or takeover activity. 147
Organisational Used to describe acceptable norms of behaviour within a business: 'the way we do 148
culture things round here'.
Outsourcing Contracting another business to perform certain business functions, allowing 47, 226
significant increases in capacity when needed.
Overdraft A facility offered by a bank to allow a customer to continue spending money even 80
when their account becomes negative. There will be an agreed limit to the overdraft.
Overhead costs Costs incurred by the business as a whole but can be difficult to attribute to a 94
particular section of the business. For example, the costs of running Nestle's Head
Office can be hard to attribute to the actual production of any one of its hundreds of
different products.
Overhead expenses Payments for something that is of immediate use to the business, other than the 187
actual products they sell.
Overtrading When a business experiences cash flow problems as a result of expanding too quickly 74,147
without sufficient cash in the bank.
PESTLE The major sources of external changes faced by businesses: Political, Economic, 11
Social, Technological, Legal and Environmental.
Primary research New research conducted for a particular purpose. 13
Product A business's attempts to make its product stand out from those of rivals, perhaps 17,130
differentiation through marketing, design or quality.
Productivity A measure of the efficiency of the production process. It is usually measured as 109
output per worker per time period.
Profit The difference between the revenue of a business and the costs generated by the 99
business during a period of time.
Profit and loss Shows a firm's revenue for a time period along with all the costs associated with 184
account generating that revenue.
Profit satisficing Blending a desire for profit with other factors, such as building a good reputation or 67
having a good work-life balance.
Profitability Profit as a percentage of sales revenue. 100
Promotion Methods used by the business to communicate information and persuade consumers 31
to purchase a product.
Protectionism Giving preference to domestic producers by making it harder for foreign companies to 218
export to your country.
Qualitative research Research which is unlikely to be carried out on a large-enough scale to give 14
statistically valid data, but is instead aimed at providing insights as to why customers
behave the way they do.
Quality circle A group of staff who meet regularly to find quality improvements. 116
Quantitative Research conducted on a large-enough scale to provide statistically reliable data, 14
research usually aimed at discovering factual information about how customers behave.
Quota A physical limit on the volume of a product that can be imported in a year. Once the 219
quota is used up, only domestically produced goods will be available.
Rate of interest The amount charged by a lender per year for borrowing money. This is expressed as a 119
percentage of the amount of money outstanding.
Real income The amount by which average incomes have adjusted for inflation - the amount by 26
which prices have risen.
Risk assessment A process used to identify, quantify and decide on the likelihood of negative future 202
events occurring.
Scenario planning visualising possible future situations for a business and then devising plans for how to 202
exploit likely opportunities and minimise the effects of likely threats.
Secondary research Using pre-existing data that has been gathered for another purpose. 13
Shareholders The owners of a limited company. 178
Short-termism When the actions of managers over-prioritise immediate issues, ignoring long-term ones. 171
Sources of finance Places from which business may gain finance. These can be internal or external 78
sources.

Span of control The number of subordinates directly answerable to one manager. 52
Staff turnover The proportion of staff who leave a business during a year. 46
Stakeholders Groups that are influenced by and influence the operations of a business. 177
Statement of A document produced by public limited companies that shows revenue, a break-down 100
comprehensive of different types of cost and different types of profit for a year.
income
Stock The materials, partially made products and finished goods owned by a business that 112
have not been sold.
Strategy The plan devised by the business to achieve its objectives. 67
Subsidy A payment made by government to a business producing a certain product or located 220
in a particular area that the government wishes to support.
Substitute A similar, rival product that consumers may choose instead. 19
Succession planning Preparing replacements for key personnel in advance of their departure. 204
Sustainability Making something using materials that will still be available in the future. 31
SWOT analysis Identifies a business's Strengths and Weaknesses along with the Opportunities and 134
Threats it faces.
Synergies The benefits of two things coming together that could not exist when they are 149
separate, such as economies of scale resulting from a merger of two businesses.
Takeover When one business buys a controlling interest in another business. 233
Tariff A tax imposed on an imported product to allow it to enter a country. 219
Time series data A series of figures covering an extended period of time. 156
Trade credit Where goods or services provided by a supplier are not paid for immediately. 81
Trading bloc A group of countries that sign up to free trade between them, protected by a tariff 221
wall against imports from outside.
Training Designed to enhance employees' existing skills or develop new skills. 51
Transfer pricing A technique used by multinationals to adjust the internal prices paid by one branch 250
of their operations to another as a way of minimising the total tax bill paid by the
company.
Trend The general path that a variable takes over a period of time. 88
Unique selling point A particular feature of a product or service that no rival provides. 33
(USP)
Variance analysis Looking back to calculate the difference between a budgeted figure and the actual 96
figure that occurred.
Venture capital A method of providing finance in higher risk investments, generally through a 80
combination of loans and shares.
Working capital The money that is available for the day-to-day running of the business. 103
Zero-hours contract An employment contract that has a minimum of zero hours a week. So the employee 46
is not guaranteed any work or income and is only told of their 'working week' a few
days in advance.

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Mass markets and niche markets REVISED

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