2

The Publishers would like to thank the following for permission

to reproduce copyright material.
Acknowledgements
pg. 4, Reproduced with the permission of Fatface
(www.fatface.com); pg. 14, Department of Business, Innovation
and Skills:© Crown Copyright; pg. 17, Reproduced with the
permission of Honest Burgers (www.honestburgers.co.uk); pg.
27–28, Reproduced with the permission of Sport England
(www.sportengland.org); pg. 61, Reproduced with the
permission of eMarketer; pg.65, From ‘WhatsApp: the secret
weapon for small businesses’, The Telegraph, 29/01/15 (Rebecca
Burn-Callendar) © Telegraph Media Group Limited; pg. 88,
ONS © Crown Copyright; pg. 89, Trading Economics data ©
Crown Copyright; pg. 93, Trading Economics data, Source U.S.
Bureau of Economic Analysis; p95, World Bank, Global exports
1960-2015; p96, CIA World Factbook pg. 100, Reproduced with
the permission of Merrythought Ltd; p120, Ofcom © Crown
Copyright; pg. 147, Reproduced with the permission of
Warwick Business School; pg. 155, Reproduced with the
permission of Center Parcs UK; pg. 221, Reproduced with the
permission of Sport England (www.sportengland.org).
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ISBN: 9781471899386
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© Malcolm Surridge and Andrew Gillespie
First published in 2009
This edition published in 2017 by
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5
Contents
Introduction

1 Business in the real world

1.1 The purpose and nature of businesses
1.2 Business ownership
1.3 Setting business aims and objectives
1.4 Stakeholders
1.5 Business location
1.6 Business planning
1.7 Expanding a business

2 Influences on business
2.1 Technology
2.2 Ethical and environmental considerations
2.3 The economic climate of business
2.4 Globalisation
2.5 Legislation
6
 2.6 The competitive environment

3 Business operations
3.1 Production processes
3.2 The role of procurement
3.3 The concept of quality
3.4 Good customer service

4 Human resources
4.1 Organisational structures
4.2 Recruitment and selection of employees
4.3 Motivating employees
4.4 Training

5 Marketing
5.1 Identifying and understanding customers
5.2 Segmentation
5.3 The purpose and methods of market research
5.4 Elements of the marketing mix
5.5 Using the marketing mix: product and pricing
5.6 Promotion and distribution

6 Finance

7
6.1 Sources of finance
6.2 Cash flow
6.3 Financial terms and calculations
6.4 Analysing the financial performance of a business

Glossary

8
Introduction
Welcome to your AQA GCSE Business course.

1. What you will study

Your GCSE is divided into six parts which we have presented as
separate chapters.
Chapter 1: Business in the real world. This part of the course
is designed to introduce you to the subject. It considers the
purpose of business activity, the role of business enterprise and
entrepreneurship, and the dynamic nature of business. While
studying this unit you will encounter the different legal forms a
business can take, the goals they set themselves, how they
decide where to locate and how they plan their activities. Both
this chapter and Chapter 2 relate to the four functional areas of
business (business operations, human resources, marketing and
finance) that are covered within chapters 3 to 6.
Chapter 2: Influences on business. All businesses are
influenced by external factors and this unit considers some of
the most important of these, including technology, the economic
climate, globalisation and the law.
Chapter 3: Business operations. Discover the different ways
that businesses produce goods and services, how they manage
their stock and their suppliers and how they attempt to produce

9
high quality products and provide excellent customer service.
Chapter 4: Human resources. Topics within this chapter
include how businesses structure their organisations, how they
recruit and select new employees and how they motivate and
train those employees once they start work.
Chapter 5: Marketing. This chapter encompasses the ways in
which businesses identify, understand and target their customers
with advertising and other methods of promoting their products.
This chapter will help you to understand how businesses
discover the needs of their customers using market research.
Chapter 6: Finance. This final chapter will help you to
understand how businesses raise the finance they need to
establish and expand their businesses. It will also show how
businesses manage their cash, calculate their profits (or losses)
and use financial data to judge their performance.

2. The benefits of using this book

Each chapter within this book is divided into a number of
sections to give you a series of short topics to study. Included
throughout are the following:
• Key terms have been defined to help you to use business
terminology to identify and explain business activity as
required by the specification.
• Regular ‘Business insight’ boxes link the theory that you study
to examples of actual businesses. It is important that you can
see how different businesses are affected by issues and topics
from throughout the GCSE course.
• ‘Maths moment’ features will help you to use numbers
effectively. Using quantitative data effectively is an important
skill within GCSE Business.
• The book is illustrated with a large number of pictures and

10
 diagrams to help you to understand the subject. Many of these
have questions which are intended to make you think more
deeply about the issue.
• ‘Study tips’ give you advice on a range of topics to enhance
your understanding of this subject.
• At the end of each section there are short answer and data
response questions. These allow you to test your knowledge
and understanding.
• At the end of each chapter there are further practice questions
and some sample answers showing you the ways to tackle
(and sometimes how not to tackle) these types of questions.

3. What examinations will you have to

take?
Your GCSE course is assessed through two examinations.
Paper 1: Influences of operations and HRM on business
activity. This examination is worth a maximum of 90 marks and
comprises 50% of your GCSE result. It lasts for one hour and 45
minutes and covers:
• Business in the real world
• Influences on business
• Business operations
• Human resources
Paper 2: Influences of marketing and finance on business
activity. This examination is worth a maximum of 90 marks and
comprises 50% of your GCSE result. It lasts for one hour and 45
minutes and covers:
• Business in the real world
• Influences on business
• Marketing

11
• Finance
Both examination papers have three sections:
• Section A: multiple choice and short answer questions worth
10 marks.
• Section B: a short case study with questions worth
approximately 40 marks.
• Section C: a short case study with questions worth
approximately 40 marks.
Good luck with your GCSE Business course.
Malcolm Surridge & Andrew Gillespie
April 2017

12
1 Business in the real
world

The purpose and nature of every business is different. In

this chapter, we look at the very beginning of starting a
business. We consider the reasons that you might choose
to start one, the types of business that exist, setting aims
and objectives to measure how successful the business
is, and how a business can grow and expand. We also
look at how location can affect a business, the different
stakeholders that have an interest in the business and the
kinds of activities that businesses carry out.

13
Topic 1.1

The purpose and nature of

businesses
There are many different forms of business and many
different reasons why businesses exist. In this topic, we
will consider why people set up in business and the typical
objectives that organisations have. We will also examine
the environment in which businesses operate and how this
can affect their behaviour.
By the end of this topic, you should know:
• the purpose of business
• the reasons for starting a business
• the basic functions and types of business
• business enterprise and entrepreneurship
• the dynamic nature of business.

The purpose of business

A business is an organisation that produces a good or supplies a
service. A good is a physical product, such as a car. A service

14
is an intangible item (that is, it is something that you cannot
physically touch), such as financial advice or a yoga lesson. A
business involves people – sometimes one and sometimes
thousands – and aims to provide something that is demanded by
others. Businesses provide a range of products for customers.
A customer is someone who buys a product. Products are used
by consumers. For example, if you buy a mobile phone for
yourself, you are the customer and the consumer. If your parents
buy it for you, they are the customer and you are the consumer.

Key terms
A good is a physical product, such as a car.
A service is an intangible product (that is, you cannot
touch it), such as financial advice or a bus journey.
A customer is someone who buys a product from a
business.
A consumer is someone who uses goods and services
produced by businesses.

A business is successful if it can meet the needs and wants of

customers effectively. A need is a basic human requirement – we
need to eat and drink, for example. A want is the desire for a
particular product. We need to drink, but we want Coca-Cola.
We need to get from A to B, but we want to do so in a Ferrari.

Reasons for starting a

business
People who start up their own business are called
entrepreneurs. Entrepreneurs are willing to take risks to set

15
up on their own. They see an opportunity and have the
determination, motivation and focus to start their own
businesses rather than working for someone else. The ability to
be an entrepreneur – to take risks to develop a business idea – is
known as entrepreneurship.

What are the objectives of

entrepreneurs?
There are many reasons why people might want to be
entrepreneurs. For example:
• They want to be their own boss and make their own decisions
(rather than being employed by, and reporting to, someone
else).
• They want to keep all the profits of a business for themselves
(rather than working for owners who keep the profits) so they
earn more money than if they were employed by someone
else.
• They need a job and starting their own business is one way of
making sure that they are employed and, hopefully, that they
earn money.

16
• They have an interest or hobby and this grows into a business.
• They want to prove something to themselves (and possibly
others) by showing they can start a business for themselves.
This may give them a sense of satisfaction.
• They are unhappy with their present job and want to do
something different.
• They want more flexible working hours. They want to be able
to work when they want to, rather than having to work the
hours that an employer wants them to work.
• They have spotted a business opportunity and believe they can
make profits from providing this good or service.
• They want to provide a service for others. Some businesses
are set up to help other people, for example, a shop set up for
and run by the local community or a local centre set up to help
the homeless. These are known as social enterprises and
are not necessarily profit-making.

Key terms
An entrepreneur is someone who is willing to take the
risks involved in starting a new business.
Entrepreneurship refers to the ability to be an
entrepreneur – to take risks to develop a business idea.
A social enterprise is a business that is set up to help
society rather than to make a profit.

Setting up in business creates many exciting opportunities for

people – they can make their own decisions and create
something new. If the business is successful, there is likely to be
a sense of personal achievement. Establishing a business gives
people an opportunity to show their skills and possibly make
more money than they could by working for someone else.

17
Factors of production – land, labour,
capital, enterprise
Factors of production are the resources (or materials) that
businesses use to provide their goods or services. These include:
• land – the physical land and the site on which the business is
located, and other natural resources a business might use
• labour – the skills and numbers of employees employed by a
business
• capital – the equipment used to provide the goods or services,
such as machinery and equipment
• enterprise – the skills of the people involved in the business
to identify business opportunities and bring together resources
to meet these opportunities.

18
What a business is able to produce will depend on the quantity
and quality of its resources and the way in which these resources
are combined and managed.

Opportunity cost
The opportunity cost is the sacrifice we make whenever we
decide to do anything. If we decide to go out tonight, we
sacrifice the work we could have done. If we stay in, we
sacrifice the enjoyment of going out. There is always a trade-off
when we do anything. Whenever you make a decision, it is
important to consider the opportunity cost – what are you giving
up? For example, if you decide to set up a business, you may be
giving up a more secure income in your existing job. If you
decide to invest your savings in a business, then you are not
using these savings to earn money, which is known as interest,
in the bank.

Key terms
Resources are the inputs that businesses use to provide
their goods or services.
An enterprise is another word for a business. It also
refers to the skills of the people involved in the business to
identify business opportunities and bring together
resources to meet these opportunities.
Interest is the money paid by banks as a reward to attract
people to save with them.

Business insight
FatFace

19
Here is a description from the FatFace website of the
company’s approach and how it was founded:

‘It was 1988. Two young British guys were skiing in

the French Alps, had an idea, and started to talk.
What if they started selling tees and sweats, and
made enough money to carry on skiing? And what if it
was possible to live their dreams by setting up a small
business with a big heart?

Their favourite ski run was ‘La Face’ in Val D’Isere, a

‘black-run’ which inspired our company name
FatFace. Over 25 years later we still love adventure,
love life and have the same strong values. We still
make clothes that reflect the happy, healthy and
active lifestyles of our customers.’
Source: www.fatface.com

The founders of FatFace set up a business because

it was a hobby that they loved and wanted to
pursue. Analyse two other reasons why people
might set up a business.
(6 marks)

20
What are the characteristics of
entrepreneurs?
There are thousands if not millions of entrepreneurs in any
country and so, not surprisingly, the characteristics of these
people differ in many ways. However, most entrepreneurs are:
• Innovative. This means an entrepreneur is good at spotting an
opportunity. They can see a problem with the way things are
done and can imagine a better way of doing things. They have
a vision of how things could be.
• Risk takers. An entrepreneur takes a risk that their idea is
going to work. In reality, many new ideas fail. Setting up a
business involves time, money and emotional effort. If you
get it wrong, you may have lost your savings and you may
feel as if you have failed. So you need to be prepared for this.
• Hard working and determined. If you are setting up a
business, you need to be prepared for it to be a struggle. As a
new business, you will not be well known and will probably
have to bargain hard to get a good deal with suppliers. You
need to work hard to get your business known and, in many
cases, it will just be you at the start and so it can be quite
exhausting.
• Organised. Running your own business involves many skills
and many decisions. You will often have lots to do and will
usually have to be good at meeting deadlines. You will have to
organise materials, people, production, orders, deliveries and
finances. So you need to be good at managing things.

Study tip
In order to decide whether or not a business is
successful, it is always important to know why someone

21
 started up the business in the first place. If the original aim
of the organisation was to help others, then even if it does
not make a profit it may still be a success.

Business insight
Richard Branson
Richard Branson, the founder of Virgin, set up his first
business – a magazine called Student – in the 1960s
when he was still at school. He used to run it from the
school phone box. Since then, he has gone on to create
hundreds of businesses under the Virgin name, involving
music, nightclubs, trains, planes, taxis, bridal wear, cola,
insurance and pensions.
Analyse the characteristics that might explain
Branson’s success.
(6 marks)

Types of business and their

basic functions
What sectors do businesses operate
in?
Whatever you can think of, some business somewhere is
probably providing it. There are many different types of
business and they can be classified in different ways. For
example, some businesses offer physical goods, such as
furniture. Others provide a service, such as education. Many
businesses provide a combination of the two: we may choose to

22
go to a restaurant because of the atmosphere and environment (a
service) as well as the food (a good).
Businesses can also be classified in terms of their stage in the
production process:
• The primary sector is made up of organisations that are at the
first stage of production and use raw materials. Farms, oil
exploration companies and fishing fleets are primary
businesses.
• The secondary sector is made up of organisations that are at
the second stage of the production process. They are involved
in using primary resources and converting these into products.
Examples of secondary businesses are manufacturers and
printers.
• The tertiary sector is the final stage and is made up of
organisations that provide services, for example, fast food
stores, estate agents and delivery companies.

Maths moment
About 2 per cent of workers in the UK are employed in the
primary sector. About 22 per cent are employed in the
secondary sector.
1 What percentage of employees are employed in
the tertiary sector?
2 What are the biggest businesses in your area?
Are they primary, secondary or tertiary?

23
The functions of a business
A business transforms resources into outputs. To be successful,
it must understand its customers effectively and make sure it
provides products that are in demand. It needs to think about the
nature of the product, how to promote the benefits of the
product to potential customers, what price to set and how and
where customers will want to buy it. These activities are all part
of the marketing function (see Chapter 5).
The business must produce the good or service. For example,
running a hotel involves activities such as taking bookings,
cleaning rooms, managing the restaurant, organising check outs.
The activities involved in the production of the product are part
of the operations function (see Chapter 3).

To provide the product will involve people. In many cases, there

may only be one person in the business, but some organisations
have hundreds or thousands of people working for them.

24
Managing people (for example, recruiting and training staff and
deciding how to reward them) is known as the human resource
function (see Chapter 4).
A business will also have to manage money. It may need to raise
finance, it will need to monitor what is spent in different parts of
the business and it will need to calculate whether the business
has enough money. These activities are part of the finance
function (see Chapter 6).
Whether the business is small or large and whatever products it
provides, it will have marketing, finance, human resource and
operations functions.

The dynamic nature of

business
The business environment
A business will be affected by changes in the ‘business
environment’. This refers to all the factors outside a business
that can affect it.
Changes in the business environment can be described under the
following headings:
• Technological change. Technology is changing at a rapid rate.
This creates new markets and products. Snapchat is relatively
new, for example. Technology also changes the way we shop
and how and what we buy. Think of the challenge to hotels
provided by AirBnB, which now allows people to search
online to find somewhere to stay in someone else’s house or
flat so they do not need a hotel. See Topic 2.1 for more on the
influence of technology.

25
• Economic change. This involves a range of economic factors
outside a business, such as the cost of borrowing money from
banks (the interest rate), the rate at which prices are
increasing (which is called inflation) and the income in the
economy (which is called Gross Domestic Product or
GDP). The term ‘economic environment’ is sometimes used
to refer to these economic factors outside a business (see
Topic 2.3).
• Legal change. These are new laws and regulations
(legislation). These may affect costs (for example, by insisting
businesses pay a minimum wage to their employees) or
demand for a product (for example, by preventing tobacco
companies advertising their products). See Topic 2.5 for more
about the influence of legislation on business.
• Environmental expectations. Customers and consumers are
increasingly interested in the impact of a business on the
environment. What resources is it using? How is it producing
the product? How does it transport its product? The impact of
the actions of a business can influence whether a customer
uses that business or not. Even if demand was not affected,
some business people would still be concerned about the
environmental impact because it affects what the world will be
like for future generations. See Topic 2.2 for more about
environmental considerations.

Key terms
Interest rates refer to the cost of borrowing money or the
reward for saving money, expressed as a percentage.
Inflation refers to the rate at which prices are increasing.
For example, if inflation is 2 per cent, prices are generally
growing by 2 per cent that year.

26
Gross Domestic Product (GDP) measures all the
income earned in a country’s economy in a year.

The business environment is constantly changing (that is, it is

dynamic). Just look at any newspaper or news site and you will
appreciate how much change there is – changes in incomes,
changes in the number of people working, new laws, new
competitors, and so on. A business has to keep adapting. You
may once have made money from selling typewriters, but you
would struggle to do so these days. You are unlikely to
experience increased demand for cigarettes in the UK and so you
would need to look for other opportunities. Businesses cannot
stay still. They need to be nimble.

Study tip
Try not to confuse the business environment, which
includes legal change, economic change, social and

27
technological change, with environmental issues, which
refer to factors such as pollution and global warming.

Business insight
Coca-Cola Zero Sugar
In 2016, Coca-Cola spent around £10 million advertising
its Coca-Cola Zero Sugar. The message of its advertising
was ‘Tastes more like Coke, looks more like Coke’. Over
4 million samples of the new product were also given
away to help launch it.
Zero Sugar has been developed to make the taste even
closer to classic Coke than Coke Zero, which it replaced.
It is part of a campaign to encourage more classic Coke
drinkers to switch to a low- or no-calorie version.
Coca-Cola, along with its soft drink rivals, has now been
given an economic incentive to move its consumers over,
after Chancellor George Osborne announced the so-
called ‘sugar tax’ in the 2016 budget.
The tax charges soft drinks manufacturers a levy (tax)
per litre of sugary drink packaged for sale, at two rates.
The higher rate includes drinks with more than 8 g of
sugar per 100 ml, such as classic Coke. The lower rate
covers those with 5–8 g, including mid-calorie version
Coke Life. Those under 5 g are exempt.
A growing number of people in society want to reduce
their sugar intake but have been reluctant to try a no-
sugar option because they do not think it tastes as good
as the original.
Analyse the factors in the external environment that
have led to the launch of Coca-Cola Zero Sugar.
(6 marks)

28
Business insight
Analysing trends in society
Recent trends in society that might create market
opportunities include:
• greater interest in the environment
• greater interest in healthy eating
• greater interest in personalised services, such as tailor-
made holidays or advice on what books you might like
• more families where both partners go out to work
• an ageing population.
Analyse how any one of these trends might affect a
business.
(6 marks)

Summary
There are many different reasons why people start up in
business. Some do it for money, some because they want
to achieve something for themselves and some because
they want to help society. Ideas come from their own
experiences, from things they have seen elsewhere and
from problems they want to solve.

Quick questions
1 State two possible sources of new ideas for a
business.
(2 marks)

29
 2 What is meant by an ‘entrepreneur’?
(2 marks)
3 Explain one reason why someone might start their
own business.
(3 marks)
4 What is meant by ‘opportunity cost’?
(2 marks)
5 What is meant by the ‘primary sector’?
(2 marks)
6 State two possible characteristics of an entrepreneur.
(2 marks)
7 State two examples of businesses in the tertiary
sector.
(2 marks)
8 State two changes in technology that can affect a
business.
(2 marks)
9 State two changes in the economic situation that can
affect a business.
(2 marks)
10 State two factors of production.
(2 marks)

Case study
Elon Musk

30
Born in 1971, Elon Musk is known as a serial
entrepreneur – he just keeps setting up businesses! He
began at school selling a computer program he had
produced. He went on to set up technology businesses
such as Zip2 and X.Com. In 1999, he established PayPal
and built this into a very successful business – when it was
sold, he earned around $180 million at the age of 32.
In 2002, Musk set up SpaceX aimed at developing space
travel to colonise Mars. In 2003, he established Tesla
Motors, a producer of electric cars. Both of these projects
were initially thought to be uncommercial but are now
attracting a lot of interest. Tesla cars are becoming more
familiar on the roads and winning many awards for their
technology. Meanwhile, the US space agency is using
SpaceX to carry space cargo.
Musk keeps looking for new ideas. He is chairman of the
solar energy developers Solar City and has published
design studies of a solar power ‘hyperloop’ transport
system that will provide extremely fast travel. Musk has

31
been named business person of the year by Fortune
magazine and, as of 2017, is said to be personally worth
over $13.9 billion.
Musk has been described as a disrupter – he likes to
challenge things and change them. He says he is simply
trying to make things better. Along the way, he has
invested all of his money into SpaceX and Tesla – at
times, it looked like he would lose it all because the
technology was not working. Many thought he was foolish
to risk all his wealth, but Musk says that he felt someone
had to try it!
1 Identify two reasons for someone setting up their own
business.
(2 marks)
2 Explain two possible characteristics of a successful
entrepreneur such as Musk.
(4 marks)
3 Analyse the possible reasons why Musk wants to be an
entrepreneur.
(6 marks)
4 Evaluate the reasons why a government should help
entrepreneurs set up in business.
(12 marks)

32
Topic 1.2

Business ownership
There are many different types of business in the UK,
including sole traders, partnerships and private limited
companies. This topic looks at the different forms of
business ownership and considers the advantages and
disadvantages of each.
By the end of this topic, you should know:
• what a sole trader is
• what a partnership is
• what a private limited company (ltd) is
• what a public limited company (plc) is
• what a not-for-profit organisation is
• the advantages and disadvantages of the different types
of business ownership.

Business ownership
Anyone starting up in business needs to think about what type
of business they will have in the eyes of the law (that is, what
form of business ownership it will have). There are various
options, as shown in Figure 1.3.

33
Sole trader
A sole trader is a form of business that is owned and managed
by one person. For example, if you set up your own business
fixing people’s computers, you are a sole trader. Setting up as a
sole trader is easy. You do not need to register with the
government or fill in lots of forms. All you have to do is start
trading. This is why it is such a popular form of business and
why this method is the one that many famous business people
first experienced. Sole traders are owned and managed by the
same person, although they may employ other staff.

Key term
A sole trader is someone who sets up in business on his
or her own.

Advantages of being a sole trader

• It is quick and easy to set up as a sole trader. Other forms of
business, in comparison, involve registering with the
government.
• You make all the decisions for yourself so you do not need to
consult lots of other people. This can mean that decision-

34
 making is fast and you can get things done the way you want
them.
• You keep all the profits yourself, so if your business is
successful you do not have to share the rewards with other
people.

Disadvantages of being a sole trader

• It can be quite stressful making all the decisions yourself.
Some people will find it difficult to cope with this amount of
pressure.
• A sole trader needs to handle all aspects of the business: the
finances, the marketing and the running of the business itself.
Some people may not be good at all of these things.
• If the business goes wrong, you have unlimited liability.
This means that you can lose everything you own.
• There is usually a tremendous amount of work to do as a sole
trader. For example, when you are working hard to build the
business up, it can be difficult to take a proper holiday. If you
are ill, the whole business may come to a standstill.
• If the sole trader dies, the business ends as well, even if he or
she has been running the business for many years.
• As a sole trader, you may find it difficult to raise as much
money as you would like in order to get the business going.
Sole traders often have to rely mainly on their own finances,
or those of friends and family, to set up their business. It may
be possible to borrow from a bank but, because so many new
businesses fail, banks tend to charge a lot of money in the
form of high interest rates on loans.
• A sole trader business is likely to be small and will not have
the power of a large business over other businesses such as
those that it buys its supplies from. This may mean higher
costs and lower profits.

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Key terms
Profit measures the difference between the values of a
business’s revenue (sales) and its total costs.
Unlimited liability means that the personal possessions
of the owners of a business are at risk if there are any
problems. There is no limit to the amount of money the
owners may have to pay out.

Partnership
Under the 1890 Partnership Act, a partnership is created when
two or more people set up in business to pursue a common
purpose, such as profit. For example, a group of designers may
set up a studio together, or a group of doctors might set up a
practice. Partnerships are usually allowed to have a maximum of
20 partners, although exceptions include solicitors, accountants,
auctioneers and estate agents.

Deed of Partnership
When setting up a partnership, the people involved (the
partners) are advised to write a legal document called a Deed of

36
Partnership. This sets out the rules of the partnership. The
Deed of Partnership will usually include details of:
• how to divide up profits – for example, this may be related to
how much money each partner puts in at the start or how
much work they do in comparison to the others
• how decisions are to be made (voting rights)
• how to value the business if someone wants to leave
• how to decide on whether someone else can join the
partnership.

Key terms
A partnership occurs when two or more people join
together in a business enterprise to pursue profit.
A Deed of Partnership is an agreement between
partners that sets out the rules of the partnership, such as
how profits will be divided and how the partnership will be
valued if someone wants to leave.

The purpose of the Deed of Partnership is to avoid disputes. If

there is no Deed of Partnership, the profits must be paid out
equally, regardless of how much input each person has had.

37
Advantages of partnership
• Several people are involved in a partnership so each one can
contribute money. This should mean more funds are available
compared with sole traders who may have to rely on their
own funds.
• In a partnership, there are more people involved as owners
than there are with a sole trader. Therefore, there can be more
people involved with discussing problems and deciding on
strategies. This may lead to better decisions being made. The
partners can benefit from each other’s experience and insight
into problems.
• Each of the partners can specialise in a particular aspect of the
business, which can mean a better and broader service is
provided. For example, in a legal partnership someone may
focus on company law, someone may deal with consumer law
and someone may deal with property law. This can provide
specialist knowledge in more areas than a sole trader may be
capable of.
• Partners can cover for each other, for example, if someone is
ill or wants a holiday. This can mean that being in a
partnership is less stressful than running a business on your

38
 own.

Disadvantages of partnership
• The partners may have different ideas about how to solve a
problem. This can lead to disputes. By bringing in partners,
the owners are bringing in stakeholders who have a direct
role in the business and who will want to express their views.
• Decisions may be slower than for a sole trader because all the
partners are consulted, rather than just making a decision for
yourself.
• The rewards are divided between partners rather than being
kept by one person.
• The partners normally have unlimited liability. Even if a
mistake is made by one partner, all the partners must pay the
price.

Key term
Stakeholders are individuals and organisations that are
affected by, and affect, the activities of a business.

Companies
A company is owned by its investors, who are called
shareholders. There are different types of shares, but the
most common ones are called ‘ordinary shares’. Owners of
ordinary shares have one vote for every share they have. If you

39
have 51 per cent of the shares, for example, you have 51 per
cent of the total votes.

Key terms
A company is a business that has its own legal identity. It
can own items, owe money, sue and be sued.
A shareholder is a person or an organisation that owns
part of a company. Each shareholder owns a ‘share’ of the
business.

A company has its own existence in law. This means that it can
own things such as land and equipment. It also means that when
you, as a member of the public, buy products, you buy them
from the company rather than the individuals who own it. By
creating a company, the shareholders are showing the difference
between what they own as private individuals and what the
company owns. This means that they have limited liability. This
is very important because it means that people can invest in
companies and be fully aware of the most that they can lose if it
all goes wrong. Without this, it would be more difficult to attract
investors because they would be worried about losing
everything they owned if there were problems.
The owners of a company are the shareholders. The people who
control the company and make the decisions every day are
called managers. In many private limited companies (see below),
the shareholders are the managers. However, in public limited
companies, the shareholders and managers are often different
groups of people and this creates a separation between
ownership and control. It is possible that the owners and the
managers have different objectives. The managers, for example,
may want to invest in long-term projects, such as developing a
new product, whereas the owners may prefer to take money out

40
of the business now. This can cause conflict.

Company types
Under the 1980 Companies Act, there are two types of company
in the UK: private limited companies (which put ‘ltd’ after their
names) and public limited companies (which put ‘plc’ after their
names). Both types of company are owned by shareholders and
both have limited liability. However, there are differences:
• A private limited company (ltd) cannot publicly advertise its
shares for sale and is often owned by family members. In a
private company, it is possible to place restrictions on whom
shares can be sold to, for example, in order to keep a business
owned by family members.
• A public limited company (plc) can advertise its shares and
can be listed (also called ‘quoted’) on the Stock Exchange.
It must have a share capital of over £50,000. In a plc, it is not
possible to place restrictions on whom the shares are sold to.
This means that, if you own some of the shares of a plc, you
can sell them to whoever you want and other people can buy
them easily via the Stock Exchange.
A flotation occurs when a private limited company decides to
become a public limited company. To do this, shares must be
sold to the general public and the firm must meet the regulations
of the Stock Exchange.

41
Key terms
The Stock Exchange is a market for buying and selling
shares of public limited companies. Large numbers of
shares are being bought and sold all the time.
A flotation occurs when a private limited company (ltd)
becomes a public limited company (plc) and has its shares
listed on the Stock Exchange.

Maths moment

1 Estimate the total number of businesses in the

UK at the start of 2015.
2 Calculate the proportion of businesses in the UK
that were companies at the start of 2015.
Comment on your findings.

42
Private limited companies
A private limited company:
• is owned by shareholders – when a business is starting up, its
shareholders tend to be the business founders, although they
may bring in outside investors if they need more funding. The
shareholders of many private limited companies are family
members
• has ‘ltd’ after its name
• cannot advertise its shares to the general public – if shares are
sold, this will be done privately
• can include certain restrictions in its Articles of Association to
limit who the shares are sold to (for example, only family
members). This helps to make sure that one owner of the
business does not sell shares to someone the others do not
want.

Advantages of setting up as a private

limited company
• Liability is limited. This means that the shareholders’ personal
possessions are safe, and can help businesses to gain access to
funding from investors. Investors would be unlikely to take
the risk of putting their money into a start-up if there was
unlimited liability. But with limited liability, they are
guaranteed a limit to their losses if things go wrong.

43
• For many customers, a company seems to have more status
than a sole trader. People assume that a company is better in
some way. Setting up as a company may, therefore, be a good
marketing move.
• If the business founders die, the company still exists and
whoever owns the shares now continues with the business.
• Managers can be employed to run the day-to-day business
while the owners retain control and the profits are distributed
among the shareholders.

Study tip
You might be asked to compare the advantages of one
business legal structure with another. Think about:
• the liability of the business (Is it limited or unlimited?)
• the control of the business (Do the owners want to keep
complete control or are they willing to bring in other
people?)
• the skills and experience required (Do the owners have
enough skills or would they benefit from other people’s
experience?)
• whether or not the owners want to work with others.

Disadvantages of setting up as a
private limited company
• Various legal procedures need to be completed, such as
registering the company, which take a little time and some
money.
• A summary of the business’s financial accounts must be
produced and these have to be available to the general public.
In making information available to other people, including
competitors, the business will lose some privacy.

44
• Accounts must be checked by an independent accountant
(called an auditor), which will create additional cost.
• The business must pay corporation tax (individuals pay
income tax) and this may be more than an individual would
pay personally.
• Any additional investors in the business become important
stakeholders. For every share they own they will have a vote,
and so they have a direct influence on the business. They may
not necessarily have the same values and objectives as the
original owners. Some entrepreneurs find it difficult to work
with other investors in a company as their styles clash.

Public limited companies

A public limited company is one that has shares that are sold to
the general public. These shares can be bought and sold easily
on the Stock Exchange. The share price changes when there is
more or less demand for them.

Advantages of becoming a public

limited company
• A public limited company can advertise its shares to the
general public. This means it has access to a greater number of
potential investors than a private limited company and
therefore it may be possible to raise very large sums of money
by selling shares. These could be used to finance expansion.
• Public companies attract more media coverage because they
usually have more shareholders. By becoming a plc, a
business is likely to attract more interest from television and
newspapers, which provides a good form of cheap publicity.
• Public limited companies are usually thought of as having
more status than private companies (and are often bigger).

45
 This can impress customers.
• Investors may be willing to buy shares because they should be
able to sell them later on relatively easily. There are usually
many shares in public limited companies and these are traded
regularly. So if as an investor you decide you want to sell your
shares, you should be able to find someone who wants to buy
them.

Disadvantages of becoming a public

limited company
• Although more media coverage can be good, it can also be
bad. If a plc makes a mistake or does something wrong, the
media are more likely to cover the story than if the business
was a private limited company.
• A plc cannot control who buys its shares, so managers may
find that a competitor buys control of the company and takes
it over.
• A plc is more regulated than a limited company – it has more
things it must do according to the law. For example, it must
produce more detailed information on its finances each year
and send it to shareholders. This can be expensive as well as
giving information away to potential competitors and the
media.
• When a private company becomes a public limited company, it
brings in more outside investors. The original owners may not
agree with the views and objectives of the new owners – they
may clash when trying to agree what the business should be
doing.

Study tip
Private limited companies do not have to become public
companies unless they want more investment from

46
outside investors. During the process of flotation,
companies have to be sure that there will be demand for
their shares at the price they set. This cannot be
guaranteed – it depends on what investors think the
business will earn in the future.

Business insight
Fitbit

The Fitbit company produces wearable technology. For

example, it produces a wristband that monitors how many
steps you have taken during the day, how many calories
you have burned and how far you have travelled. In 2015,
Fitbit sold its shares to the general public to become a
public company in the USA.
Fitbit had imagined its shares would sell for between $14
and $16, but when they were put on sale the price went up
to $20. Having sold these shares, the company was

47
 valued at over $4.1 billion. The funds the company raised
from the sale will be used for research into new products.
Fitbit made losses for many years, but in 2014 made
profits of $131.8 million. In 2015, it sold over 10 million
devices.
Analyse two factors that might have determined the
price of the shares Fitbit put on sale.
(6 marks)

Share ownership
Many of the shares of public limited companies are owned by
financial institutions, such as insurance companies and banks.
Only around 14 per cent of plc shares in the UK are owned by
individuals. The financial institutions often put pressure on the
managers of plcs to pay out a lot of their profits in the short
term; this is so that the financial institutions can reward their
own owners, but this does mean that the plcs have less funds to
invest.

Business insight
Honest Burgers
In 2011, Tom Barton, 29, and Philip Eeles, 32, who were
friends from university, joined up with an experienced
restauranteur, Dorian Waite, 48, to start a business
together. The three of them wanted to create an upmarket
burger chain. They spotted that there was a growing
demand for ‘premium burgers’, using high-quality
ingredients, and decided to target this market segment
with their restaurants. The three of them set up Honest
Burgers Ltd and within four years had grown their
business to ten sites. Sales had grown to £6.9 million by

48
 2015, making it one of the fastest growing companies in
the UK. The company’s objective is to continue to grow
quickly over the next few years.

Analyse the possible reasons why Tom, Philip and

Dorian created a company rather than forming a
partnership.
(6 marks)

Maths moment
Look at the data for Honest Burgers in Table 1.4. What is
the amount of sales per employee? Use this formula:

Not-for-profit organisations
Not-for-profit organisations are set up to achieve objectives
other than profit. For example, a charity may be set up to help
the homeless or people abroad after an earthquake or someone
might set up a youth club to provide facilities for young people
in their area. Not-for-profit organisations will still have to raise
funds and invest just like companies. However, the purpose of
the business is not to make profit for investors. A not-for-profit

49
organisation often has social objectives – it is set up to help
society rather than focusing on profits; any profits made are
invested into the business to help society further.

Key term
A not-for-profit organisation is set up to achieve
objectives other than profit; for example, a charity.

Which is the right form of

business?
The right form of business will depend on the situation of the
organisation. For example, when first setting up a business,
many individuals will operate as a sole trader. This is because
this form of business does not need to be registered and you can
simply start trading. At this stage, the entrepreneur probably
does not have many assets at risk and protecting these through
limited liability is not essential. As the business grows, the
owner has more personal assets that could be lost and he or she
may want to attract outside investors. At this point, the
entrepreneur may want to sell shares to raise finance to help the
business grow. To attract investors, limited liability is likely to be
important so that those buying shares know there is a limit to
their risk.

50
If the people have social objectives (that is, they want to help
society) rather than to make profits, it would make sense to set
up as a not-for-profit organisation.

Summary
There are many different legal structures of a business.
Each has advantages and disadvantages. For example, a
sole trader is easy to set up, but has unlimited liability. A
partnership has the benefit of the input of several different
people, but there is a danger that they will not agree. A
company has limited liability, but has to make information
more public. Choosing the right legal structure is an

51
important business decision when starting up.
When a business wants to grow, it may change its status
from a private limited company to a public limited company.
This has advantages (for example, shares can be sold to
the general public) and disadvantages (for example, the
business is more vulnerable to takeover). Owners will
have to decide whether the benefits of plc status outweigh
the disadvantages.

Quick questions
1 State two reasons why an entrepreneur might want to
be a sole trader.
(2 marks)
2 State two possible problems of being a sole trader.
(2 marks)
3 What is meant by ‘limited liability’?
(2 marks)
4 What is a ‘shareholder’?
(2 marks)
5 State two differences between a private limited
company and a public limited company.
(2 marks)
6 State two advantages of a partnership compared to
being a sole trader.
(2 marks)
7 What is a ‘partnership’?
(2 marks)
8 State two possible problems of a partnership.
(2 marks)

52
 9 What is meant by a ‘Deed of Partnership’?
(2 marks)
10 Why might someone buy shares in a company?
(2 marks)

Case study
Snapchat

Snap is the company that owns Snapchat, the picture- and

video-sharing app. It is planning to sell its shares to the
general public. It is estimated that the company will be
worth $25 billion, depending on the price people are willing
to pay for the shares.
The founder and Chief Executive Officer Evan Spiegel,

53
26, is said to be worth $2.1 billion. The company was
founded in 2011 and was expected to generate $366.7
million in worldwide revenue from advertising in 2016. In
2015, the company’s total revenue was a fraction of that
number at $60 million.
The service, notably popular with younger people, allows
users to send pictures and videos of them looking like
dogs, zombies or with other strange effects. It has around
58 million users. The Snapchat app is designed so
messages delete once they are read or expire. With 10
billion videos being watched every day, the site has seen a
350 per cent increase in use between 2015 and 2016.
In September 2016, the company announced that it was
going to expand and launch Spectacles, glasses that can
record ten-second clips that can be sent to smartphones.
Its first hardware product became available at the end of
2016.
1 What is meant by a ‘private limited company’?
(2 marks)
2 Explain two benefits to Snap of launching products that
are not apps.
(4 marks)
3 Analyse the factors that might affect the price of the
shares if Snapchat decided to float.
(6 marks)
4 Imagine the managers of Snapchat are considering how
to raise funds for investment. Should they:
• float the company on the Stock Exchange, or
• borrow from a bank?
Evaluate which option you would choose.
(12 marks)

54
55
Topic 1.3

Setting business aims and

objectives
Whenever you set out to do something, it helps if you have
a clear idea of what you are trying to achieve. What grade
do you want in your Business GCSE, for example? If you
are clear about what you want to achieve, you will find it
easier to sort out your priorities and make decisions, such
as how much time and effort to devote to a project.
By the end of this topic, you should know:
• the difference between aims and objectives
• the purpose of setting objectives
• the types of business objectives
• the role of objectives in running a business
• how and why objectives may differ between businesses
• how and why the objectives set may change as
businesses evolve
• how a business might use objectives to measure its
success
• how the success of a business can be measured in
other ways than just profit.

56
What are aims and objectives?
An aim is a general goal of the business; for example, the
owners may aim to grow the business or make it more
profitable.
An objective is a specific target that turns the aim into
something that is easier to measure and assess progress. For
example, the aim may be to grow, whereas the objective set from
this might be to grow sales by 25 per cent within three years.
The aim may be to be more profitable, whereas the objective set
from this may be to increase profits by 30 per cent within five
years. The aims and objectives provide a focus for everything
you do and will enable you to look back and see whether you
have done what you wanted to. You may, at any given moment,
have more than one objective. As a student, for example, you
may have an objective to do well in your exams, while also
continuing with your sports and having a part-time job to earn
money for your holidays. Entrepreneurs may want to make sure
that they provide a good service and earn enough money to live
on, while also having some time for their interests and their
families. Managers in bigger businesses may be trying to make
enough profit for their shareholders, while also looking after
their employees and helping their communities.

Key terms
An aim is a general goal of a business.
An objective is a specific target that is set for a business
to achieve.

The purpose of setting

57
objectives
By setting objectives, managers will be clear about what they are
trying to achieve. This is important for the following reasons:
• It helps with decision-making and with establishing priorities.
For example, if the objective is to grow the business overseas,
then there should be a focus on looking for new orders
abroad. If the objective is to stay local, there should be a focus
on potential customers nearby.
• It helps investors to understand the direction in which the
business is heading. This might mean they are more willing to
agree to certain decisions. For example, if there is an objective
of doubling sales, investors might be more willing to agree to
an investment in a new factory. Having clear objectives might
help, therefore, when trying to raise money to set up a
business.
• It provides a target so that everyone can compare the actual
results with the planned results to decide how successful the
business has been.
• It can motivate everyone connected with the business because
they know what they are trying to do and how they can
measure their success.

Business insight
Google’s ‘10 things’

58
 The founders of Google wrote ‘10 things’ when the
company was just a few years old. They think these aims
are still relevant to the business today:
1 Focus on the user and all else will follow.
2 It’s best to do one thing really, really well. We do
search.
3 Fast is better than slow.
4 Democracy on the web works.
5 You don’t need to be at your desk to need an answer.
6 You can make money without doing evil.
7 There’s always more information out there.
8 The need for information crosses all borders.
9 You can be serious without a suit.
10 Great just isn’t good enough.
You can find out more about Google’s aims at
www.google.com/about
Analyse the benefits to Google of setting out its ten
aims.
(6 marks)

The role of objectives

The precise objectives of businesses will vary between
organisations and over time. In the same way, your objectives
may be different from your friends and what you are aiming to
achieve may be different at different stages of your life.
However, objectives typically centre on the following areas.

Survival

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Survival is particularly important when a business is being set
up. Starting a business is risky and presents many challenges. In
the short run, at least, simply surviving is an achievement. To get
the business’s name known, it may be necessary to charge lower
prices and make lower profits than the entrepreneur would like
to make in the long run. Survival may also become important
when the economy is doing badly. If people are earning less
money and spending in the economy falls, some businesses may
focus on surviving. For example, they may accept lower prices
(and profits) to get some sales.

Earning a profit
Although there may be times when a business does not make a
profit, in most cases this will be one of its long-term objectives.
Profit occurs if the value of what a business sells over a given
time period is greater than the costs of providing and selling
these products. If a profit cannot be made, the owners of
businesses would usually take resources out of this business and
use them elsewhere. Of course, it may take time to generate
profit – companies such as Ocado have taken several years to
build the brand and become profitable – but if a profit simply
cannot be generated in the long term, the business is likely to
close. However, it is not just making a profit; the business needs
to make enough profit to cover the opportunity cost of these
resources. How much is enough will vary depending on the
owners and what they are looking for.

Business insight
Tesla

60
 The US electric carmaker Tesla is widely admired as one
of the most highly innovative companies in the world, but
has yet to make a profit. It has had 13 consecutive
quarters (three-month periods) of losses.
Tesla has been criticised recently for accidents that have
occurred in its autopilot cars. Computer hackers have
also managed to disrupt the cars from a distance of 12
miles away. However, demand is up and it is now
producing over 100,000 cars a year.
Analyse why Tesla would carry on producing cars if
it is making a loss.
(6 marks)

Shareholder value
A company is owned by its shareholders. The shareholders
employ managers to run the business on their behalf. Managers
will aim to reward their shareholders by:
• generating profits to pay dividends – a financial reward paid
on each share
• running the business well so that people want to buy the
shares. This increases the demand for them and makes the

61
 price of them go up. The people owning the shares, therefore,
now own something worth more than when they bought it
and could sell it for more than they paid for it. By increasing
the price of the shares, managers will have increased the
shareholder value.

Customer satisfaction
Businesses may set targets that focus on achieving a particular
level of customer satisfaction by providing a better service or a
wider range of products than their competitors. This should
hopefully lead to more profits in the long run. If customers are
satisfied, they are more likely to come back and buy more
products. They will also tell their friends to try the products as
well. However, ensuring features such as fast delivery, excellent
customer information, a wide variety of products and services
may involve high costs and lower profits in the short run.

Market share
Businesses may set themselves a target in terms of the share of
the market they hope to achieve. The market share measures the
sales of one product or business as a percentage of the total
market sales. A business may set out to achieve, say, 20 per cent
or 30 per cent of a market’s sales within five years.

Business insight
Next

62
According to its website, the main objective of the Next
group is to earn long-term returns for its shareholders
through the profits earned for each share and the
dividends paid.
It aims to achieve this through activities such as:
• improving and developing Next product ranges – the
success of this is measured by the sales
• increasing its sales space, provided it is profitable
• increasing the number of profitable Next Directory
customers and their spending
• making sure the business is efficient through efficient
product sourcing, stock management and cost control
• focusing on customer service and satisfaction levels.
Source: Next: www.nextplc.co.uk

Analyse the possible reasons why Next sets the

objective of earning long-term returns for its
shareholders.
(6 marks)

63
Growth
Many businesses will have an objective of growth. The owners
and managers may want the business to open more stores, sell
more products or increase its revenue. Growth may come within
the local region, for example, an independent café gaining more
customers, nationally (such as Costa opening more stores in the
UK) or internationally (such as Costa opening up in Asia). In
each case, a business must consider the likely demand and costs,
and whether it is likely to succeed. Operating abroad, for
example, can be difficult due to differences in people’s lifestyles,
shopping habits and values. Sometimes it can be difficult for an
overseas business to understand these unless it changes what it
does. McDonald’s, for example, changes its menu in different
countries.
For more about growth, see Topic 1.7.

Being ethical
The ethics of a decision are what is regarded as right or wrong.
Some businesses will want to behave in an ethical manner – for
example, paying their staff reasonable wages, treating their
suppliers and customers with respect and being honest with
them about what is happening in their business. Unethical
businesses may be criticised by the media and lose customers.
By being ethical, a business may benefit by:
• getting favourable media coverage
• using the ethical message in its marketing
• attracting customers, investors and employees.
Acting ethically may sometimes increase costs, for example,
when paying employees more than the minimum required by the
law, or when maintaining production in the UK to protect jobs

64
rather than relocating production to a cheaper location overseas.
Such increased costs must be weighed against the likely costs of
less ethical behaviour – the business could suffer a loss of
demand if employees and customers do not approve of its
actions.
For more about ethical considerations, see Topic 2.2.

Environmental and sustainability

targets
Businesses might want to make sure that their activities do not
damage the environment. They may set targets to limit the
energy they use, to limit their carbon footprint, to achieve certain
recycling targets, to reduce wastage or to reuse more of their
supplies. They may also be interested in making sure the
materials are from sustainable sources (this means the sources
are renewed or will not run out). For example, a furniture
company might only use wood from a supplier that replants
whenever it cuts down a tree; a retailer might try to use wind or
solar power to provide the energy for its stores. Resources such
as oil are non-sustainable (they cannot be used forever) and are
running out. This is why some businesses are trying to find
alternative resources.
For more about environmental considerations, see Topic 2.2.

Business insight
M&S’s Plan A 2020
According to Marks & Spencer (M&S), its customers are
increasingly aware of the impact of business actions on
the world and so companies need to work hard to build
and maintain customers’ trust. Increased pressure on
natural resources and a failure to look after these

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resources can increase costs and make accessing raw
materials more difficult.
M&S believes a successful business needs to be
environmentally and socially sustainable. It launched Plan
A in 2007. This is a business plan, designed to prepare
the business for the future requirements of its customers.
Having achieved many of its targets in the original Plan A
- including carbon-neutral operations, sending zero waste
to landfill and reducing packaging by 25 per cent - in 2014,
M&S launched Plan A 2020. This has 100 new, revised
and existing environmental commitments.

Analyse why M&S might want to become a

sustainable business.
(6 marks)

Maths moment
The equation for market share is:

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 If your sales are £20,000 and the total market sales are
£400,000, your market share is:

What would your market share be if your sales

increased to £50,000 and the market stayed the
same size?

Effective objectives
To be effective, an objective should clearly state:
• what the target is – for example, to increase profits by 20 per
cent
• when it has to be achieved – for example, to achieve the target
within two years
• who is to achieve it – who is in charge of making sure the
target is hit
• how to achieve it – what is and what is not acceptable
behaviour.
To be successful, businesses must set objectives that are
achievable and involve only those resources that are available.
The resources involved may include the following:
• Time. Managers often have many different tasks to complete
so they must feel they have a sufficient amount of time
available to focus on a given target.
• People. Does the business have the staff it needs?
• Money. Does it have the necessary finance to buy the
resources and materials required?

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• Equipment. Does it have the machinery and facilities needed
to achieve the target?

Not-for-profit organisations
For most private sector organisations, profit is an
important objective. However, not all organisations aim to make
profits. For example, public sector organisations, such as
schools and hospitals, aim to provide a free service for the
public. Within the private sector, not-for-profit organisations
include social clubs and charities. There are over 180,000
registered charities in the UK, including Macmillan Cancer
Support and the Isle of Wight Donkey Sanctuary. Charities in
England and Wales are monitored by the Charity Commission
and their objectives are to benefit the particular cause that they
were set up to help.

Key terms
Private sector organisations are owned by individuals.
Public sector organisations are owned by the
government.

Changing objectives
When an entrepreneur starts a business, the objectives are
usually to survive the first few months or years. Establishing a
business can be difficult and so surviving is often quite an
achievement. It may be enough to win some orders, prove the
business idea works and begin to build a reputation. Given the
costs of starting up and of promoting the business to gain
customers, as well as the difficulty of gaining customers early

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on, it is likely that a new business will make losses at first. Over
time, it will be expected to make profits to cover the opportunity
cost (see Topic 1.1) of the resources involved.

As a business becomes more established, its objectives may

change. For example, it may want to grow. Managers and
owners often want the business to get bigger in order to have
more sales and profits. This growth may involve developing
more products so the range of goods and services it offers may
become wider. It may also involve expanding overseas to target
new customers.
Bigger, more established organisations are also usually open to
more scrutiny (attention) from the media and government than
other businesses. Bigger businesses will employ more people,
have more suppliers and have a bigger impact on the

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community. This means they may want to accept greater
responsibilities and be more likely to have environmental and
social targets.

Using objectives to measure

success
You can only know whether someone is being successful if you
know what they are trying to achieve. Consider a football match
in which a team at the top of the Premiership scores a draw with
a team at the bottom. At first, you may think they have done
badly. However, when you discover they only needed a draw to
win the league this season, you can understand what they were
doing. Only when you know what the desired result is can you
make a proper judgement about whether or not things are going
well. The same is true in business. A business making profits of
£25,000 a year may be a tremendous success to the 18-year-old
who started it up as a hobby and was only hoping to make a
maximum of £10,000 a year. However, it may be a major
disappointment to a team of experienced investors who had set
themselves a target of £200,000 profit a year.

Study tip
Always look for the objectives of the people starting up a
business. Only then can you judge properly whether or not
they have succeeded. You may not be happy with
earnings of £20,000 a year, but someone else might be.

Business objectives provide a point of focus, helping businesses

to make decisions about what to do and to review how things
are going. This enables them to take appropriate decisions if
things get off track. Imagine you decide to take a year out and

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go travelling. You will probably set targets about what you hope
to have seen and done by particular moments during the year. In
reality, you might spend longer than you imagined in various
places. By having objectives, you can see how to catch up the
time to make sure you do everything you want in the year. In the
same way, in business, if sales are 10 per cent lower than
expected, it is possible to analyse the likely reasons for this and
then take steps to boost sales again.

Business insight
Sport England
Sport England is an organisation set up to build an active
nation with more people taking part in sport, whether this
is going to the gym, walking or taking part in team sports.
Sport England’s mission is to enable everyone in England,
regardless of their age, background or ability, to take part
in sport or an activity.
It wants to:
• increase the number of people in England taking part in
sport and activity and decrease the number of people
who are physically inactive
• increase the proportion of young people (11–18) who
have a positive attitude to sport and being active
• ensure public facilities are used fully and effectively to
get maximum use from communities
• increase the number of adults using the great outdoors
for exercise and wellbeing.

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1 Four things that Sport England wants to do are stated
above. Explain why the way they are written means they
are not actually ‘objectives’.
(4 marks)
2 Analyse how setting objectives might be useful for
Sport England.
(9 marks)

Summary
A business should have objectives. The objectives set out
what the business wants to achieve. They can be used to
measure performance and assess progress. The nature
of the objectives depends on factors such as who owns
the business and whether it is a new or established
business. The nature of the objectives may change over
time, for example, if the business has new owners.

Quick questions
1 What is an ‘objective’?

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 (2 marks)
2 State two features of an effective objective.
(2 marks)
3 State two advantages for a business of setting an
objective.
(2 marks)
4 State two possible objectives of a business.
(2 marks)
5 State two reasons why a business might change its
objectives.
(2 marks)
6 What is meant by ‘profit’?
(2 marks)
7 What is meant by ‘market share’?
(2 marks)
8 How can objectives be used to measure
performance?
(2 marks)
9 What is meant by an ‘aim’?
(2 marks)
10 Why might a business have environmental targets?
(2 marks)

Case study
Ben & Jerry’s
Ben & Jerry’s, the US company that makes ice-cream,
was founded in Vermont in 1978 by Ben Cohen and Jerry
Greenfield, who described themselves as hippies. The two
friends started their ice-cream careers with a $5 ice-

73
cream-making correspondence course from Pennsylvania
State University and a $12,000 investment ($4,000 of
which was borrowed). Their ice-cream is now world
famous but, despite the growth, both Ben and Jerry have
always maintained their links with their community and
promoted a number of good causes. It is known as a very
ethical business.
One of the company’s mottos is: ‘Business has a
responsibility to the community in which it operates.’
The actions the company takes include reducing waste,
trying to adopt environmentally friendly methods of
production and respecting their employees. It sets
objectives in these areas.
Ben & Jerry’s believe it is important to make a profit as a
business, but that it can do it ethically.
1 What is meant by ‘business ethics’?
(2 marks)
2 Explain two benefits to a business of setting objectives.
(4 marks)
3 Analyse the reasons why businesses set profit as an
objective.
(6 marks)
4 Evaluate the benefits of acting ethically to a business
such as Ben & Jerry’s.
(12 marks)

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Topic 1.4

Stakeholders
In this topic, we consider the various individuals and
groups (called stakeholders) that will be affected by the
activities of a business. We examine the impact a
business can have on stakeholders and the way in which
stakeholders might affect business decision-making.
By the end of this topic, you should know:
• who the main stakeholders of businesses are
• what the objectives of stakeholders are
• what the impact of business activity is on stakeholders
• what impact and influence stakeholders have on
businesses.

The main stakeholders of

businesses

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The objectives of a business should be set by the owners. It is
their business and everyone working within it should aim to
meet their needs. If the owners want more profits, this is what
everyone should aim for. However, the final decisions the
owners take are likely to be influenced by the different
stakeholders connected to the business.
A stakeholder is an individual or organisation that affects and is
affected by the activities of an organisation. Stakeholders
include the owners, employees, customers, suppliers, the local
community and the government.
All of these groups will have their own objectives and these may
influence the targets set by businesses. For example:
• Owners may want to maximise their returns. For example,
they may want to be paid high dividends.

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• Employees may want to earn more as a reward for their
efforts. They may also want the business to grow so they have
promotion opportunities.
• Suppliers may want to be paid on time. The business may,
therefore, set a target to pay all bills within a given period of
time.
• The community may want the business to behave responsibly.
The business may, therefore, set a target in areas such as
recycling, noise, waste reduction and even try to employ local
people. The local community may want to reduce the
environmental impact of the activities of a business.
• The customers can also have an important role to play. For
example, small firms may be reliant on relatively few
customers and, therefore, these buyers become quite
powerful. A small firm selling to a large supermarket may
have to accept the terms offered by the supermarket if it wants
to win the order. This means the buyers can affect what
constitutes a realistic objective for a business in terms of, say,
the likely level of sales and profits.

Key term
Dividends are the financial rewards paid out to
shareholders each year.

The objectives of stakeholders

Table 1.5 shows the typical objectives of different stakeholder
groups.

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How does a business have an
impact on stakeholders?
The activities of a business will have an impact on many
stakeholders. For example:
• The success of the business will affect the number of people
employed and how much they earn.
• The values of the owners and managers will affect how well
treated employees are and how much attention is given to the
quality of their life at work and their future careers; for
example, does the business invest in training and giving them
skills for the next stage of their career?
• A business is likely to have an impact on the local community;
for example, it may decide to try to employ local people, it
may invest in local facilities and it may affect congestion
levels in the area.
• The way a business treats its suppliers will affect their success.
Does it pay them on time? Does it pay them a fair price or
does it try to use its power to push down the price? Does it try
to build a positive relationship with suppliers or does it try to
force suppliers to compete against each other for orders?
• The success of the business may affect its share price and the

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 dividends that can be paid out affecting the rewards to
shareholders.
• A business may try to reduce the amount of tax it pays by
using whatever legal means it can; companies such as Amazon
have done this. Or a business may decide to pay what it
regards as a ‘fair’ amount of tax, even if it could legally pay
less. This will affect the government’s revenue.

How stakeholders can

influence a business
Stakeholders can influence a business in many ways:
• Negotiation. Employees may negotiate for better pay.
Suppliers may demand better terms and conditions.
• Direct action. Customers can stop buying the products of a
business if they are unhappy with the way it behaves.
Employees can go on strike and refuse to work if they do not
get what they want.
• Refusal to co-operate. Local councils can refuse to co-
operate with a business if they do not like its behaviour. For
example, they could refuse planning permission for it to
redevelop or expand its operations. Employees could resist
any changes that the owners suggest and could show they are
unhappy by not working hard.
• Voting. The owners of a business can make their views clear
and can vote on what the organisation should do next. For
example, if three people set up a business, it may be that two
of the owners outvote the other one when deciding what
should be done.

79
Key term
Negotiation occurs when two sides discuss what they
want and try to reach a solution.

When dealing with stakeholders, a business may think about:

• how it communicates with stakeholders. Does it need to keep
them informed? If so, how should it do this? Through
newsletters? Organise meetings (such as the Annual General
Meeting (AGM), which is a meeting that companies must have
each year for their shareholders)?
• whether it should involve different stakeholders in
discussions. For example, it may want to hold meetings where
stakeholders can raise their points of view. Managers may
want employee representatives on committees and in meetings
to make sure their views are heard.

Study tip
To decide how particular stakeholders can affect the
objectives of a business, you need to consider what
power that group has and what actions they could take to
affect the business if it does not pay attention to them.

Business insight
Post Office workers strike
In 2016, thousands of Post Office workers went on a 24-
hour strike (that is, they did not go to work) in a dispute
over management decisions to close branches, reduce
the number of jobs and change their pension entitlements.
This led to the closure of around 118 of 305 offices in city
and town centres due to a lack of staff. Across the

80
country as a whole, almost 99 per cent of the 11,600 Post
Office branches remained ‘open for business as usual’.
Analyse the possible impact of a 24-hour strike on
the business and its stakeholders.
(6 marks)

Summary
A stakeholder is any person or organisation that is
affected by the activities of a business. Stakeholders will
have their own objectives. Sometimes these will overlap
with each other but sometimes they will conflict.

Quick questions
1 What is meant by a ‘stakeholder’?
(2 marks)
2 State two stakeholders in a business.
(2 marks)
3 Are all stakeholders also shareholders? Explain your
answer.
(2 marks)
4 Show, with an example, how stakeholders might have
different objectives.
(2 marks)
5 Show, with an example, how stakeholders might have
the same objectives.
(2 marks)
6 Explain one way in which a stakeholder might
influence the business objectives.

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 (2 marks)
7 Explain one possible objective of suppliers.
(2 marks)
8 Explain one possible objective of employees.
(2 marks)
9 Explain one possible objective of shareholders.
(2 marks)
10 Explain one possible objective of the local community
around a business.
(2 marks)

Case study
Unilever

Paul Polman is Chief Executive of Unilever, one of the

world’s biggest companies. Unilever produces a wide
range of products from washing powders to food. The

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company employs over 170,000 people and has a market
value of almost £90 billion.
Polman has encouraged all his team at Unilever to take a
long-term view when making decisions. He has stopped
updating investors every three months because he thinks
this is a distraction and leads to too much of a short-term
focus. He has made everyone in the business focus on
environmental issues. For example, the company is
committed to reducing the calories in its ice-cream and is
aiming to remove coal from its energy usage within five
years.
However, although Polman may want to focus on long-
term global issues, he also has to consider the demands
of the company’s shareholders who want dividends.
Polman admits this is something of a balancing act with
the various stakeholder groups, but believes that investors
are increasingly understanding the benefits of a long-term
approach. He believes that acting now to save the planet
will save money later and will increasingly prove popular
with investors. Polman says that around 70 per cent of the
shareholders of Unilever have been with the business
since he has and that he is deliberately encouraging long-
term investors.
Polman is determined to prove that, whatever the
economic or political situation in the world, Unilever can
deliver revenue growth and profitability. He believes
Unilever can have a positive impact on the environment
while also meeting the needs of its shareholders.
1 What is a ‘shareholder’?
(2 marks)
2 Explain one possible reason why Polman stopped
updating investors every three months.

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 (4 marks)
3 Analyse the possible impact that a company such as
Unilever can have on its environment.
(6 marks)
4 Evaluate Polman’s view that looking after your
stakeholders can improve the long-term profits of a
business.
(12 marks)

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Topic 1.5

Business location
One of the key decisions a business faces is the choice
of its location. Location can affect costs and demand, and
have a big impact on its overall success. In this topic, we
examine the factors influencing the location decision for
start-up businesses.
By the end of this topic, you should know:
• why location is important
• the factors affecting location.

Why is location important?

You have a brilliant business idea. You know there is a market
and are sure you can deliver good value for money. But where
do you locate your business? Your location decision is very
important because it can affect the following:
• Costs. The amount to be paid in rent or to buy a premises
varies according to location. The rent for premises in the
centre of London, for example, is greater than for offices in
central Wales. The costs of facilities can affect the level of
profit a business makes.

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• Sales. Location may affect whether or not the business gets
customers. A hotel or theme park in the wrong location may
struggle to attract visitors, for example.
• Image. For some products, where they are produced can have
an important impact on their image. A perfume from
Southampton or a wine from Bradford may struggle to sell. A
language school on the coast or a gift shop in a tourist town
may be more successful.

Factors influencing location

Factors that influence where a business should locate include the
following.

The type of business

The type of business will have a big impact on where it should
or where it can be located. A web design business could
probably be set up from a bedroom (and, indeed, many have
been). A shop, on the other hand, needs to be near potential
customers. A service delivering flowers to people’s homes
would need to take account of the road system. Generally
speaking, factories are more concerned about supplies and
transport systems, whereas shops are more interested in being
close to their customers.

The proximity to the market

A business will want to know where its customers are located
and ensure that it can reach them easily. This is more important
in some industries than others. For example, an online price
comparison site does not need to be near its customers as they

86
access its services via the internet. However, a service business
will often need to be near its customers. For example, a
hairdresser, a pub or a café will want to be easily accessible.

Competitors
It is important to consider the location of competitors. In some
cases, a business will not want to be too close to its rivals. Petrol
stations, for example, may be located some distance apart from
each other. However, in other cases, competitors do want to be
relatively close to each other. A new hotel business, for example,
is likely to be more successful if it opens in an existing tourist
area, perhaps with other hotels nearby, as this draws in the
visitors. A new restaurant may want to be in an area of town
known for its good eating places. When visitors come to that
part of town, they may end up choosing the new restaurant.

Availability of raw materials

Some businesses rely on raw materials. A wine business will
want to be near the grape vines that it uses to produce wine. A
dairy business will want to be near its cows.

Availability and cost of labour

Some businesses, such as Microsoft and Google, want highly
skilled and able individuals. Such workers can often be
recruited from the best universities, and so these businesses
often set up near, and make good links with, these institutions.
Other businesses have relocated production to countries, such as
China and Vietnam, where wages are lower.

Transport links
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Businesses aiming to export (that is, sell abroad) might need to
be near an airport or a port so they can transport goods easily. If
you want to do business in London but cannot afford London
rents, you might choose to locate somewhere outside the city
(with cheaper rents) but where the road or train links are
effective so you can get to London quickly.

Technology
Many businesses these days rely on good communications
systems, such as internet access and mobile communications.
The availability of such good communications means more
businesses can be run from home. Anything that can be done
online, such as designing, writing, editing and programming, can
be done from home.

Costs
Location decisions are often affected by costs and the amount of
money the business can afford. Start-up businesses often have
limited funds available and this restricts their options. For
example, you may have to start your cleaning business from
home to begin with to save money. Later on, if the business
works, you may move into office premises. A business will
compare the costs of any location with the likely revenue it can
earn. It may be that choosing a higher-cost location actually
leads to more profit; a prime site for a cafe, for example, can
lead to more visitors and more profits.

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Overseas location
Advantages of locating overseas
• Cheaper labour. Wages in countries such as China and India
are much lower than in the UK.
• Access to resources that are not easily available in the UK.
For example, growing bananas is easier in South America than
in England.
• Financial incentives from foreign governments. Some
governments are keen to attract foreign businesses to their
country and so offer money or lower taxes to attract them.
This may make it cheaper for the business to operate in that
country.
• Avoids protectionist measures by foreign governments.
Some governments want to help their own firms and so they
protect them from overseas competition. This can done

89
 through taxes on foreign goods (called tariffs) or by limiting
the number of foreign goods (imports) allowed to enter the
country (this is called a quota). By locating within the
country, a business can usually avoid these barriers and so can
find it easier to sell in that country.
• The market overseas may be growing fast. If the market in
the home country is experiencing slow growth, or if the
company cannot get much bigger in the home country,
moving abroad allows faster growth. Tesco is already very big
in the UK and sales of food are not likely to grow very
quickly. This is why Tesco has expanded abroad into countries
such as the USA, China, Poland and Hungary.

Key terms
Protectionist measures are policies that governments
use to protect their own businesses against foreign
competition.
A tariff is a tax on foreign goods imported into a country.
Imports are goods and services purchased from
overseas by consumers of businesses.
A quota is a limit on the number of foreign goods imported
into a country.

Business insight
Disneyland opens in Shanghai

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In 2016, the entertainment business, Disney, opened a
theme park in Shanghai. It had taken over ten years of
planning and involved an investment of around $5.5 billion.
The company is planning on China’s growing middle class
spending more on travel, tourism and leisure.
The theme park includes two hotels, a shopping district
and six themed areas – Mickey Avenue, Gardens of
Imagination, Fantasyland, Adventure Isle, Treasure Cove
and Tomorrowland.
The park features storytelling and design features that
Disney hopes will appeal to a Chinese audience.
Shanghai’s traditional Shikumen-style architecture will be
highlighted, as will themes from the Chinese zodiac.
Analyse the factors Disney will have considered
before deciding on Shanghai as a location for one
of its parks.
(6 marks)

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Disadvantages of locating overseas
• There may be different rules and regulations in other
countries. These can affect how a business treats its staff or
advertises its products, and what safety tests must be passed.
Managers must understand these differences, but it may be
expensive to change what you do.
• Customers may have different tastes. Products may need to
be changed to suit different markets, which can be expensive.

Study tip
When thinking about a business’s decision to relocate
abroad, you need to consider how different stakeholders
are affected. Some may be worse off and some may be
better off. Consider a business relocating to a low-cost
location in Vietnam. Employees in the UK may lose their
jobs and the UK government may lose tax income.
However, shareholders may make more profits and the
community in Vietnam may benefit.

Business insight
Burberry
In 2007, the British clothing brand Burberry decided to
stop production in the Rhondda Valley in Wales and
relocate to China. Three hundred workers lost their jobs.
The company describes itself as a ‘luxury brand with a
distinctive British sensibility’. It claimed that the
manufacturing cost of each individual polo shirt in Wales
was £11, compared to a potential £4 in China. Each year
that the factory was kept open in Wales, Burberry argued,
would reduce its profits by £2 million.
Analyse the case for and against Burberry moving

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production to China.
(6 marks)

Business insight
Toyota
For over 50 years, Toyota vehicles have been sold in
over 170 countries and regions across the world. As the
company has exported more, it has also produced more
in many countries; it has a policy of producing vehicles
where the demand exists. It now has 51 production bases
in 26 different countries and regions.
One of the challenges this creates is ensuring that the
quality is not affected. Wherever you build a Toyota car, it
must be the same quality. The company does not put a
label on vehicles which says ‘Made in the USA’ or ‘Made
in Japan’; it simply says ‘Made by Toyota’. This means
that it must ensure quality is the same wherever a car is
produced.
Analyse the factors Toyota might consider when
deciding where to locate a factory.
(6 marks)

Study tip
The ‘right’ location for a business will depend on the
nature of the business. Make sure you think about the
particular business in the exam question. Does it need to
be near raw materials? How close does it have to be to its
customers?

Business insight

93
Hewlett Packard

The global computer business Hewlett Packard (HP)

began in a garage in Palo Alto, California. In 1938, Bill
Hewlett and Dave Packard decided to take the risk and
start out in business for themselves. Dave left his job at
General Electric in New York and returned to Palo Alto
while Bill looked for rented accommodation for them to live
and work. He found one place that seemed perfect on
Addison Avenue. The property had a ground floor flat for
Dave and his wife, an 8 × 18-foot shed for Bill to live in
and a garage Bill and Dave could use as their workshop.
They shared the rent of $45 per month. The garage
served as a research laboratory, development workshop
and manufacturing facility for early products, including the
Model 200A audio oscillator. By 1940, the company
already needed more space and HP moved into larger

94
quarters nearby on Page Mill Road.
The garage was dedicated as the ‘Birthplace of Silicon
Valley’ in 1989, and HP acquired the property in 2000 and
restored it back to the way it was in 1939.
Analyse the reasons why Hewlett and Packard
might have chosen this location for their first
business venture.
(6 marks)

Summary
The location of a business can affect its costs and the
demand for its product, which in turn can have a big impact
on its profits. Choosing the right location is therefore an
important business decision. Where the right location
actually is depends on many different factors including
costs, demand, technology, suppliers and competitors.

Quick questions
1 Explain one reason why technology might affect the
location of a business.
(2 marks)
2 Explain one reason why the labour market might affect
the location of a business.
(2 marks)
3 Explain one reason why the infrastructure might affect
the location of a business.
(2 marks)
4 State two businesses that would need to locate close

95
 to their customers.
(2 marks)
5 Explain one factor that might influence the location of
a retail outlet.
(2 marks)
6 Explain one factor that might influence the location of
a theme park.
(2 marks)
7 Explain one factor that might influence the location of
a coal mining business.
(2 marks)
8 Explain one factor that might influence the location of
a caravan site.
(2 marks)
9 Explain one factor that might influence the location of
a computer games design business.
(2 marks)
10 State two types of business that need to be located
near their supplies.
(2 marks)

Case study
Relocating to China
Zak Lilly has just told his workforce that he is closing the
factory. His business makes plastic pipes and tubing that
are used by plumbers across the UK. Zak was born in
Manchester and had tried to keep production there for as
long as possible, but he knows he can no longer make a
profit with a UK base. The market is very competitive and,
unless he produces abroad, he knows he will make a loss

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and go out of business fairly soon. Zak feels sad about
shutting the UK factory down but feels he has no choice.
He has found a cheap site in China and is moving
production there in the next few months.
1 What is meant by ‘loss’?
(2 marks)
2 Explain how moving production to China might help
Zak’s business to survive.
(4 marks)
3 Analyse the objectives Zak might set for his business in
the short and long term.
(6 marks)
4 Discuss the ways in which the stakeholders of Zak’s
business will be affected by the relocation.
(12 marks)

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Topic 1.6

Business planning
Whenever you are thinking of doing something, it can help
to write out a plan first. This can help you to remember
what exactly you are supposed to do, plus when and in
what order you are supposed to do it. A business plan sets
out where a business is heading and how it intends to get
there. This can be helpful to many groups both inside and
outside the business. This topic examines the benefits
and also the problems associated with a business plan.
By the end of this topic, you should know:
• the purpose of business planning
• the main sections within a business start-up plan
• the basic financial terms used in a business plan
• the basic financial calculations useful to interpret a
business plan.

The purpose of business

planning
A business plan states what a business is trying to achieve

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over the next few years and how it intends to accomplish these
aims. A business plan may be created to:
• help set up a business successfully. Establishing a new
business involves many decisions and often the person
making them is relatively inexperienced. By planning,
entrepreneurs have to think ahead and gather data. This helps
them to assess the risk of various decisions and hopefully
make better decisions. Business planning is important to
anticipate any problems. If problems are identified in advance,
the business should be better able to deal with them.
• raise finance. A business plan is useful to show to possible
investors. If someone was thinking of investing money into a
business, for example, he or she would want to see what the
managers intended to do with it and when they were likely to
see a return on their investment. They would want to
understand why the managers think the business will succeed.
For example, they might want to know by how much sales are
expected to increase, what the profit target is and how the
business will attract customers. A bank, therefore, will usually
require a business plan before deciding whether to give a
loan.
• set objectives. A plan will set out what a business wants to
achieve. This can help provide a clear target for everyone in
the business. Having a target can be motivating and helps
people to make decisions because they know what they are
trying to achieve. The effectiveness of actions can be assessed
against the objectives that have been set.
• co-ordinate actions. A plan should set out how an objective is
going to be achieved – what resources are needed, what the
time frame is, what the targets for the different parts of the
business are. A plan, therefore, helps to co-ordinate the
activities within the various parts of the business to achieve
the objective.

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Key terms
A business plan is a document setting out what a
business does and what it hopes to achieve in the future.
Business planning is the process of producing a
business plan.

Problems of business planning

Some of the difficulties about business planning include:
• Uncertainty. It is not always easy to look ahead and predict
what is going to happen in a market or to estimate future sales
figures with any degree of accuracy. Plans might not be totally
accurate. Market conditions can change very quickly (for
example, a new competitor might start up), which means that
plans can easily become out of date. Managers may decide to
target a part of the market that does not end up growing or

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 their plan may be unsuccessful. Simply having a business plan
may reduce the risk of getting it wrong, but does not remove
the risk altogether.
• Lack of experience. People starting up their own business
may not have the necessary skills to plan ahead effectively. An
entrepreneur may be a good hairdresser or good at running a
shop, but that does not automatically mean they will be able to
look ahead and effectively imagine changes in the future of
the market. Bigger businesses can use experts and have access
to more resources, such as expensive market research, to help
them; new businesses may not have these advantages.
• Change. A business plan must not be produced once and then
used forever. Business plans need to be regularly reviewed
and updated – managers always need to know where the
business is going and how it is going to get there. This is
because conditions are always changing, with new laws, new
competitors and changes in customer tastes.

Key terms
Uncertainty occurs where there is a lack of information
about a situation. This means the outcome or
consequences are very difficult to predict.
A risk is the possibility of something going wrong.

A business plan can, therefore, help managers to look ahead.

However, there are considerable risks when starting up. Having
a business plan does not guarantee success. The business may
not succeed, and entrepreneurs may lose their original
investment. Nevertheless, having a plan means that
entrepreneurs know what they are trying to achieve; if things
turn out differently, they can take action to get things back on
track.

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Reducing the risk of business
planning
To try to reduce the risk of business plans going wrong,
businesses can:
• research the market thoroughly
• talk to experts and consultants (if they can afford it)
• plan for a variety of possible outcomes
• regularly review and update the plan so that it remains
relevant and any problems are spotted quickly.
No one can remove all risks of doing business, but it is possible
to reduce them or at least prepare for them and better planning
helps to do this.

The main sections of a

business plan
The sections that are usually found within a business plan
include:
• background information on the founders and investors and
their previous experience
• an analysis of the market and the firm’s expected position
within it; this should include a detailed analysis of the
customers that will be targeted
• the firm’s objectives
• details of the price it will set and expected sales
• an explanation of how the business will compete against its
rivals – how it will be competitive, and what makes it better
than the competition

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• an analysis of the financial position of the business, including
forecasts of profits and cash flow.

Study tip
Producing a business plan can help a business to
organise its activities, but it does not guarantee success.
To judge how useful a particular plan is, you need to look
at who produced it, how it was produced and what
research they did. If things have gone wrong, was it the
result of bad luck, or should the managers have predicted
that these problems might have occurred?

What is included in the

financial section of a business
plan?
A business plan will usually set out how much profit a business
is expected to make. Profit can be calculated using the equation:

Profit is calculated for a given period; for example, we often

measure the profit of a business over a year.
• The revenue of a business is the value of its sales. For
example, if 200 units of a product are sold at £5, the revenue
would be:

• The total costs of a business are made up of fixed costs and

variable costs:
• Fixed costs are costs that do not change with output. For

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 example, the rent of a building will be set for a given
period. During that time, the rent will not change regardless
of how much is being produced. This does not mean that
fixed costs never change – the rent might be increased at
some point, for example – but the key point is that the fixed
costs do not change with the amount produced.
• Variable costs are costs that do change with output. For
example, in a café the more sandwiches that are produced,
the more bread that will be used. The cost of bread is,
therefore, a variable cost.

Key terms
Revenue is the income that a firm receives from selling
its goods or services. It is also referred to as ‘turnover’. It
is measured by the number of units sold multiplied by the
price.
Total costs are fixed costs plus variable costs.
Fixed costs are those costs that do not change when a
business changes its output.

Key term
Variable costs are the costs that vary directly with the
business’s level of output.

If revenue is greater than total costs, a profit is made. The value

of the sales more than covers the costs for that period.
If revenue is less than costs over a given period, a loss is made.
The value of the sales is less than the costs of producing and
selling the product.

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Maths moment
The selling price of a product is £20. The variable costs
per unit are £12. The fixed costs are £150,000.
If the business sells 200,000 units:
1 What is its total revenue?
2 What are the variable costs?
3 What are the total costs?
4 What is the profit of the business?

Business insight
Royal Dutch Shell
Between 2015 and 2016, the Royal Dutch Shell company
cut over 12,000 jobs around the world. These cuts were
mainly due to Shell’s takeover of oil and gas exploration
firm BG Group and major falls in oil prices. The company
has said that it needed to reduce its costs, improve its
production efficiency and have a business that meets the
needs of the future. Its profits fell from $19 billion in 2014
to $3.8 billion in 2015.
The company has been hit hard by the fall in the price of
oil which has fallen from more than $110 a barrel since
mid-2014 to below $40 per barrel.
Analyse factors that affect the profits of Shell.
(6 marks)

Summary

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A business plan sets out what a business wants to do and
how it intends to do this. Having to produce a plan makes
businesses think about what might happen and what they
need to do. A good business plan can also help a
business to raise finance. A plan should be regularly
reviewed and updated as conditions change.

Quick questions
1 The selling price of a product is £25. The variable
costs per unit are £10. The fixed costs are £150,000.
What are the profits of the business if it sells 300,000
units?
(2 marks)
2 Explain two elements of a business plan.
(2 marks)
3 Explain one reason why a business might produce a
business plan.
(2 marks)
4 Explain one reason why things may not work out in the
way the plan forecast.
(2 marks)
5 How can a business reduce the risk of a business plan
failing?
(2 marks)
6 State two stakeholders who might be interested in the
business plan.
(2 marks)
7 Explain one reason why a business plan needs
reviewing regularly.
(2 marks)

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 8 Explain one reason why a business plan might help a
business to raise finance.
(2 marks)
9 A business plan might include sales forecasts. Explain
one reason why having a sales forecast is important.
(2 marks)
10 Explain one reason why the business plan should
state the target customer group.
(2 marks)

Case study
Susie’s Jewellery
Susie Emslie left school aged 18 and, rather than going to
university, she decided she wanted to set up her own
business making jewellery. Susie was very environmentally
aware and her jewellery would be made out of recycled
products and materials. Unfortunately, Susie did not have
sufficient savings herself to finance the business. Her
family could not help, so she decided she would have to
bring in an investor or borrow the money. Having taken
business studies at GCSE and A-level, she knew it was
important to produce a business plan.
1 What is meant by a ‘business plan’?
(2 marks)
2 Explain two items that should be included in Susie’s
business plan.
(4 marks)
3 Analyse how having a business plan might help Susie’s
business to be more successful.
(6 marks)

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4 Evaluate the factors that a bank would look for in
Susie’s plan before lending to her. Justify your answer.
(12 marks)

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Topic 1.7

Expanding a business
In this topic, we will examine why businesses want to
expand and how they might do this. We will also consider
the advantages and disadvantages of growth.
By the end of this topic, you should know:
• the methods of business expansion
• the benefits and drawbacks of expansion
• the economies of scale
• the diseconomies of scale.

Business expansion
The expansion or growth of a business is a common objective.
A business may want to become the biggest airline in the UK or
the biggest seller of soft drinks, for example. To achieve this, it
may have to spend money on new equipment or new premises.
Bigger firms are more powerful in their markets, so can often
get cheaper materials because they are such important
customers. Big companies are also more well known; this can
help when they want to launch new products because shops may
be more willing to stock their products and customers may be

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more willing to try them. By getting bigger, firms may be safer
from hostile takeovers because they will be worth a lot more and
will be more expensive to buy. Some investors will also be keen
for the business to grow because this provides a sense of
achievement.

Amazon was set up in 1994, Google in 1998 and Facebook was

launched in 2004. Just think how much these businesses have
grown since then.

Methods of business
expansion
A business may expand through:
• internal growth (also called organic growth) by selling
more of its own products
• external growth (also called integration) by joining with
another business.

Key terms
Internal growth (also known as organic growth) occurs
when a business gets bigger by selling more of its
products.
External growth (also known as integration) occurs
when a business gets bigger by joining or buying other
businesses.

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Internal growth tends to be slower than external growth, but
may be more manageable because of this. When businesses join
together, their size changes suddenly and it can be difficult to
manage with new staff and different ways of doing things.

Measuring the size of a business

Business expansion occurs when the firm gets bigger. This is
usually measured in terms of an increase in the value of sales.
However, it could be measured using other indicators, such as
the value of the business, number of employees or number of
outlets.
• Value of sales. The value of a firm’s sales is also called its
revenue or turnover (see Topic 1.6). The bigger the turnover,
the bigger the business. Increasing sales may also increase a
firm’s market share. Market share measures the sales of one
firm as a percentage of the total market.
• Value of the business. The size of a business can be
measured by calculating the value of its assets (what it owns)
minus its liabilities (what it owes). The higher the value of the
business, the more its owners are worth. Another way of
measuring the value of a business (if it is a company) is to
calculate the value of its shares. This is called its market
capitalisation.
• Number of employees. Some organisations do not sell their
products (for example, the National Health Service) so it is
impossible to measure revenue. The size of these businesses
may be measured using the number of employees.

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Key term
The market capitalisation of a company measures the
value of all its shares:
market capitalisation = market price of a share × the
number of shares

The most appropriate measure of the size of an organisation

depends in part on the type of business being considered. When
comparing taxi companies, for example, you might look at how
many taxis they have. When measuring the size of supermarkets,
you might look at how many stores they have. When measuring
the size of a charity, you might measure how much money it
raises or the number of staff it has.

Maths moment
A business sells 250,000 units at an average price of
£12.
What is its turnover?

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Internal growth
Internal (or organic) growth can occur in several different ways.
These include franchising, opening new stores, e-commerce and
outsourcing.

Franchising
Franchising occurs when one business sells the right to another
business to use its name and sell its products. For example,
many McDonald’s fast food outlets are franchises. This means
that someone has bought the right from McDonald’s to use its
name and sell its products.

Advantage of selling a franchise

The advantage of selling a franchise is that the business can
grow faster because it does not need to be able to finance the
opening of every store. The person buying the franchise (called
the franchisee) provides the finance to set up the business and
also pays for the right to do so. This means the business selling
the franchise (called the franchisor) generates revenue from
selling the franchise as well as having its growth financed by the
franchisee.

Key terms
A franchise occurs when a franchisor sells the rights to
its products to a franchisee; this is usually in return for a
fee and percentage of turnover.
A franchisee buys a franchise usually in return for a fee
and percentage of turnover.

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A franchisor sells a franchise usually in return for a fee
and percentage of turnover.

However, the franchisor will want to maintain the standards and

quality of its products and services and will, therefore, want to
monitor the activities of the franchisees.

Advantages of buying a franchise

• The franchisee is buying a product that has a track record. It
can assess the success of the product to date and hopefully
make a better decision on whether it should buy it or not.
• The franchisee will have access to the experience of the other
franchises and the franchisor. For example, McDonald’s will
provide expert advice and training on how to run one of its
stores.

Business insight

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 McDonald’s
A McDonald’s franchisee owns his or her own business
and typically manages a team of over 70 employees. The
franchisee will gain most of the rewards if the business is
successful. The management of the store is down to the
franchisee, but he or she is supported by McDonald’s in
many areas, for example, in terms of training or if a
franchisee needs advice on how to work best in the
community. A McDonald’s franchisee requires at least
£85,000 to invest. A store will usually cost between
£150,000 and £400,000 to buy. Franchisees will get nine
months’ training if they are accepted and are introduced
to the world-famous McDonald’s operating system.
Franchisees pay McDonald’s between 10 and 18 per cent
of sales, plus a 5 per cent service fee for using the
McDonald’s system. A franchisee is also required to
contribute 4.5 per cent of sales to the group marketing
campaign.
Source: McDonald’s: www.mcdonalds.co.uk

1 Analyse why McDonald’s grows by selling

franchises.
(6 marks)
2 Analyse the advantages of buying a McDonald’s
franchise.
(6 marks)

Opening new stores

A business can grow by opening new stores. Just think of the
number of Costa coffee stores opened in the last few years.
Opening a store will require research to identify the right

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location and investment to get the stores up and running.

E-commerce
Rather than opening a physical store, a business might start to
sell online. For example, businesses such as ASOS have been
very successful at generating sales without physical stores. For
other businesses that have physical stores already, going online
can add another channel to access the market. The major
supermarkets, for example, have both physical and e-
commerce operations. E-commerce can allow a business to
access customers across the globe 24 hours a day. However, it is
not without its issues. If the business has physical products, it
has to find ways of distributing these in the markets it is
covering and doing so at a cost that does not outweigh the
benefits of going online. It also has to be sure that going online
does not affect its other sales; people may simply switch to
buying online and stop using their stores. A growing trend in
recent years is ‘click and collect’. Customers like the ease of
shopping online, but also like collecting the goods that they have
bought online from the shop.

Outsourcing
Outsourcing occurs when a business uses other organisations
to produce its products for it. If demand is growing, but the
business does not have time or does not want to take the risk of
expanding its own production facilities, it can outsource its
production to another organisation. For example, a clothes
retailer may use other producers to make its clothes. This
enables a business to grow quickly because it does not have to
invest in expanding its own facilities. However, it does mean it
has to be careful to control the quality and it may cost more than
producing the items itself.

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Key terms
E-commerce (or electronic commerce) is the act of
buying or selling a product using an electronic system
such as the internet.
Outsourcing occurs when a business uses another
business to produce for it.

External growth
External growth (also called integration) occurs when firms join
together.
• A merger occurs when two or more firms join together and
create another joint business.
• A takeover (or acquisition) occurs when one firm gains
control of another and buys it up.

Key terms
A merger occurs when two or more businesses join
together to form a new business.
A takeover occurs when one business buys control of
another one.

Types of integration
Figure 1.12 shows some different types of integration.

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• Horizontal integration occurs when one firm joins with
another firm at the same stage of the same production process.
• Vertical integration occurs when one firm joins with another
firm at a different stage of the same production process. This
can be backward vertical integration, when a firm joins
with its suppliers, or forward vertical integration, when a
firm joins with its distributors. For example, Pepsi bought
Kentucky Fried Chicken, the fast-food chain, so it could sell
its drinks there; this is an example of forward vertical
integration.
• Conglomerate integration occurs when one firm joins
together with another firm in a different type of production
process. For example, Rentokil Initial’s businesses include
office cleaning, security, pest control and parcel delivery.

Business insight
Steinhoff International takes over Poundland
In 2016, the discount retail chain Poundland agreed to a
£597 million takeover by South African retail group
Steinhoff International. This would enable Steinhoff to
expand in the UK and the rest of Europe. This is partly to
reduce its reliance on South Africa, where the economy is
not doing well.
Poundland operates more than 900 stores across the

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UK, Ireland and Spain, and employs 18,000 people.
Steinhoff’s headquarters are in South Africa. It has:
• 6,500 retail outlets in 30 countries
• 22 manufacturing facilities
• 40 retail brands, including Bensons for Beds and
Harveys in the UK, Conforama in Europe, Pep and
Ackermans in South Africa and Snooze in Australia.
Steinhoff paid 227 pence per share for Poundland. The
discount retailer’s share price had fallen from 418p in
February 2015 to below 200p before the deal was
announced.
1 Analyse the possible reasons why Steinhoff
wanted to buy Poundland.
(6 marks)
2 Analyse the factors that might have influenced
the price Steinhoff was willing to pay for
Poundland.
(6 marks)

Study tip
When deciding whether internal or external growth is
better for a business, think about the following:
• How rapidly does the business want to grow?
• What are the two businesses like? Will the two firms
and their employees get on? Will their policies and
approaches be very different?
• If a takeover is being considered, how much will it cost
to buy the other business? Is it worth it?
• How well could the managers control a business that
suddenly became much bigger?

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Advantages of business
expansion
• It can lead to economies of scale, which are benefits that
come with a larger size.
• It can lead to more power in the market. For example, retailers
are likely to be more willing to stock the products of a well-
known brand.
• Big firms have more status and the people in charge will feel
more important, especially if it has grown while they were in
charge. If a business is well known, it will also be easier to
launch more products in the future.
• Big firms are more expensive to take over so those in charge
might feel safer.
• The rewards for staff are often linked to the size of the
business so they may be eager for growth.

Key term
Economies of scale occur when a business’s unit costs
of production fall as its output rises and the business
expands.

Business insight
YouTube is sold to Google
The founders of YouTube, Chad Hurley and Steve Chen,
sold the business to Google for $1.65 billion 20 months
after they set it up. Hurley and Chen were both aged
under 30 years and set up the business in a garage in

120
 California. Google had its own service showing people’s
films, but YouTube was much more popular and had a
market share of over 60 per cent. People watch films on
YouTube more than 100 million times daily.
Analyse the factors Google would have considered
when deciding on the amount it paid for YouTube.
(6 marks)

Disadvantages of business
expansion
• Decision-making becomes slower because there are so many
people to consult in a big business. There are likely to be
many levels of hierarchy and this means messages have to
pass between these levels, (that is, there are long chains of
communication). Not only is this slow, but it may also mean
that messages get distorted as they pass from one person to
another.
• Employees may feel isolated because there are so many of
them and they no longer feel special and an important part of
the organisation. This may mean they become demotivated.
• Controlling and co-ordinating a business that has many clients
or products and that is possibly based in many different places
can be difficult and may be less efficient.
These disadvantages are called diseconomies of scale. They
occur because of the difficulties of managing a big business.

Key term
Diseconomies of scale occur when the cost per unit

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increases as a business expands.

Economies and diseconomies

of scale
Economies of scale occur when the cost per unit (or unit cost)
falls with greater scale of production. One type of economy of
scale is bulk buying. Big firms buy in bulk and so they can
negotiate better prices with suppliers. This keeps unit costs
down. Another economy of scale is known as technical
economy of scale. This occurs when large-scale production
enables a business to make efficient use of technology. For
example, a production line is very expensive to set up. If only
one car a day was produced, this would be extremely expensive.
However, if the production line is used to produce hundreds of
cars a day, the costs of the production line can be spread over
more units reducing the cost per car (the unit cost).

An example of economies and

diseconomies of scale
As the name suggests, unit costs measure the cost of a unit.
These are also called average costs. To calculate unit costs, use
this equation:

Table 1.8 illustrates economies and diseconomies of scale:

• The unit cost falls as the output of the business increases from
100 units to 400 units. The business is experiencing economies
of scale.

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• As the business expands further from 400 units to 500 units,
the unit costs increase. The business is now experiencing
diseconomies of scale.

Maths moment

1 Complete Table 1.9 by calculating the unit costs.

2 At what level of output does the business
experience diseconomies of scale?

Study tip
If you are asked whether or not a business should grow,
you need to weigh up the advantages of growth against
the disadvantages. Will the company be able to cope with
managing a bigger business? Is it likely to experience

123
 diseconomies of scale?

Expanding abroad
One option facing businesses when they grow is to expand
abroad. This enables the business to target more customers and
potentially sell more. However, entering new markets brings
many challenges:
• The law and regulations facing businesses may differ.
• The existing businesses may resist new entrants to the market.
• Customers’ buying habits and expectations may be different.
Although there are many highly successful businesses selling
globally, such as Coca-Cola and Apple, there are also a number
of businesses that have struggled abroad.

Summary
Expansion is a common business objective. It can bring
many advantages, such as economies of scale and
market power. However, it can also bring disadvantages,
such as diseconomies of scale. Owners and managers
will have to decide on the right size for their business.
As businesses expand, their aims and objectives will
change. For example, they may want to expand overseas
or become dominant in their market. They also need to be
more conscious of the ethics of their behaviour and of
environmental issues because their activities will be
monitored very carefully by their stakeholders.

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Quick questions
1 State two ways the growth in the size of a business
can be measured.
(2 marks)
2 What is meant by ‘external growth’?
(2 marks)
3 What is meant by ‘internal growth’?
(2 marks)
4 What is meant by ‘economies of scale’?
(2 marks)
5 What is meant by ‘unit cost’?
(2 marks)
6 State two benefits of expansion.
(2 marks)
7 State two drawbacks of expansion.
(2 marks)
8 State two types of economies of scale.
(2 marks)
9 State two types of diseconomies of scale.
(2 marks)
10 Explain the difference between a merger and a
takeover.
(2 marks)

Case study
Tyrrells and Amplify
In 2016, the upmarket snack business, Tyrrells, was taken

125
over by a US firm called Amplify Snack Brands. The
Herefordshire-based producer of hand-cooked crisps was
sold for £300 million. Tyrrells does not sell in North
America and Amplify has no business in the UK, so it was
felt to be a good fit.
Amplify will roll out the Tyrrells brand in America and
Tyrrells will do the same with Amplify’s SkinnyPop brand in
the UK. Tyrrells includes the Australian firm Yarra Valley
Snack Foods, which it acquired in 2015 and the German-
based company Aroma Snacks, which it acquired in 2016.
Tyrrells was founded in 2002 by potato farmer William
Chase. He decided to move into making crisps where he
felt he could make more profits than selling potatoes to the
big supermarkets. Mr Chase sold the company in 2008 for
nearly £40 million. He used some of the money he raised
from the sale to set up a distillery producing premium
vodka and gin.
1 What is meant by a ‘private limited company’?
(2 marks)
2 Explain how Amplify would take over Tyrrells.
(4 marks)
3 Analyse the factors that might determine the value of
Tyrrells when it was sold.
(6 marks)
4 Amplify bought Tyrrells as a means of expanding.
Evaluate whether a takeover is a better way of
expanding than organic growth.
(12 marks)

Chapter review – Business in the real world

126
Read question 1, the sample answers and the comments.
Then try question 2.
1 Read Item A and answer the questions that follow.
Item A
In 2016, the UK government approved the building of a
third runway at Heathrow Airport to expand the capacity of
UK airports. The government said this would help UK
businesses to trade abroad more easily and to create
jobs. The Department for Transport stated a new runway
at Heathrow would bring economic benefits to passengers
and the wider economy worth up to £61 billion. It said it
would create as many as 77,000 additional local jobs over
the next 14 years.
Heathrow Airport Ltd said the expansion would mean it
could now offer more direct flights to UK destinations as
well as up to 40 new cities abroad. Construction is unlikely
to begin before 2020, if it begins at all! This is because
there is still considerable opposition from many
stakeholders who would like to stop the project actually
happening. Some of these stakeholders complain about
the noise the runway would lead to; some are upset they
would lose their homes for the runway to be built; others
are unhappy with the impact on pollution levels and the
possible increase in traffic congestion.

(a) What is meant by a stakeholder?

(2 marks)
(a) A stakeholder is an owner of a company.

The definition given is a shareholder; while a

shareholder is an example of a stakeholder.

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 This is not an appropriate definition.

(b) Explain one benefit for investors of setting up a

business as a company.
(4 marks)
(b) By setting up as a company, the investors will
have limited liability. This means that the
investors can lose the money they have
invested into the company but they cannot
lose their personal assets. This provides
investors with protection and reduces the risk
of investment.

This shows a precise understanding of limited

liability which is a benefit of establishing a
company. A clear and relevant response.

(c) Analyse how the activities of two of the business

functions within Heathrow Airport help the business
to make a profit.
(6 marks)
(c) The business functions are marketing,
operations, finance and human resources.
Human resources will involve recruiting and
training staff. It may do this to run all the
different aspects of the airport such as the
security, the running of the shops, and the
parking.
The marketing function will try and
understand what customers want and help
ensure they provide for this. This may mean
ensuring it is easy to book, there are places to

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 stay nearby and there are the right range of
shops to buy things from.
The operations function runs the actual
airport. It will make sure that the airport runs
efficiently. This means that planes land and
take off on time. And that passengers move
around the airport easily and without queues.
They will make sure things work from the
parking to the shops to the aircraft.
The finance function will raise money if
required for investment and will measure
spending and costs.

This answer shows that the student

understands the different functions of a
business. He or she shows insight into what
these functions might involve at an airport.
However, the answer covers four functions
when the question only asked for two; this
means time is wasted on producing four points
rather than selecting and developing two. Also
the answer does not analyse how these
functions help the business to make a profit.
This is missing an important aspect of the
question. The answer shows understanding but
does not analyse.

(d) Analyse the case for and against the opening of a

new runway at Heathrow. Recommend whether it
should be opened or not.
(12 marks)
(d) Opening up a runway at Heathrow will create

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jobs. It will create jobs for those building the
runway and all the materials used in its
building. Once it is open, it will create more
jobs at the airport. It will also help tourism and
British businesses to sell their things abroad
and so this will create even more jobs. With
more people working, this will lead to more
spending and this should lead to even more
jobs and growth in the economy. This is why
opening a new runway at Heathrow may be a
good thing.
However, it will also cause pollution and
noise problems. There may be increased
traffic around the airport slowing up car travel
for others. There may be more noise for those
living nearby and some may have to give up
their houses so it can be built. This means
that socially and environmentally the costs
may be great and outweigh the benefits of
building it.
Overall, it will depend on the size of the costs
and these can be difficult to measure. It is
difficult to know exactly how many extra jobs
there will be and what the environmental
impact will be. How do you measure things
like people’s unhappiness with moving? It will
be a trade-off and depends on the size of
these things. Perhaps the recommendation
should be to go ahead if the benefits exceed
the costs and this may happen if steps are
taken to reduce the costs, e.g. controls over
when flights happen and the pollution they
are allowed to generate. It may be that the

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 recommendation is to have another runway
but not at this location if the costs would be
lower elsewhere.

The answer considers both sides and brings

them together very well.
2 Read Item B and answer the questions that follow.
Item B
Fran Watts is the managing director of The Book
Experience, a private limited company. Fran set up her
first bookshop ten years ago and since then her business
has grown and grown. Fran has always been ambitious
and she is determined to make The Book Experience one
of the largest chains of bookshops in the UK with a large
market share. Until five years ago, she had grown the
business via organic growth. She then decided that she
could grow faster by external growth and has already
taken over two other chains of bookshops based in
different parts of the country. She had considered selling
franchises but decided against it. The Book Experience is
rapidly establishing itself as a real competitor to
companies such as Borders and Waterstones. Fran is a
bit worried how they might react to her success. She is
also worried about the criticism her business is getting in
the media. Many people claim that once her stores set up
in an area it becomes impossible for smaller, independent
bookshops to survive because they cannot compete on
price. The local bookshops say that The Book Experience
is acting unethically and leading to the closure of shops all
over the country.
Last year Fran decided that The Book Experience would

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do better as a public limited company so she floated the
business. As part of the flotation, she had to produce a
document to show to potential investors. In this, she set
out new objectives for the growing business that included
international expansion.

(a) State two features of a public limited company.

(2 marks)
(b) Explain two problems for Fran of becoming a public
limited company.
(4 marks)
(c) Analyse why expanding abroad may be difficult for
The Book Experience.
(6 marks)
(d) Do you think Fran was right to decide against
franchising? Explain your answer.
(9 marks)

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2 Influences on business

In this chapter, we will look at a range of external

influences that can affect the way businesses operate.
One of these influences is changes in technology, which
can affect the products that businesses supply and the
way that they make them. Changes in the economy, such
as reductions in consumers’ incomes impact on
businesses as do changes in laws. Businesses have also
been affected by pressures to be ethical (i.e. to do the
‘right’ things) and to protect the environment. A key
external influence has been globalisation which has led to
highly efficient rivals from overseas for many UK
businesses. Globalisation has also offered businesses
more chances to sell products overseas. This chapter
also considers how businesses have responded to these
external factors by, for example, producing new products,
using new methods of production or relocating overseas.

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Topic 2.1

Technology
Technology is playing an increasingly important role in the
activities of many businesses nowadays, and not just
those directly involved in selling technology products such
as Apple. This topic considers how developments in
information and communication technology (ICT) have
influenced important aspects of business activity.
By the end of this topic, you should know:
• what information and communications technology is
• the ways in which businesses use e-commerce
• the ways in which businesses use digital
communications to communicate with stakeholders such
as customers and suppliers.

What is information and

communications technology?
You may be familiar with information and
communications technology (ICT) as one of the subjects
that you have studied at school. ICT is of great value to all

134
businesses whether they are large or small. ICT is the computing
and communications systems that a business might use to
exchange information with stakeholders such as customers,
suppliers, the government and employees. The technologies that
may be used as part of ICT are summarised in Figure 2.1.

Key term
Information and communications technology (ICT) is
the computing and communications systems that a
business might use to exchange information with
stakeholders.

The technology used within ICT by businesses is developing

over time. The development of the internet transformed ICT as
businesses developed websites. These are used to promote and
sell their products and to collect information from customers
and other stakeholders.
Many larger businesses operate intranets which are private
communication networks only accessible by the business’s
employees; some businesses use extranets which are similar,

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but accessible by other selected stakeholders, such as suppliers.
These mini-internets can be used by employees to communicate
with each other, to monitor production and the quality of goods
and services, and to place orders with suppliers. Intranets can
provide access to many types of information that employees
need and replace vast amounts of paperwork. For example,
intranets might include training videos or discussion groups
aimed at improving how the business operates. Some hospitals
use extranets to give local doctors access to a booking system so
they can make appointments for their patients.

Key terms
Stakeholders are individuals and organisations that are
affected by, and affect, the activities of a business.
Intranets are communication networks which can only be
accessed by an organisation’s employees.
Extranets are similar to intranets but can also be
accessed by other organisations such as suppliers.

Businesses use a variety of devices to access their ICT systems.

Initially these were mainly desktop computers, but more recently
technological developments have seen the increasing use of
smaller and more portable devices such as laptops, tablets and
smartphones.

The impact of ICT on business

activities
Rapid developments in technology have led to changes in the
ways in which ICT is used, with implications for the way
businesses operate.

136
The location of employees
Developments in communications have meant that businesses
are able to employ people in a wide range of different locations,
not just in the business’s offices, factories or shops. Many UK
businesses have increasing numbers of employees working from
home. They are connected to the business through electronic
systems including the business’s intranet.

Study tip
This chapter considers a range of factors which can
influence business activities: technology, ethics and the
environment, the economic climate, globalisation,
legislation and competition. You should understand the
nature of these influences and how they impact on the
four functional areas of business:
• business operations
• human resources
• marketing
• finance.

A number of UK businesses have located their call centres

(which provide customer services) and other administrative
activities overseas. This use of ICT helps to increase profits as
wages and other operating costs are lower overseas. Cheap
telephone and internet communications make this a practical
option for many organisations. Developments in ICT software
help make call-centre workers more efficient. Employees can
quickly retrieve and display customers’ data, reducing the need
to transfer callers to other departments.

137
However, further developments in ICT may see a reduction in
the use of employees located in overseas call centres.
Increasingly, businesses are developing software which can
carry out many of the tasks previously performed in call centres.
The Business insight on the Blue Prism Group below provides
examples of such developments.

Business insight
Blue Prism Group plc
UK businesses employ people to carry out millions of
routine administrative tasks. For example, when a
customer of a mobile phone service provider (such as
Vodafone) wants to move an old phone number to a new
SIM card, a lot of simple tasks have to be carried out.
Someone has to update numerous databases, often by
cutting and pasting information. Such routine tasks can
often be completed more quickly and accurately by a
machine.

138
 Blue Prism describes itself as a company that develops
software robots - a virtual workforce for businesses.
Software robots can, for example, be designed to
respond to enquiries from customers and other
stakeholders. The most advanced software robots send
difficult questions to employees and learn from the
responses. The software is programmed taking into
account the human answers. As a result, the performance
of the software improves over time – and the business’s
labour costs are reduced.
The Blue Prism Group works with over 100 businesses in
a range of industries including O2, World Hotels and the
National Health Service.
Analyse why Blue Prism’s products are likely to be
very popular with many businesses in the UK.
(6 marks)

Key term
Software robots are advanced computer programs that
can operate a range of administrative activities previously
carried out by employees.

Collecting, storing and analysing

information
Businesses are able to collect huge amounts of varied data using
the latest ICT systems. This is the area where much advanced
technology has been developed. Technology companies such as
Google and Facebook are able to collect huge amounts of data
about the users of their services. This data can be used to target
customers with appropriate goods and services. It can also be

139
used to improve the services offered by businesses, helping
them to meet customers’ needs as fully as possible.

Businesses do not need to own equipment (called servers) to

store the information that they collect. Many companies, for
example, Microsoft, Amazon and Google, provide cloud
computing services. Cloud computing services allow
organisations to store data on another business’s computing
system and to have access via the internet. Google’s Cloud
Platform offers powerful computers to analyse data alongside
databases for storage.

Key term
Cloud computing is a general term for the delivery of
specialist computing services, such as the storage of very
large amounts of data, provided by businesses using the
internet.

140
Cloud computing services can also analyse data and help to
identify important trends, such as changes in consumer
behaviour, quickly and accurately. This allows the businesses
concerned to make swift and efficient responses to changes in
their markets.
Progress in the field of ICT has led to particularly important and
large-scale changes in two aspects of business activity. These are
the use of e-commerce and of digital communication. We shall
look at these in more detail below.

E-commerce
E-commerce, or electronic commerce, takes place when goods
and services are sold using an electronic system such as the
internet. That part of e-commerce which involves the use of
handheld wireless devices such as smartphones is termed mobile
commerce or m-commerce. We look at how businesses use e-
commerce and m-commerce to improve their marketing on page
256.

Key terms
E-commerce (or electronic commerce) is the act of
buying or selling a product using an electronic system
such as the internet.
M-commerce (or mobile commerce) is the buying and
selling of products through wireless handheld devices
such as smartphones.

E-commerce includes the following types of sales using

electronic systems:
• businesses selling to customers or to other businesses using

141
 their websites
• individuals selling to other people directly through websites
such as eBay.
In the UK, it is possible to buy the following products online
using e-commerce:
• goods such as food, clothing and furniture
• digital products including audio books, music tracks and
downloaded TV programmes
• a range of services including car and home insurance
• products related to entertainment such as festival tickets and
flights.
An increasing number of businesses are using the internet to sell
products to their customers. As a result, the percentage of total
retail spending by consumers in the UK conducted through
businesses’ websites is rising steadily (as shown in Table 2.1)
and reached 16.8 per cent in 2016.

142
To be effective in the field of e-commerce, businesses depend
on operating websites which are clear, easy to navigate and have
payment systems which are secure and easy to use. Many
businesses engaging in e-commerce use payment systems
operated by businesses such as PayPal, which can reassure
consumers.

Using e-commerce to access more

markets
Many businesses are placing greater emphasis on e-commerce as
it offers a means of accessing wider markets. For example, the
UK’s supermarkets, such as Morrisons and Sainsbury’s, can sell
groceries online to consumers who live in areas where they do
not have a shop nearby. Customers simply order using the
supermarket’s website and the goods are delivered to their
homes.
E-commerce can provide much of a business’s growth in sales
by letting it sell to new groups of customers. Arcadia, a UK

143
clothing retailer that owns Topshop and Burton, increased its
online sales to other businesses. In 2015, Arcadia’s online sales
rose by 23.9 per cent, while its sales through its stores fell by 0.9
per cent. In addition, businesses can encourage consumers to
rate products which they sell. This helps businesses’ managers to
monitor the needs of consumers and to provide popular goods
and services.
Importantly, e-commerce allows the smaller businesses to target
national or even global markets with their products. The
business is able to advertise its products widely without
spending large sums of money on advertising. If the business
operates a good-quality website, it makes its products accessible
to customers throughout the world. Arran Aromatics, discussed
below, is an example of a small business which has been able to
sell to a much wider market using e-commerce.

Business insight
Arran Aromatics
Arran Aromatics manufactures cosmetics, perfumes and
candles on the Isle of Arran, off the west coast of
Scotland. The company was established in its founder’s
kitchen in 1989. Since then, the company has grown
quickly.
The business uses its location on Arran to inspire the
creation of new products. Its website says:

‘The rich colour palette of this unique blend of

landscapes and the diversity of its herbs and flowers
fuel our creativity and passion for beautiful things,
beautifully made.’
The business uses its website to advertise and sell its
products. It produces cosmetics for a number of leading

144
 UK hotel chains, including Malmaison. It also sells its
cosmetics, candles and perfumes through ten outlets in
Scotland.
Source: Arran Aromatics: http://wholesale.arranaromatics.com/our-story

Analyse how Arran Aromatics’ website helps the

business to advertise its products.
(6 marks)

Digital communication
Digital communication uses devices such as laptop

145
computers, tablets and smartphones to transfer information. This
information is encoded into a digital form. Digital
communication can take a number of different forms:
• email
• texts
• webchat
• teleconferencing and video-conferencing
• apps (or applications)
• the use of social media websites, such as Facebook, Twitter,
WhatsApp or Instagram, designed mainly to encourage digital
communication.

Key terms
Digital communication is the transmission of
information electronically between computing devices.
Webchat is a simple means of communicating in real time
(that is, instantly) using only web browsers such as Firefox
or Internet Explorer.
Apps (or applications) are pieces of software designed
for a specific purpose and for use on smartphones and
tablets
Social media are methods of online communication such
as websites and applications. They share information and
help to develop social and professional contacts.

Digital forms of communication have transformed the ways in

which businesses communicate with their stakeholders. We
consider how digital methods have changed the ways businesses
communicate with some key stakeholder groups below.

146
Customers and potential customers
Digital communication means that businesses have far more
contact with customers and possible customers than in the past.
They help businesses to communicate in different ways. For
example, customers can communicate with businesses using
texts, email or social media websites, such as Twitter or
Facebook. They can ask questions, place orders or make
complaints. Businesses have had to respond by training
employees to manage these new forms of communication and
by creating social media accounts on key websites.

The rise in popularity of social media has resulted in many

businesses appointing people with specific responsibility to
manage the business’s contacts with customers through social
media. Managing the business’s profile effectively on social
media is vital to maintain a good reputation. Not responding

147
quickly and positively to criticism on Twitter or other social
media sites can damage a business’s reputation.
Equally, using social media effectively can help to maintain (or
repair) a business’s reputation. In 2012, O2, the UK
telecommunications company, received criticism on social media
when its mobile phone services crashed. The company’s social
media department responded honestly and with humour,
answering a suggestion to ignore offensive tweets by saying (of
their critics): ‘They’re not so bad. Sometimes all they need is a
bit of care and attention :) …’. This was an important use of
digital communication by O2 as research reveals that 17 per cent
of all Twitter users in the UK received information about the
company’s problems.
All businesses, whatever their size, are able to use digital
communication to engage in new and potentially valuable ways
with customers. For example, large businesses can use it to keep
huge numbers of customers aware of important developments
such as the launch of a new product. Similarly, small businesses,
with limited resources, may use it to promote their services to
potential customers.

Business insight
WhatsApp and Taylor & Hart
WhatsApp is a social messaging service which was
bought by Facebook in 2014. It is one of the world’s
fastest-growing communication apps. It has more than 1
billion users and carries 30 billion messages each day.
WhatsApp allows users to chat in real-time and supports
multimedia, including video and voice messages.
Taylor & Hart is a diamond ring design and manufacturing
business. It offers online consultations to customers
looking for unique, individually designed rings. Co-founder

148
 Nikolay Piriankov uses WhatsApp to build relationships
with his customers. ‘Customers asked for it,’ he says.
‘Now every design consultant has WhatsApp on their
work phone. We make sure they can reach their
consultant, 24 hours a day.’
Source: Adapted from the Telegraph, 29 January 2015

Explain one reason why every design consultant at

Taylor & Hart has WhatsApp on their work phone.
(4 marks)

The global online retailer, Amazon, is using the latest ICT to

provide a very simple ordering system for its customers, as
described in the Business insight below.

Business insight
Amazon’s instant ordering system
In 2016, Amazon launched its Dash instant purchase
buttons in the UK. The Dash buttons allow consumers to
buy products such as coffee, dishwasher tablets and
washing powder by simply pushing a button on a digital
device connected wirelessly to the internet. Amazon has
only recently started selling groceries to UK consumers.
Consumers buy a separate digital button for each brand
(examples include Andrex, Play-Doh, Listerine and
Dettol). Pushing the button places an order for a specified
quantity of the branded product, which is delivered by
Amazon.
Amazon initially offered 40 buttons for different product
brands to UK consumers. Each Dash button costs £4.99
to purchase, but this amount is taken off the customer’s
first order. The Dash buttons are linked to an Amazon
account and instantly order replacement items from

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 specific suppliers with whom Amazon has agreements.
Analyse the possible benefits to Amazon from the
use of this type of ICT.
(6 marks)

This use of ICT enables Amazon to improve its operations and

to use less labour, thus saving wage costs. Using technology in
this way is cheap, reliable and efficient.

Suppliers and employees

ICT allows businesses to manage their relationships with
suppliers more efficiently. Many businesses operate systems to
automatically re-order supplies when necessary. This can be
efficient, allowing the business to hold a low level of supplies.
This reduces storage charges but ensures the business has
sufficient supplies.
Some enterprises have created new business models based on
the use of digital communication, for example, the use of apps.
They are able to communicate more effectively with suppliers
and employees to deliver services efficiently and at low cost.
Uber is an example of such a business.

Business insight
Uber
Uber is an American company that provides taxi services
in cities across the world. Customers have the Uber app
on their smartphones and use this to request a taxi. This
is displayed to Uber’s drivers. When a driver accepts the
request, the customer receives information including the
time of arrival, driver’s name and the registration number
of the taxi.

150
 Payment for the taxi service is automatically taken from
the passenger’s credit card. Uber uses digital software
linked to its app to calculate fares according to the
number of customers and the number of taxis available.
During periods of high demand, fares can rise sharply.
Uber’s drivers are connected to the same app. When
they sign on for work, they connect to the app and
requests from passengers, their locations and
destinations appear on their smartphones. Satellite
technology is used to guide drivers to their passengers’
locations.

Analyse the benefits Uber receives from

communicating with passengers and drivers using
digital technology.
(6 marks)

Digital technology can also provide vital information to

managers of a business, helping to improve decision-making.
For example, this technology can provide data on the number of
visitors to a shop, how long they spend in the store and whether
they are repeat customers. Managers can compare trends over

151
time which, for example, could be used to monitor the
effectiveness of a particular marketing campaign. Other
advantages to managers follow from the use of this digital
technology. If managers can predict the number of customers at
specific times, they can ensure that sufficient staff are available.

Other stakeholders
A number of high-profile companies, including PayPal and
Intel, have decided to hold online shareholder meetings. In
the past, these meetings have been at specific locations and can
be poorly attended. Hosting these meetings online improves the
companies’ communications. More shareholders can ‘attend’ as
they do not have to travel. The company can monitor
shareholder attendance and participation. It can also benefit
from knowing the views of a larger number of its shareholders.

Key term
A shareholder is a person or organisation that owns part
of a company. Each shareholder owns a ‘share’ of the
business.

Summary
Rapid advances in technology, especially those relating to
the internet, have resulted in businesses using ICT in
different ways. Businesses of all sizes have benefited
from engaging in e-commerce, not least as it enables
them to sell goods and services efficiently to much wider
markets. Alongside this, developments in digital technology
have helped businesses to communicate more fully with
stakeholders.

152
Quick questions
1 What is meant by the term ‘information and
communications technology’ or ‘ICT’?
(2 marks)
2 Give two examples of information that a business
might exchange with its customers using ICT.
(2 marks)
3 Explain one reason why a business might decide to
use software robots as a form of business technology.
(2 marks)
4 State two reasons why a business might decide to
use cloud computing services such as those offered
by Google.
(2 marks)
5 Which of the following is the best definition of e-
commerce?
(a) The buying and selling of products through
wireless handheld devices such as smartphones
(b) The act of buying or selling a product using an
electronic system such as the internet
(c) The transmission of information electronically
between computing devices
(d) A means of communicating in real time (that is,
instantly) using only web browsers such as Firefox
or Chrome
(1 marks)
6 State two reasons why increasing numbers of
retailers are using e-commerce.
(2 marks)
7 What is meant by the term ‘digital communication’?

153
 (2 marks)
8 Explain one reason why a business might use social
media websites to communicate with its customers.
(2 marks)
9 What is meant by the term ‘app’ (or ‘application’)?
(2 marks)
10 State two reasons why a large company might decide
to hold meetings with shareholders online.
(2 marks)

Case study
BT
BT is the UK’s largest telecommunications company. It
employs over 88,000 people, many of whom use its
intranet. Its employees in the UK are well paid. BT’s
products include telephone and broadband services. It
faces tough competition from powerful rivals such as Sky.
BT has 18 million customers in the UK. The company has
been criticised at times for providing poor quality customer
service, for example, being slow to respond to customer
problems. It now provides a web chat service to help deal
with customer enquiries and problems.
Since 2003, BT has operated call centres in Delhi and
Bengaluru in India. These have been unpopular with some
of its UK customers, who say the accents are difficult to
understand. Some call centres have returned to the UK.
BT’s customers can use the BT mobile phone app to
check their bill or track an engineer ahead of an
appointment for a repair or to install a phone line.
BT operates BT Cloud Compute giving business

154
customers individually designed cloud computing services.
These integrate with the business customer’s own
computer systems. Its cloud services include storing and
analysing data.
1 Identify two ways in which BT communicates with its
stakeholders using digital technology.
(2 marks)
2 Explain why BT uses web chat to communicate with its
customers.
(4 marks)
3 Analyse the benefits to BT’s business customers of
being able to use its cloud computing services.
(6 marks)
4 Analyse the ways in which BT’s use of digital technology
allows it to reduce its costs of production. You should
consider:
• its use of call centres
• its use of mobile apps.
You must evaluate which approach has had the greatest
impact. Use evidence to support your answer.
(12 marks)

155
Topic 2.2

Ethical and environmental

considerations
Ethical and environmental issues attract a lot of attention
in the media and have become increasingly important
issues for businesses’ stakeholders. Some businesses
use ethical or environmental policies as a means of
differentiating themselves from competitors.
By the end of this topic, you should know:
• how ethical considerations affect the activities of
businesses and how a trade-off between ethics and
profit may exist
• how environmental factors affect the behaviour of
businesses and consumers and affect their decisions
• the meaning and importance of sustainable methods of
production – we will focus on the costs and benefits to
businesses of behaving ethically and in an
environmentally friendly manner
• the advantages and disadvantages to businesses from
behaving ethically and in an environmentally responsible
manner.

156
Businesses and ethical
considerations
What are ethics?
Ethics refers to whether a business decision is thought to be
morally right or wrong. Customers, employees, shareholders
and other stakeholders are becoming increasingly interested in
all aspects of a business’s activities. They are no longer simply
interested in a business’s products and the prices at which it
sells. They want to know how and where the goods and services
are produced, what materials are used and how the business
treats its suppliers and its employees. A business’s stakeholders
want to know whether the business is ethical. This means
whether it makes decisions that are morally right or, for
example, those that result in the highest profits.

Key terms
Ethics refers to whether a business decision is thought to
be morally right or wrong. An ethical decision is made on
the basis of what is judged to be morally right.
Profit measures the difference between the values of a
business’s revenue (sales) and its total costs.

Stakeholders such as consumers, employees, shareholders and

people who live close to the business may ask questions such as:
• Are suppliers (especially small businesses) paid on time, or is
payment delayed?
• Are employees treated fairly? Are they paid well? Is child
labour used in overseas factories?

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• Are consumers aware of the materials used to make products?
• Is the business’s advertising truthful and fair? Are its products
harmful?
Figure 2.2 illustrates the differences between business activities
that are ethical and legal, but may be considered unethical, and
illegal activities.
Environmental issues are a part of ethical behaviour by
businesses. We will consider these in detail later in this topic.

Study tip
Do think about how ethical decisions by businesses can
affect all types of business activities (such as marketing
and finance) as well as the way in which they produce
goods and services.

Business insight
Lush
Lush is on high streets across the UK and is regarded by
many as an ethical business. The chain of shops sells
cosmetics and a large range of soaps. Lush’s soaps,
shampoos and shower gels are manufactured using

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 vegetarian or vegan recipes. The company encourages
consumers to recycle containers.
Lush does not buy supplies from businesses that use
animals to test products and supports many charities,
especially those protecting the environment. For example,
Lush is a supporter of Sea Shepherd, an organisation that
seeks to protect whales, seals and other aquatic animals.
Lush wants people to enjoy working for the company. All
employees receive wages above the minimum wage rate
and discounts on company products. If an employee’s
birthday falls on a normal working day, they are given an
extra day’s paid holiday.
Explain two reasons why many people might
consider Lush to be an ethical company.
(6 marks)

How can businesses behave

ethically?
Businesses can behave ethically by considering the whole
community and not just the business’s profits when making
decisions. Some businesses, such as Apple and BP, are huge and
their decisions impact on many individuals and groups. If
businesses consider the impact of their decisions on the wider
community, they are more likely to be ethical.
Businesses can behave in ethical ways in each of their functional
areas – that is in the areas of marketing, operations, human
resources and finance. We consider these functional areas in
Chapters 3–6.

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Ethical marketing
Businesses that engage in ethical marketing seek to behave
honestly, fairly and responsibly in all marketing activities. This
might involve decisions such as:
• designing new products to reduce the damage they do to the
environment – Tesla, an American car manufacturer, has
designed a range of electric cars to reduce emissions that
cause pollution
• avoiding targeting children with advertisements for products
with potentially harmful side-effects, such as junk food
• not using a dominant market position to set unacceptably high
prices – some pharmaceutical (drug) companies have been
criticised for charging very high prices for essential medicines
for which they are the only producer.

Ethical business operations

The operations function of a business converts inputs (such as
labour and raw materials) into finished products. It is sometimes
called the production function. There are a number of ways a
business can have ethical operations:
• Managers might choose not to buy resources from suppliers
that are involved in unethical practices, such as destroying the
rainforest or the employment of child labour.
• An ethical business is likely to manufacture products that can
be recycled (and not thrown away) once their useful life is
over. Jaguar Land Rover, the UK car manufacturer,
announced plans in 2016 to make its cars from aluminium
which can be recycled an unlimited number of times.

Ethical human resources

For many businesses, people are their most important resources.

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This is especially true of businesses that supply services such as
healthcare. Managers can take decisions to manage their human
resources ethically. This may include not using zero-hours
contracts. Using zero-hours contracts means employees do not
know how many hours, if any, they will be asked to work each
week. Other examples of ethical behaviour include:
• offering employees the opportunity of high-quality training,
despite its cost
• paying wages sufficient to allow employees a decent standard
of living.

Business Insight
Sports Direct
Sports Direct is a UK clothing retailer established by Mike
Ashley in 1982. The company operates 670 sports
clothing stores of which approximately 420 are in the UK.
Sports Direct has received widespread criticism in 2016
for some of the working practices within the company.
• About 90 per cent of the company’s workers were
employed on zero-hours contracts, meaning they have
no guaranteed hours of work.
• The company’s employees have been fined 15 minutes’
pay for being one minute late.
• Employees have had to wait for security searches at
the end of their shifts and have not been paid for this
time.
Mike Ashley has said the company needs to improve the
way it treats its workers.
Analyse the benefits that Sports Direct might
receive from treating its employees more ethically.
(6 marks)

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Ethical finance
Ethical financial decisions may involve a business spending on
community facilities which will not directly boost the business’s
profits. Some businesses invest in facilities for the local
community or pay their employees to undertake charitable work
during normal working hours.

Many large companies, such as Apple, Amazon and Starbucks,

have received a lot of criticism for arranging their finances so as
to pay very small amounts of tax. Google responded to criticism
of its tax arrangements by paying £130 million in taxes to the UK
government, although this was thought to be too little by some
critics.

Business ethics and profits

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If a business takes a decision to behave ethically, it may be that
its profits will decline, at least in the short-run. Ethical decisions
often make it more expensive for businesses to produce and sell
goods and services. This can lead to lower profits. Any of the
following ethical actions can result in lower profits:
• using environmentally friendly resources or fair trade
products, which are more costly
• providing employees with high-quality training (after which
they may take a job elsewhere)
• offering lower-priced products to certain groups such as
pensioners
• acting in a socially responsible way by taking into account
the needs of all stakeholders when making decisions and not
just those of shareholders.

Key terms
Fair trade products are those for which customers pay
higher prices and offer better trading terms, such as
payments with orders. The aim is to improve the living
standards of people in poorer countries where the
products are produced.
Social responsibility is an approach to managing
businesses in which the interests of all groups in society
are taken into account when making decisions.

Business Insight
UK retailers and Myanmar
The fashion clothing retailer H&M has faced claims that
its suppliers used children as young as 14 in factories in
Myanmar. Some children worked 12-hour days. The

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 claims have raised new fears about conditions in
Myanmar. A number of UK retailers including Marks &
Spencer, Tesco, Primark and New Look also have
suppliers in the country.
H&M said it had taken action with factories over both ID
cards and overtime after being made aware that a group
of 14-17-year-olds had been working long hours. Other
UK fashion retailers say a move to pay workers £1.82 for
an eight-hour day will help Myanmar’s clothing industry to
thrive.
Analyse the reasons why H&M uses suppliers in
Myanmar where children may be employed.
(6 marks)

Businesses can, therefore, face a trade-off between taking ethical

decisions and generating the highest possible profits.
However, this may not always be true. Having a reputation as an
ethical business can help a business to attract large numbers of
customers, despite relatively high prices. Ben & Jerry’s ice-
cream is very popular with consumers in the UK and elsewhere,
despite its relatively high prices. In part, this is because the
business takes well-publicised ethical decisions. Similarly, some
businesses benefit from offering good wages and high-quality
training. This helps them to attract the best-quality employees as
well as motivating existing workers. These positive effects on
the workforce can boost the business’s efficiency and profits.
Many businesses, for example, the Co-operative Bank, publicise
their ethical behaviour in their advertising.
Businesses that are seen to behave unethically can suffer from
bad publicity. This can damage the business’s reputation,
reducing its sales and profits. Sports Direct is at risk of this
occurring following public criticisms of the way in which it

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treats its employees (see the Business insight on page 71).
We consider the advantages and disadvantages of ethical
behaviour for businesses at the end of this section.

Businesses and the

environment
When we use the term the environment in this chapter it
refers to the natural world: the landscape in which we live and
its natural features such as the seas, rivers, forests and
mountains.

The effects of business activity on the

environment
Business activity can result in damage to the environment. For
example, building a major shopping centre such as Bluewater in
Kent can result in traffic congestion and air pollution. This is the
result of thousands of cars, vans and lorries travelling to and
from Bluewater. The environmental consequences of business
activity are an example of what is known as external costs.
External costs of production arise when a business’s activities
result in harmful effects on other people not directly involved in
production. In other words they impose costs on others in
society and not just the business concerned.

Key terms
The environment is the natural world in which we live. It
is the landscape and its natural features such as the seas,
rivers, forests and mountains.

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External costs of production arise when a business’s
activities result in harmful effects on other people not
directly involved in production.

Traffic congestion
Traffic congestion in the UK and other countries is very costly in
terms of pollution. In 2013, almost 70 per cent of the UK’s
workforce commuted to work by car during peak times. The
average driver spent 124 hours a year in traffic jams, with
engines producing pollutants such as carbon dioxide and
nitrogen oxide. Air pollution is the worst in cities such as
London where traffic is regularly caught in jams. Traffic
congestion causes huge amounts of air pollution and causes
enormous external costs. Table 2.3 summarises these effects.

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 Maths moment
Using the data in Table 2.3, calculate the percentage
increases in the amount of carbon dioxide produced by
the UK and USA between 2013 and 2030 (a forecast).
Which is higher?

Air and noise pollution

Figure 2.3 summarises the potential sources of air pollution.
Many of these are the result of business activities:
• Agriculture. Research has shown that agriculture is the major
cause of air pollution in Europe. Nitrogen fertilisers that are
used to grow crops and animal waste cause the pollution.
• Manufacturing industries. These cause air pollution by
emitting gases during the production of goods.
• Transport. Cars and lorries emit huge amounts of polluting
gases as do aircraft.
• Power stations. Many power stations in the UK and
elsewhere use coal and gas to generate electricity. This causes

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 huge emissions of carbon dioxide and other gases.

Pollution can also take the form of noise. Noise pollution is any
disagreeable sounds that cause discomfort to people and
animals. The major cause is machinery and particularly cars,
lorries and aircraft. Noise pollution can have negative effects on
the environment. A number of studies suggest that wildlife is
stressed by noise pollution, which can affect the breeding
patterns of many wild animals and threaten their long-term
survival.

The use of scarce resources

Many resources used by businesses are either scarce or non-
renewable. Natural resources such as oil, coal, gold and zinc
are non-renewable. This means that a limited amount exists in
the world and once used, an alternative has to be found. For
example, forecasts suggest that the world’s resources of natural
gas could be used by 2050. Other resources are renewable, for
example, some timber or solar energy.

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Key term
Non-renewable resources are those of which only a
limited amount exists such as coal and oil.

If businesses and consumers take decisions to produce and buy

products that use up limited or non-renewable resources,
problems may occur in the future. Future generations will not
have access to oil, for example, to power engines. Decisions by
businesses and consumers based on the use of limited resources
are not sustainable in the long term. We look at the idea of
sustainability on page 76.

Global warming
Global warming is the gradual heating of Earth’s surface,
oceans and atmosphere. It leads to rises in average temperatures.
This can have many harmful effects for the environment
including:
• melting of ice in the polar regions, causing rising sea levels
• changes in patterns of weather, meaning different crops have
to be grown
• shortages of water and drought.

Key term
Global warming is the gradual heating of Earth’s
surface, oceans and atmosphere.

The concept of global warming is controversial. However, many

scientists believe that business activities result in the release of
carbon dioxide, nitrous oxide and other harmful gases. The
cutting down of the rainforests, the use of fossil fuels such as oil

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to produce and transport products and the use of artificial
fertilisers to grow crops all contribute to global warming.
Consumers contribute to global warming by deciding to buy
products which are known to contribute to global warming. For
example, decisions to fly to another country on holiday or to
buy a car that produces high levels of emissions contribute to
the release of carbon dioxide and other gases. Global warming is
the result. Figure 2.4 offers some indication of a sharp rise in
average temperatures since 1980.

Business Insight
Palm oil and deforestation

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Palm oil is found in approximately 50 per cent of products
on supermarket shelves in one form or another. These
products include foods, cosmetics, animal foods and
medicines. Palm oil is linked to the destruction of the
world’s rainforests. The creation of new oil palm
plantations to meet the rising demand for palm oil has
resulted in the destruction of many rainforests. Many are
located in Indonesia and Malaysia where incomes are
relatively low.
Today there are about 13 million hectares of palm oil
plantations in the world. The use of the rainforest in this
way damages the environment. It destroys the biodiversity
in these forests, along with the habitat of species such as
the orangutan.
Analyse one reason why businesses in Malaysia
and Indonesia destroy the rainforest when it causes
severe damage to the environment.
(4 marks)

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How businesses and consumers can
show environmental responsibility
Businesses are able to make decisions designed to protect the
environment from their activities. These decisions are more
likely if consumers and pressure groups, such as
Greenpeace, take action to encourage environmental
responsibility by businesses.

Sustainability
Sustainable methods of production are those that can
continue in the long term without damaging the environment.
Without sustainable production, future generations could have to
cope with a damaged environment as a consequence of
decisions taken today.

Key terms
A pressure group is a group of people with a common
interest who influence public opinion and decisions by
businesses and governments.
Environmental responsibility refers to the taking of
decisions by businesses, consumers, governments and
other groups with the intention of protecting the
environment.
Sustainability refers to methods of production which can
be continued in the long term without damage to the
environment.

Sustainable production methods include:

• the use of renewable sources of energy such as solar and wind

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 power
• means of transport that do not cause pollution, for example,
electric vehicles
• making products from recycled or renewable materials such as
sustainable timber
• producing goods and services without the use of chemicals
and other products that damage the environment.
Marks & Spencer, one of the UK’s best-known businesses, is
committed to become ‘the world’s most sustainable retailer’ by
2020. This will require the company to:
• select its suppliers very carefully to ensure they are not
damaging the environment
• build environmentally friendly stores using, for example, solar
power and to reduce carbon emissions from transport.

Disposing of waste
Modern societies produce huge amounts of waste. Waste can be
unused food, packaging or old products. Europe produces 1.8
billion tonnes of waste every year.
Disposing of the waste from production carefully can avoid a
range of environmental problems, such as water pollution and
air pollution, as products emit gases as they degrade. Hazardous
chemicals can also remain in the soil threatening the health of
humans and animals.

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The two major methods of disposing of waste are landfill
(burying it) and incineration (burning it). Both can result in
damage to the environment.
Environmentally responsible businesses aim to reduce the
amounts of waste that result from the production and
consumption of their products. This may involve the use of
reduced amounts of packaging or products that last longer – so
fewer are produced. In 2016, Tesco announced that it had
redesigned its packaging to keep meat products (for example,
chicken fillets) fresher for longer. It expects this to reduce the
amount of food that becomes waste.

Recycling
One major method of reducing waste is through recycling
which reuses materials to produce new products. While it is
commonplace for bottles and cans to be recycled, businesses are
increasingly designing products that can be recycled. For

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example, buildings are now dismantled, rather than demolished
and buried, with a view to reusing the bricks and metal, as well
as fixtures and fittings such as windows.

Key term
Recycling is the reuse of raw materials used in making
products, often for many times. Examples include the
reuse of glass, paper and metals.

Business Insight
Levi Strauss
Levi Strauss is an American clothing manufacturer,
perhaps best known for its range of jeans. It is introducing
a clothes recycling operation in the UK, based on a model
that is successful in the USA. It offers a 10 per cent
discount on Levi’s products for consumers who donate
old clothes and shoes. This operation has attracted a lot
of publicity in the USA. Some other retailers, such as
H&M, have similar schemes.
Collection boxes are being installed in Levi’s stores in the
UK, and customers who bring in any brand of clean, dry
clothing or shoes for recycling will be given a voucher.
This can be traded in for a discount on new clothes.
The company has plans to expand the recycling operation
throughout Europe by December 2017.
Analyse why Levi Strauss is introducing its
recycling operation into the UK.
(6 marks)

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Creating and using different methods
of transport
We saw earlier that transport is a major cause of environmental
damage. Businesses that manufacture cars, lorries and planes are
all seeking to produce vehicles that can be recycled and produce
fewer emissions of harmful gases. For example, many car
manufacturers are producing increasing numbers of electric cars.
At the same time, businesses are seeking to use methods of
transport that are less damaging to the environment. In 2016,
easyJet, the low-fare airline, announced that it was to trial the
use of hydrogen fuel cells on the aircraft it uses. This could
reduce its use of aviation fuel by 50,000 tonnes per year. Over
30 per cent of London buses were using biofuels in 2016,
substantially reducing carbon emissions in the capital.

Study tip
Do make sure that you understand how businesses and
consumers show environmental responsibility in the
decisions that they make. It can be helpful to know
examples of such decisions. This topic gives you several
examples.

Consumers’ decisions and the

environment
It is easy to think that businesses are solely responsible for
environmentally responsible methods of production. Of course,
they do have a significant responsibility, but so do consumers.
Consumers can take a range of decisions that can help to protect
the environment:

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• They can recycle products at home to reduce the amount of
waste they produce.
• They can buy environmentally friendly products whenever
possible. This encourages businesses to produce these
products.
• They can also complain to businesses (possibly using social
media) whenever they are seen to cause damage to the
environment.
Many consumers become members of pressure groups, such as
the RSPB, Greenpeace or Friends of the Earth. These groups
campaign to protect the environment.

The advantages and

disadvantages of

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environmentally friendly and
ethical policies
The advantages
• An increasing number of businesses have adopted at least
some environmentally friendly policies. Many produce an
annual environmental report which publicises their
environmentally friendly actions. This can result in some
positive publicity for the business, especially if its competitors
are not reporting in this way. Many businesses that are
environmentally friendly use this in their advertising. Marks &
Spencer has used its environmentally friendly policies (known
as Plan A) prominently in its advertising since 2007 (see Topic
1.3, page 25). Similarly ethical businesses use their moral
behaviour strongly in advertising and other marketing.
• Ethical and environmentally friendly businesses can frequently
charge higher prices for their products. Consumers place a
greater value on their goods and services as they do less
damage to the environment or to other stakeholder groups.
Thus they are willing to pay more for them. This can help to
increase the business’s profits.
• Introducing ethical and environmentally friendly methods of
production can help a business to win new customers by
being different from its competitors. The Co-operative Bank
presents itself as an ethical and environmentally friendly
business. This helps to distinguish it from other banks.

Key term
Environmental reporting is the publication of a
business’s environmental performance to the general

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public.

The disadvantages
• Implementing ethical and environmentally friendly policies
can increase costs. Using materials that do not damage the
environment or paying employees higher wages can be more
costly. It is often cheaper for a business to use new rather than
recycled resources or to pay minimum wage rates. We saw
earlier that Levi Strauss operates a recycling scheme. This will
involve administrative costs and it will lose revenue as it is
giving customers vouchers to pay in part for its products.
Unless environmentally friendly policies attract more
customers, or allow higher prices, they can lower profits.
• Businesses that present themselves as ethical or
environmentally friendly have to ensure that they are just that!
If they are found not to be so, they can receive very damaging
publicity. Sales and profits may fall sharply as a consequence.
Volkswagen, the German car manufacturer, is suffering
reduced sales in many markets following revelations that it
‘cheated’ in tests of its cars’ emissions.

Summary
Businesses have to take into account ethical and
environmental influences when taking decisions. Being
seen to behave more ethically by taking morally correct
decisions and seeking to protect the environment can
attract customers. However, such ethical and
environmentally friendly actions can be costly and,
therefore, threaten businesses’ profit levels. It can be a
tricky balancing act.

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Quick questions
1 What is meant by the term ‘ethics’?
(2 marks)
2 State two questions that might be asked to decide
whether a business is ethical or not.
(2 marks)
3 Explain one way in which a business could engage in
ethical marketing.
(2 marks)
4 Which of the following is most likely to be judged an
ethical decision?
(a) Paying employees the legal minimum wage
(b) Setting prices to make maximum profits
(c) Using zero-hours contracts for most employees
(d) Providing all employees with highquality training
(1 mark)
5 Explain one reason why ethical decisions may reduce
a business’s profits.
(2 marks)
6 What is meant by the term ‘environment’?
(2 marks)
7 Which of the following business activities is least likely
to result in an external cost?
(a) Using coal to generate electricity
(b) Manufacturing products using recycled materials
(c) Importing products using aircraft to transport them
(d) Using large quantities of artificial fertilisers to grow
crops
(1 mark)

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 8 Which of the following is a renewable resource?
(a) Oil
(b) Iron ore
(c) Tidal power
(d) Coal
(1 mark)
9 What is meant by the term ‘sustainable production’?
(2 marks)
10 Give two examples of environmentally responsible
decisions that consumers can take.
(2 marks)

Case study
Deliveroo
Deliveroo is an online food delivery company that
operates in the UK and 11 other countries. It delivers food
from restaurants which do not have their own delivery
service, for example, Pizza Express and Wagamama. It
has grown quickly, earning revenues of £130 million in
2015–16. Deliveroo has just received £212 million from
investors to finance further expansion of the company.
The company has been involved in a pay dispute with its
delivery drivers. It sent an email to its workers telling them
they would be paid £3.75 per delivery instead of an hourly
rate of £7 plus £1 per delivery. The new scheme could see
the employees earn less than the living wage, particularly
when the company has few orders. This could cause
difficulties for the company and may lead to a change of
plan.

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Deliveroo has said it will enforce the pay terms and
claimed that its drivers had responded positively in early
trials. It is expecting to face increasing competition from
companies such as Uber in the near future.
1 Identify two stakeholders who may be affected if this
new pay deal is agreed.
(2 marks)
2 Explain why this decision may be considered to be
unethical.
(4 marks)
3 A nalyse how Deliveroo’s activities might harm the
environment.
(6 marks)
4 Analyse the consequences for Deliveroo from its
decision to change its pay system. In your answer, you
should consider:
• the advantages to the business
• the disadvantages to the business.
You must evaluate whether the advantages will be
greater than the disadvantages. Use evidence to
support your answer.
(12 marks)

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Topic 2.3

The economic climate of

business
The economic climate can change relatively quickly from
one which provides a good trading environment for
businesses to one in which trading is difficult. The
economic climate for businesses is a significant external
influence on a wide range of decisions taken by
managers.
By the end of this topic, you should know:
• what is meant by the economic climate
• how changes in the rate of interest might affect
businesses and spending by consumers
• the impact on businesses of changes in the level of
employment
• how consumers’ incomes and levels of spending can
change.

What is the economic climate?

Before describing the economic climate, it is important to

183
understand what is meant by ’the economy’. The UK and
other economies are made up of millions of consumers and
many thousands of businesses, as well as the national and local
governments. All these people and organisations take decisions
on what to buy, sell, produce, import from overseas, where to
work and many other matters. All together the actions and
decisions taken by these individuals and organisations decide
what is to be produced, bought and sold. This is ‘the economy’.
The economic climate is a term that refers to the state of an
economy. This term considers whether an economy is:
• producing a greater or a smaller quantity of goods and
services
• providing consumers with falling or rising incomes

Key terms
The economy is made up of millions of individual
consumers, many thousands of businesses and
governments. All take decisions on what to buy and
produce.
Consumers are individuals who buy goods and services
from businesses.
The economic climate describes the state of key factors
within a country such as the level of goods and services
produced and the number of jobs available.

184
• experiencing a rise or a fall in the amount that consumers can
spend on goods and services
• offering more or fewer jobs for people.
As Figure 2.6 shows, it is possible to describe a change in the
economic climate as improving or weakening, depending on
what is happening to key factors such as production levels and
the number of jobs available. Generally speaking, a rise in these
key economic factors indicates an improving economic climate.

185
Business insight
Brexit leads to concerns about a weakening
economic climate
Many small and medium-sized businesses had concerns
about the UK’s future economic climate following the
decision to leave the European Union.
Research showed that over 25 per cent of small and
medium-sized businesses believed that the economic
climate would worsen. Only 20 per cent of these
businesses expected to expand in 2016-17, while 57 per
cent anticipated zero growth in the production of goods
and services. About 10 per cent feared that their
businesses would produce a smaller amount of goods and
services in 2016–17, and some forecasted shutting down.
Analyse the likely consequences for businesses if

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 the economic climate in the UK does weaken.
(6 marks)

Interest rates and the

economic climate
Interest rates are the cost of borrowing money, expressed as a
percentage rate. Thus, if a business or consumer borrows
money, they have to repay the amount borrowed plus an
additional amount – the interest payment. The additional amount
is stated as a percentage to make it easier to understand. A higher
percentage rate means a larger ‘extra’ payment. Equally, if a
consumer or business saves money (by putting it into a bank
account, for example), they receive an extra amount in the form
of an interest payment.

Key term
Interest rates refer to the cost of borrowing money or the
reward for saving money, expressed as a percentage.

Changes in interest rates can affect the economic climate of a

country. They have this impact because they affect decisions
taken both by consumers and businesses.

Consumers and changes in interest

rates
A change in interest rates will have two broad effects on
consumers’ decisions. It may affect the amount they decide to
save and the amount they choose to spend. The impact can be

187
significant if there are large changes in interest rates.
Let’s assume that there is a fall in interest rates – as happened in
the UK in August 2016. This will be likely to have the following
effects:
• Saving by consumers. A fall in interest rates will lead to some
consumers deciding not to save, as the interest they receive
will have been reduced. They may decide to spend existing
savings on goods and services and save less in the future.
• Spending by consumers. As well as spending their savings,
consumers will be more willing to borrow money to buy more
expensive items such as houses and cars. They will do this
because lower interest rates reduce the additional amount they
have to repay.
A rise in interest rates will have the opposite effects.

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Businesses and changes in interest
rates
Some businesses rely heavily on borrowed money to finance
their activities. Sometimes this money is just borrowed for a
short period of time, for example, to pay for raw materials. On
other occasions, it may be borrowed for a long period of time,
for example, to pay for a new factory or offices.
Some businesses rely on borrowing to finance their businesses.
For example, some fee-paying schools may rely on short-term
borrowing as they only receive fees from parents at the start of
each term. However, they have to pay teachers’ wages and other

189
costs throughout the term. They may use a flexible short-term
loan, called an overdraft, for this purpose. An overdraft is a
flexible loan which businesses can use, whenever necessary, up
to an agreed limit.

Key term
An overdraft is a flexible loan which businesses can use,
whenever necessary, up to an agreed limit.

Borrowing large amounts of money, especially over long periods

of time, means that businesses can be affected significantly by
changes in interest rates.
• Rising interest rates. In this situation, a business may face a
large increase in the amount of interest it pays on its existing
loans. This could increase its costs, reducing profits. In
extreme cases, a large rise in interest rates may result in a
business being unable to repay its loans. In this case, it will
probably stop trading.
• Falling interest rates. This is a more favourable situation for
many businesses with borrowings. It may be that borrowing
costs will be reduced, helping to improve the business’s
profits. However, those businesses with large savings may
receive reduced returns.
One way in which a business can protect itself against changes
in the cost of its borrowing is to negotiate loans with fixed rates
of interest. This means the rate of interest is unchanged
throughout the period of the loan. However, fixed rate loans
may have higher rates of interest from the start.

Businesses, interest rates and

consumer spending
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Businesses can also be affected following a change in interest
rates by consumers’ decisions to spend less or more on their
goods or services. If interest rates rise, some consumers may
decide to save more. Other consumers may choose not to take
out loans to buy new cars or technology, such as televisions or
computers. These decisions could result in a business selling
fewer products and receiving less revenue from its sales. The
outcome is likely to be lower profits.
Businesses that sell luxury goods will be affected most when
interest rates rise. Similarly, they benefit most from interest rate
reductions.
Lower interest rates can prompt reductions in saving and higher
levels of borrowing and spending by consumers. This should
help to increase a business’s profits.

Business insight
New car sales rise as interest rates reduced
Sales of new cars in the UK rose in August 2016,
recording a total of 81,640 for the month. During the first
eight months of 2016, sales of new cars reached 1.68
million. This matched 2015, which was a record year.
In early August 2016, interest rates were reduced, despite
already being at the lowest level for over 300 years.
Explain why sales of cars might have reached
record levels in 2015 and 2016.
(4 marks)

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 Study tip
You should focus on the effects of changes in interest
rates. You are not expected to know the reasons why
interest rates are changed or the methods by which they
are changed.

It is important to remember that the effects of any change in

interest rates will be greater if it is a large change and results in
rates going to very high, or very low, levels.

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Levels of employment and
consumer spending
Businesses employ workers to produce goods and services for
sale. If the economic climate is strong and improving, there is
likely to be a rising level of employment as more workers are
needed. Wages may also rise. On the other hand, during a period
in which the economic climate is weakening, employment levels
and wages may fall.

The effects on businesses of changes

in the level of employment
At the time of writing (September 2016), the UK has enjoyed
rising levels of employment since around 2010. A common way
of measuring the level of employment is to calculate the
employment rate. This measures the percentage of people aged
16–64 in employment. It thus allows for changes in the size of
the population.

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Rising levels of employment in the UK
Figure 2.8 shows that the level of employment rose steadily
between 2011 and 2016. In the middle of 2011, the employment
rate was 70.1 per cent. This meant that just over seven out of
every ten people aged between 16 and 64 in the UK had a job.
Some of the remaining three out of ten may not have wanted
employment; they may have been students or had childcare
responsibilities. Nevertheless, some of them would have been
unemployed and looking for a job. By the summer of 2016, the
employment rate in the UK had reached 74.5 per cent. The UK’s
population had also increased over the five years. As a result,
the number of people in employment had risen from 29.10
million in 2011 to 31.75 million in 2016.

Maths moment
Use the information above to calculate the change in the
number of people in the UK aged 16-64 between 2011

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 and 2016.

Increases in the level of employment, such as that in the UK

between 2011 and 2016, can have two significant effects on
businesses:
• The possibility of higher sales. Because more people have
jobs, it is likely that consumer spending will rise. We have
seen that in 2016 approximately 2.65 million more people
were in work in the UK than in 2011. This represents many
extra customers for businesses. In addition, real wages may
have risen – that is after allowing for any increases in prices.
As a result, consumers have greater spending power and can
buy more goods and services. This is good news for many
businesses, especially those that sell luxury items.
• Increased employment costs. The UK’s employment rate of
74.5 per cent in 2016 is a high figure. This means that some
types of labour, especially skilled workers, may become

195
 scarce. As a result, wage rates can rise as businesses compete
to employ available workers. The outcome is higher
employment costs. This can reduce a business’s profits if it is
unable to raise the prices of its goods and services.
However, there are times when the employment rate, and the
number of people in work, falls. This happened in the UK
between 2008 and 2010. This can pose problems for businesses,
despite the possibility of falling wages and salaries. Consumer
spending is likely to fall and may do so sharply. This results in
falling sales for many businesses, especially those selling luxury
items such as jewellery and foreign holidays.
We consider the effects of changes in consumer spending on UK
businesses more fully below.

The effects on businesses of changes

in consumer spending
Consumer spending refers to the value of goods and
services bought by consumers over a time period, usually a
month or a year. This spending will be on essential products
such as food, housing and heating, as well as on non-essential
products including restaurant meals, designer clothing and
alcohol. Non-essential items are luxury products that consumers
want rather than those they need.

Key term
Consumer spending refers to the value of goods and
services bought by consumers over a time period, usually
a month or a year.

It is normal for consumer spending to fall at times when

consumers’ incomes are lower. Figure 2.9 shows the level of

196
consumer spending in the UK between 2006 and 2016. It is clear
that consumer spending fell sharply between 2008 and 2010.
This occurred because the UK experienced a financial crisis and
the economic climate became significantly worse. Employees
lost their jobs or worked fewer hours each week. As a result
their incomes fell giving them less money to spend on goods
and services.
However, since 2012, the economic climate has improved along
with the level of employment. As a consequence, consumer
incomes and spending have risen.

Maths moment
Look at the data shown in Figure 2.9. When was
consumer spending in the UK:
(a) rising most quickly?
(b) falling most quickly?

The effects on businesses supplying

197
essential and non-essential products
Figure 2.9 shows us that there was a sharp fall in consumer
spending during the years 2008–2010, when the financial crisis
occurred and consumers’ incomes fell. It also shows that
consumer spending rose steadily from 2012 to 2016, when the
incomes of many consumers were rising. It is apparent,
therefore, that there is a direct link between consumers’ incomes
and the level of their spending. This is not surprising. If
consumers receive higher incomes, they are likely to spend more
and businesses’ sales will rise. If consumers’ incomes fall, so
will their spending and the sales of businesses.
The effects of lower consumer incomes and falling sales can be
felt by all functions within a business. It may affect business
operations as they have to cut production levels. Human
resources may have to employ fewer people. The marketing
department may have to cut the prices of its products and to
develop cheaper versions.
However, the levels of sales of all businesses are not affected
equally by changes in consumers’ incomes. Some businesses,
which produce or sell essential products such as basic foods, do
not experience large falls in sales when consumers’ incomes fall.
Equally, they do not enjoy significant increases in sales when
consumers’ incomes rise.
On the other hand, some businesses do sell goods and services
whose sales vary considerably when consumers’ incomes
change. These products are likely to be luxury and non-essential
items. Examples include designer handbags and organic foods.
These products are called income elastic products as their
sales are sensitive to changes in consumers’ incomes.

Key term

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Income elastic products are those whose sales are
sensitive to changes in consumers’ incomes.

Thus, businesses that produce some products may experience

significant fluctuations in their sales as consumers’ incomes
change. Others may experience fewer changes as their products
are not income elastic, or perhaps are less income elastic.

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Business insight
Ryanair’s sales unaffected by consumers’
income levels
Ryanair is best known for providing cheap flights
throughout Europe. Its website advertises flights to
European cities such as Aarhus (Denmark) and Warsaw
(Poland) for as little as £10 one-way. The company has
successfully lowered its prices over time.
By selling flights very cheaply, it has increased its sales
enormously. In 1990, it had 745,000 passengers. By
2016, the figure had risen to 117 million. Its passenger
numbers have grown steadily since 2000, even when
consumers’ incomes were falling.
Explain why Ryanair’s sales continued to rise even
when consumers’ incomes were falling.
(4 marks)

Summary
Businesses are influenced by changes in the economic
climate. Fluctuations in the level of interest rates or the
level of employment are likely to affect most businesses.
Changes in consumers’ income will affect many. Those
selling income elastic products will be affected most.

Quick questions
1 What is meant by the term ‘economic climate’?
(2 marks)

200
2 Which of the following is most likely to be a sign of an
improving economic climate?
(a) A rise in the number of people who do not have
jobs but are looking for one
(b) A rise in the number of businesses that are forced
to cease trading as they cannot repay loans
(c) A rise in the number of people in employment
(d) A rise in the number of people moving overseas
for work
(1 mark)
3 What is meant by the term ‘interest rates’?
(2 marks)
4 Which of the following best describes an overdraft?
(a) A flexible loan which businesses can use,
whenever necessary, up to an agreed limit
(b) The extent to which a business uses borrowing to
finance its activities
(c) The long-term borrowing of an agreed amount by a
business
(d) A situation in which a business raises the price of
its products
(1 mark)
5 Explain one possible effect of falling interest rates on
a business.
(2 marks)
6 Which of the following is most likely to be the result of
rising interest rates?
(a) Rising sales of expensive foreign holidays
(b) Rising production of all goods and services
(c) Rising levels of employment

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 (d) Rising levels of saving by consumers
(1 mark)
7 Explain one possible effect of falling levels of
employment on UK businesses.
(2 marks)
8 What is meant by the term ‘consumer spending’?
(2 marks)
9 Which of the following products might be described as
essential?
(a) Milk
(b) LED television
(c) Overseas holiday
(d) Restaurant meal
(1 mark)
10 Explain why a bakery’s sales of bread may not be
affected significantly by a fall in consumers’ incomes.
(2 marks)

Case study
The USA increases its interest rates
In December 2015, interest rates in the USA were
increased from 0.25 per cent to 0.50 per cent (or half a
percent). This was the first increase for nearly ten years.
Further increases in interest rates in America are
expected over the following year or two.
The higher interest rates have already had a number of
effects. Some industries, such as house building, have
been affected as consumers normally buy houses using
loans. Despite this, the news on wages and salaries is

202
positive, as shown in Figure 2.10.

However, consumers in America do have high levels of

debt. In 2015, the average American household owed
$260,000 (approximately £195,000).
1 State two other examples of products other than
houses that consumers often buy using borrowed
money.
(2 marks)
2 Explain how this increase in interest rates might affect
the finance function of a large company.
(4 marks)
3 Analyse the likely effects of this rise in interest rates on
the level of spending by American consumers.
(6 marks)
4 Analyse the effects of the rise in interest rates on
American businesses. In your answer, you should

203
consider:
• businesses that may be affected by this rise in
interest rates
• businesses that may not be affected by this rise in
interest rates.
You must evaluate whether or not American businesses
will be affected significantly by this interest rate rise.
Use evidence to support your answer.
(12 marks)

204
Topic 2.4

Globalisation
The world economy has become much more
interconnected over the past 50 years through a process
known as globalisation. This has resulted in advantages
and disadvantages for businesses in the UK. In response
to globalisation, UK businesses have had to improve
product design and quality while keeping prices low to
compete internationally. Globalisation has meant that
exchange rates have become an important factor for
many businesses in the UK. Changes in exchange rates
can have important effects on the sales and profits of
many businesses.
By the end of this section you should know:
• what is meant by globalisation
• the benefits and drawbacks of globalisation for UK
businesses
• how UK businesses compete internationally in response
to globalisation
• the impact of exchange rates on businesses.

What is globalisation?
205
Globalisation is the process through which world economies
have become steadily more interconnected since the 1970s. This
has changed the ways in which many businesses operate, as:
• the volume of trade between countries has increased
• people have moved overseas to live and work and money has
flowed between different countries
• multinational companies (MNCs) have grown in
importance and have supplied products to markets across the
world.

Key terms
Globalisation is the trend for markets to become
worldwide in scope.
A multinational company (MNC) produces goods and
services in more than one country. They are also called
transnational corporations (TNCs).

The pace of globalisation has increased in recent years because:

• incomes have risen, allowing consumers in many countries to
buy goods and services produced by multinational companies
• the cost of transporting products has fallen sharply, making it
possible to move raw materials and finished goods around the
world
• electronic communications have allowed even small
businesses to sell products to global markets.

Increased international trade

One of the most significant features of globalisation is that it has
resulted in increased trade between countries. This type of trade
is called international trade. Figure 2.11 shows the huge rise

206
in the global value of exports between 1960 and 2015. In 1960,
the total value of exports by all countries was $125 billion; by
2015 the figure had reached $16,600 billion.

Key terms
International trade is the selling of goods and services
across national borders.
Exports are goods and services produced by a business
in one country and sold in another.

This increase in international trade has occurred because

incomes have risen in many countries over this time period. This
has led to increasing demand for many products such as mobile
phones, cars and foods such as beef and palm oil. Frequently
these products are produced in other countries and exported to
where consumers live. At the same time, incomes have risen
particularly quickly in countries such as China, India and Brazil

207
leading to especially large increases in trade with these countries.
Reductions in the cost of transporting products have also
contributed to the rise in international trade. Much larger cargo
ships have been designed and built, thus reducing the cost of
transporting goods internationally. In 2014, the CSCL Globe, the
world’s largest cargo vessel, was launched. It can carry over
19,000 containers. Its size helps to reduce the cost of
transporting products by increasing the quantity carried and
reducing operating costs. This has helped MNCs to locate at least
some of their operations in countries where costs are lower. We
consider this in detail over the next two pages.

Finally, more trade agreements have been reached between

countries, allowing the exchange of goods and services with
fewer barriers to trade. The World Trade Organisation (WTO) is
an international organisation that has played an important part in
reducing barriers to trade, such as tariffs (taxes on imports of
goods and services).

Key term

208
A tariff is a tax on foreign goods imported into a country.

People have moved more freely

across international borders
Globalisation has encouraged the movement of people between
different countries seeking to improve their standard of living.
In particular, it has resulted in a flow of migrants to higher-
income countries (HICs) in Europe and North America. These
countries are attractive to migrants as businesses need employees
and wages are relatively high. Figure 2.12 shows some of the
major international flows of migrants.

In addition, globalisation has been associated with increased

international flows of money. These financial flows have helped
MNCs to invest in establishing factories, offices and shops in
other countries. This has been an important part of globalisation.

Development of multinational
209
companies
Globalisation has led to markets becoming more international.
Many businesses have adapted to this trend by trading
internationally, rather than just operating in a single market.
MNCs produce goods and services in more than one country,
taking advantage of countries where production costs are lower.
Their products are normally sold in many countries. Apple,
Lenovo and Tesco are all examples of MNCs.

Business insight
Starbucks
Starbucks is a US multinational company that operates
nearly 24,000 coffee shops in 70 countries throughout the
world. Starbucks’ coffee shops sell hot and cold drinks,
cakes and biscuits as well as light meals. Some of its
shops are licensed to sell alcoholic drinks.
Starbucks has differentiated itself from other coffee shop
chains by emphasising the quality of its coffee (especially
its dark roasted coffee) as well as the quality of its
customer experience.
Explain why Starbucks is a suitable business to
operate as a multinational company.
(4 marks)

Most MNCs were originally based in high-income countries such

as the US, France and the UK. However, in recent years rapidly
growing economies such as India, Mexico and China have
developed their own MNCs. These large companies are able to
create and promote well-known brands. Some have been
successful by selling their products at low prices. Others, such
as Lenovo, have developed brands noted for their quality.

210
MNCs have been successful where a global demand exists for
their products and if they are affordable to large numbers of
people. Merlin Entertainments, a British-based MNC, plans to
open a Legoland theme park in Shanghai. It expects the theme
park to be popular with Chinese consumers who are enjoying
rising incomes.

Globalisation has made it easier for MNCs to buy resources

cheaply from other countries. For example, in 2015 Nestlé
bought about 420,000 tonnes of palm oil from Indonesia and
Malaysia. It uses the oil in manufacturing confectionery. Some

211
MNCs have established factories in countries where labour is
cheaper to help them to minimise production costs. Since 2003,
Dyson, a UK engineering company, has carried out much of its
production in Malaysia where wage costs are substantially lower
than in the UK.

Benefits and drawbacks of

globalisation
Globalisation brings a number of benefits and drawbacks to UK
businesses.

212
Benefits of globalisation
Rapid growth
Globalisation has helped some UK businesses to grow rapidly by
providing opportunities in overseas markets. Growth offers
businesses a range of benefits including economies of scale.
For example, buying large quantities of supplies enables
businesses to pay lower prices per unit. We looked at economies
of scale in more detail on pages 51–52. Growth also helps to
generate higher profits and better returns for shareholders. Cath
Kidston, a UK designer and retailer known for its floral designs,
is opening stores in India in 2016. This will bring its total
number of overseas stores to 158.

Inward investment
Globalisation has helped the UK to attract very large sums of
inward investment. In 2015 alone, the UK received £25,500
million from foreign governments, business and individuals.
Inward investment has financed the expansion of some
industries such as motor car manufacturing. It has also helped to
finance improvements in infrastructure, including transport
systems and energy supplies, such as Hinkley Point power
station in Somerset. Some UK businesses have been bought by
foreign companies. This can help to improve the performance of
these businesses as, for example, the foreign company might
invest in training the workforce to improve their skills.

Key terms
Growth occurs when a business sells increased
quantities of its products.
Economies of scale occur when the cost of producing a

213
single unit falls as output increases.
Inward investment occurs when governments,
businesses and individuals invest capital into another
country, for example, building new factories or buying
companies.
A takeover occurs when one business buys control of
another one.

Cheaper resources
Globalisation means that UK businesses have access to cheaper
resources. For example, much of the UK’s coal is imported as it
is cheaper than that produced in the UK. Some businesses take
advantage of cheaper sources of labour overseas. In 2016,
HSBC, a UK-based bank, announced that it was to use Polish,
Indian and Chinese employees to fill 800 IT jobs as wage rates
would be lower. This can help to increase a business’s profits as
well as to make businesses more price competitive.

Maths moment
Using the information in the Business insight below,
calculate what percentage of Amazon’s sales were profits
in 2015.

Business insight
Amazon
Amazon is one of the world’s best-known e-commerce
businesses, and its value is estimated to be $65.4 billion.
In 2015, its sales revenue totalled $107 billion; its profits
for the year were $596 million. The company has a
reputation for being highly price-competitive and has

214
 established its websites in 15 high-income countries.
Amazon was initially an online retailer of books, but has
steadily expanded its operations. It now sells electronic
products, software, furniture, food, toys and jewellery.
Amazon has taken over many smaller businesses in
other countries. It operates joint ventures with other
businesses including Toys R Us, Marks & Spencer and
Mothercare.
Analyse the benefits that Amazon receives from
operating as a multinational company.
(6 marks)

Drawbacks of globalisation
New and fierce competition
UK businesses are exposed to fierce competition from overseas
firms as a consequence of globalisation. This can place them
under pressure to sell at lower prices. The prices of many
products such as clothing have fallen in UK shops in recent
years. This makes it more difficult for UK businesses to
compete, especially when some foreign businesses have the
advantage of lower labour costs. Thousands of jobs in the UK’s
steel industry have either been lost, or are at risk, because
imports of steel from China are more price competitive.
New competitors are also emerging as a result of globalisation.
The Chinese technology company Huawei only entered UK
markets in 2001, but now employs over 1,100 people. It
competes against UK businesses in a range of markets including
the installation of superfast broadband and networks for 4G
mobile phones. The emergence of new competitors makes it
more difficult for UK businesses to increase, or even maintain,

215
their market shares.

Threat of takeover
UK businesses are under increased threat of takeovers as a result
of globalisation. Buying a UK business is a quick way for a
MNC to acquire a well-known brand and gain a foothold in the
UK market. In 2010, the UK chocolate manufacturer Cadbury
was bought by the US multinational Kraft. The outcome of this
takeover was that Cadbury’s factory in Bristol was closed and
production was moved to Poland with the loss of 400 UK jobs.
Former suppliers to the Cadbury factory have also lost sales
following the takeover.

How UK businesses compete

internationally
Globalisation means that UK businesses face more intense
competition from foreign rivals in both national and
international markets. UK businesses can use two major
approaches to allow them to compete internationally.

216
Improving the design of their products
Product design involves the planning and production of a
good or service and may lead to adjustments to an existing
product or the creation of an entirely new one. Product design
includes a range of factors such as appearance, durability and
features. For example, car manufacturers continuously improve
their existing product ranges by adding features such as
automatic braking systems that help to avoid collisions. At the
same time they are developing new products such as self-driving
electric cars.

Key term
Product design translates the needs of consumers, or
the inventiveness of entrepreneurs, into a saleable

217
product.

By improving the design of its products a business can gain a

number of benefits, especially if its products are perceived to be
superior to those produced by competitors. A business can
charge a higher price if consumers prefer the design of their
products. Alternatively, the company may seek to maximise sales
by offering a product with a better design at a similar price to
rival products.

Quality and price

Quality measures the extent to which a consumer is satisfied
with a product. A high-quality product does not need to be
expensive or highly sophisticated: it merely has to meet
consumers’ needs. If a consumer is satisfied that a product meets
his or her needs fully, they are more likely to buy the product.
This decision is even more likely if the product is not sold at a
higher price than those charged by competitors for products of
lower quality.

Key terms
Quality is the extent to which a consumer is satisfied with
a product.
Price is the amount a business asks a customer to pay
for a single product.

Business insight
Merrythought
Merrythought Ltd is a UK soft toy manufacturer which has
been highly successful in selling its products in

218
international markets, especially in Japan. Recently, its
products have fallen in price overseas as the pound has
fallen in value. Below is an extract from the company’s
website.

‘Merrythought has handmade traditional teddy bears

in Ironbridge, Shropshire, UK since 1930.
Merrythought is a family business famous for crafting
the finest, jointed, mohair teddy bears. Every bear is
lovingly made by hand in our factory in the heart of
England, giving them a unique character and superior
quality that can last a lifetime. Every one of our bears
is a unique Merrythought design, artistically brought
to life using over 85 years of skills. Merrythought
teddy bears have universal appeal making them the
perfect gift for a christening, wedding or birthday as
well as special collectors’ items; our quintessentially
British teddy bears make a truly special lifelong gift.
We also make personalised teddy bears and
bespoke corporate teddy bears. You can personalise
our Traditional teddy bears to include someone’s
name, date of birth, anniversary or other special
date.’
Source: adapted from the Merrythought Ltd website

219
 1 Identify one way in which Merrythought Ltd
provides high-quality products.
(1 mark)
2 Analyse the possible reasons why Merrythought
Ltd is able to compete successfully in
international markets.
(6 marks)

However, quality and price work together to shape consumers’

buying decisions. If a business can match the quality provided
by a rival but sell at a lower price, it is more likely to succeed in
competitive international markets.

220
Long-established UK supermarkets such as Tesco and
Sainsbury’s have lost market share to competitors from Europe
such as Aldi and Lidl, who have been selling at lower prices.
Aldi and Lidl have developed a reputation for low prices and are
termed ‘discounters’. Because of this reputation Aldi and Lidl
have emphasised the quality of their products in their
advertising. Selling products judged to be good quality at low
prices is a reason for Aldi and Lidl’s success, which can be
clearly seen in Figure 2.14.

Maths moment
In August 2016, total sales revenue of supermarkets in
the UK was estimated to be £15,000 million.
Use the information in Figure 2.14 to calculate the
sales revenue for Aldi and Lidl in August 2016.

Some UK businesses have also been successful in using low

prices as a means of winning customers in international markets.
This approach is likely to be more effective when price (rather

221
than non-price factors such as design) is a key part of a
consumer’s decision to buy a product. In these circumstances
low prices can result in rapid increases in sales. The budget
airline easyJet is noted for its low prices and has been very
successful in increasing sales for its flights throughout Europe
and North Africa. In 2004, the airline carried 26 million
passengers; by 2015 this figure had risen to over 70 million.

Exchange rates
An exchange rate is the price of one currency expressed in
terms of another. For example, at the time of writing, the value
of the UK’s currency, the pound, could be expressed as follows:
£1 = $1.31 (US dollars)
£1 = €1.17 (euros)
£1 = ¥8.76 (Chinese yuan)

Key term
An exchange rate is the price of one currency expressed
in terms of another.

Effects of exchange rate changes on

export and import prices
Exchange rates are very important to businesses that engage in
international trade. Any UK business that imports raw materials
or components from overseas or that exports its products in
foreign markets will be affected by a change in exchange rates.
Exchange rates are an important factor for many UK businesses

222
as most are involved in international trade in some way.

Study tip
You will not be required to calculate the effects of
exchange rate changes on a business’s revenue from
sales or costs of production.

Rise in the exchange rate

If the exchange rate of the pound rises against other currencies,
it means that fewer pounds are needed to purchase goods and
services from other countries. Consequently, products imported
from other countries become cheaper. However, at the same
time, more units of foreign currency have to be exchanged for
each pound. This makes UK exports overseas more expensive.
Export sales are, therefore, likely to decline.

Fall in the exchange rate

If the exchange rate of the pound falls against other currencies,
this results in the opposite effects to those described above.
Imports to the UK become more expensive as more pounds are
required to buy a unit of the foreign currency. At the same time,
UK exports of products become cheaper as fewer units of
foreign currency are required to buy them.

Key term
Imports are goods and services purchased from
overseas customers in the domestic market.

The effects of these changes in the exchange rate of the pound

(or any other currency) are shown in Table 2.6.

223
Figure 2.15 shows that the pound fell against the two major
currencies over the year up to September 2016. In June 2016, the
UK held a referendum which resulted in a vote to leave the
European Union (EU) and, in response to this, the exchange rate
fell sharply. The effects of the changes shown in the figure
would be as follows:
• Goods and services imported from the USA and the 19
countries that use the euro as their national currency would be
more expensive in September 2016 compared to September
2015, ignoring any other changes.
• Products exported from the UK to those countries in
September 2016 would be cheaper than they would have been
in September 2015, again assuming no other changes occur.

224
Effects of exchange rate changes on
a business’s sales and profits
Changes in exchange rates mainly affect businesses that buy
imports from overseas for use in production, or those that sell
goods and services in other countries. However, a rise or a fall
in the exchange rate can affect the sales and profits of most
businesses.

Key term
Profit is the amount by which a business’s revenue from
all its sales exceeds its total costs.

Effects on a business’s sales

A fall in the exchange rate, as shown in Figure 2.15, offers
benefits to a business that exports as the price of its products

225
would fall when converted into a foreign currency. The
exchange rate of the pound fell by about 10 per cent against the
US dollar in June 2016. As a result, the price of UK exports in
dollars in the USA would have fallen by approximately 10 per
cent. A fall in price can be expected to increase sales of exports.
However, people and businesses do not decide whether or not to
buy goods and services just on price. Other factors such as
design, brand name, durability and reliability all affect buying
decisions. Therefore, a fall in price may not always lead to a
large rise in sales. Many UK exports are thought by overseas
consumers to be high quality. This means that sales of UK
exports are probably not affected greatly by changes in the
exchange rate.
Changes in the exchange rate of the pound can also affect
businesses selling in the UK only. A rise in the exchange rate
makes imports cheaper. This gives a price advantage to firms
that sell imports, for example, cars manufactured overseas. UK
car manufacturers such as Jaguar Land Rover may find it more
difficult to compete against these firms. In contrast, a fall in the
exchange rate makes imported products more expensive,
offering an advantage to UK businesses.

Effects on a business’s profits

A fall in the exchange rate, as shown in Figure 2.15 on page 103,
could be expected to increase the profits of a UK business that
exports its products. Its products would be cheaper overseas and
it could expect sales to rise. The business’s revenue from sales
should rise, helping to increase its profits.
However, it is likely that some of the resources used in
production will be imported. A fall in the exchange rate makes
imports of any kind more expensive. The firm’s costs of
production may rise. This could be balanced by the increase in

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profits to some extent.
A rise in the exchange rate could be expected to have broadly the
opposite effects on a business’s profits. Its products would
become more expensive overseas, possibly reducing its profits.
However, it may be that an increase in price has a limited effect
on UK export sales, as many are bought for reasons other than
low prices.

Business insight
Profits fall at Burberry
The UK fashion clothing manufacturer and retailer
Burberry recently announced that it had suffered a large
fall in profits. Its profits for the year to 31 March 2016
were £415.6 million, compared to £444.6 million for the
previous year.
Burberry, which is noted for its check design as well as its
trench coats, is seen as a classic UK luxury product by
consumers overseas. Burberry manufactures its clothing
in the UK as well as in several other countries including
China, Italy and Romania.

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The pound fell in value significantly in the second
half of 2016. Analyse the possible effects of this fall
in the exchange rate on Burberry’s profits.
(6 marks)

Summary
Globalisation is the process through which many markets
have become more international in scope. This offers
benefits and drawbacks to UK businesses. Changes in
exchange rates affect the sales and profits of most
businesses, particularly those that engage heavily in
international trade.

Quick questions
1 What is meant by the term ‘globalisation’?

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 (2 marks)
2 Which of these businesses is a multinational
company?
(a) A UK manufacturer that exports its products to 12
countries
(b) A UK business that imports raw materials and
components from Asia and Africa
(c) A UK business that competes against overseas
companies in the UK market
(d) A UK manufacturer with factories in the UK,
France and the USA
(1 mark)
3 Explain one reason why a UK company might want to
engage in international trade.
(2 marks)
4 Which of the following is not a result of globalisation?
(a) Higher prices for products in international markets
(b) Higher levels of migration between countries
(c) Greater flows of finance between countries
(d) Increased numbers of multinational companies
(1 mark)
5 What is meant by the term ‘inward investment’?
(2 marks)
6 Explain one benefit of globalisation to UK businesses.
(2 marks)
7 Explain one drawback of globalisation to UK
businesses.
(2 marks)
8 What is meant by the term ‘quality’?
(2 marks)

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 9 If the exchange rate of the pound rises, which of the
following will be true, assuming no other changes?
(a) The price of UK exports in foreign currencies will
fall.
(b) The price of imported products into the UK will fall.
(c) The sales of UK exports overseas will rise.
(d) The sales of imports into the UK will fall.
(1 mark)
10 State two reasons why a fall in the value of the pound
may not increase the profits of a UK business.
(2 marks)

Case study
Tata Steel
Tata Steel, the UK’s major steel manufacturing company,
announced the loss of 1,100 jobs in 2016. The whole UK
business was put up for sale by its Indian parent company.
This could result in the closure of its UK factories and the
loss of 15,000 jobs in total.
Tata Steel is making a loss of £1 million every day as it is
trading in a market in which prices have dropped very
sharply. This is the result of cheap imports of steel from
Chinese producers. China’s steel manufacturers produce
over 1 billion tons of steel each year and enjoy economies
of scale. Some people have criticised the Chinese
government for holding down the exchange rate of its
currency, the yuan.
Some economists hope that the substantial fall in the
exchange rate of the pound in 2016 might help Tata Steel

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to survive. Businesses in Europe buy large quantities of
steel.
Questions
1 Identify two actions which Tata Steel might take to help
it to sell more steel.
(2 marks)
2 Explain why a fall in the exchange rate of the pound
might help Tata Steel to survive.
(4 marks)
3 Analyse the possible reasons why Chinese steel
manufacturers are successful in selling their products in
international markets.
(6 marks)
4 Analyse the effects of globalisation on Tata Steel. In
your answer you should consider:
• the benefits of globalisation for the company
• the drawbacks of globalisation for the company.
Do you think that globalisation has benefi ted Tata Steel
overall? Justify your answer.
(12 marks)

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Topic 2.5

Legislation
There are many laws (also called legislation) that affect
businesses. A large number of these are intended to
protect a business’s employees at work. Other laws are
intended to protect consumers who buy businesses’
goods and services. In this topic, we look at a selection of
these laws and explain how they affect businesses and
the ways in which they can operate.
By the end of this topic, you should know:
• what legislation is
• how employment and health and safety laws affect
businesses
• the effects of laws designed to protect consumers on
businesses.

What is legislation?
The law is a framework of rules controlling the way in which
society is run. These rules apply to businesses and individuals.
Laws (or legislation) relating to employees attempt to strike a
balance in the workplace between the rights of employers and

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the rights of employees. The aim is to allow employers to use
labour efficiently while preventing the unfair treatment of
employees. Similarly, consumer protection laws prevent
businesses treating their customers unfairly, while allowing them
to sell goods and services profitably. When a law comes into
operation it is known as an Act of Parliament.

Key term
Legislation is a set of rules that governs the way society
operates. It is another term for ‘laws’.

Employment law
Laws protecting the rights of employees have increased greatly
over the last 30 years. Some of the most important ones are
explained below.

Study tip
This topic outlines a number of laws that apply to
businesses. You do not have to quote the names of these
laws in your examination, or the dates they were
introduced, but you should aim to understand how they
can affect businesses.

The National Minimum Wage and the

National Living Wage
The UK has had laws relating to minimum wage rates since
April 1999. Initially, this was called the National Minimum Wage
and the rates were updated to at least match rising prices.

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However, in 2015 the government decided that a new and higher
minimum wage was to be introduced from April 2016 for
workers aged 25 or over. This is called the National Living
Wage.

Key term
The National Living Wage is an hourly rate of pay which
is set by the government. All employees above a certain
age must receive at least this rate of pay.

The key elements of minimum wage laws from 2016 onwards

are as follows:
• Workers aged 25 or over must receive the National Living
Wage of at least £7.20 per hour. This rate is expected to
increase steadily to £9 an hour by 2020.
• For workers aged under 25, the National Minimum Wage rates
(and not the living wage rates) continue to apply. These range
from £3.30 an hour to £6.70 an hour, depending on the
employee’s age and status.
• All employees must receive the appropriate rate of pay as a
minimum. This includes temporary and part-time employees.

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National Minimum Wage rates change every October. National
Living Wage rates change every April. Table 2.7 summarises the
minimum rates of pay that different types of employee must
receive.

Business insight
The UK government has implemented a policy of ‘naming
and shaming’ employers who do not pay the minimum
wage. In February 2016, it publicised the names of over
90 employers who have not been paying the National
Minimum Wage.
The businesses owe workers more than £1.8 million.

235
 Most of this sum is owed by Total Security Services of
London. The three businesses who owed their employees
the most were:
• TSS (Total Security Services) Limited, London E4,
failed to pay £1,742,655.56 to 2,519 employees.
• Abbey House (Cumbria) Ltd, trading as Abbey House
Hotel, Barrow-in-Furness, failed to pay £13,468.47 to
13 employees.
• Richard Lewis Communications plc, Southampton,
failed to pay £8,751.99 to three employees.
The businesses concerned have to pay their employees
the money owed and may face prosecution as well.
Analyse the possible disadvantages to businesses
that are ‘named and shamed’ in this way.
(6 marks)

Equality Act, 2010

The UK government has passed a number of laws to prevent
discrimination against employees on the grounds of their
race, gender or age. In 2010, the Equality Act brought together
all legislation intended to stop discrimination.

Key term
Discrimination is treating one person differently from
another without having good reasons to do so.

This law says that employees cannot be treated differently in the

workplace on the basis of any of the following factors:
• age

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• disability
• race
• gender reassignment (people whose gender is different from
that at birth)
• marriage and civil partnership
• religion or belief
• pregnancy or maternity
• gender
• sexual orientation.

Other employment laws

There are a large number of laws giving employees a variety of
rights at work (see Figure 2.16). There are too many to identify
in full, but the list below will give you some idea of their extent:
• All pregnant employees are entitled to take 52 weeks’ leave
around the time of the birth of their child. Employers have to
pay a minimum level of pay to the worker during this period,
but can reclaim most of it from the government. The job has
to be kept open for the employee to return to if she wishes.
• All employees have a legal right to a paid holiday. Any
employee (whether full-time or part-time) in the UK has the
right to 5.6 weeks’ paid holiday each year.
• Working hours are subject to legal limits – for employees
above 18, these are limited to a 48-hour week on average.
However, workers can agree to work longer hours if they
wish.
• Employees have a legal right to choose whether or not they
wish to belong to a trade union. The owner of a business
cannot say that an employee should (or should not) become a
member of a trade union.
• Employees have to be given a contract of employment and

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 this must state the amount they are to be paid and when they
will receive that payment (weekly or monthly, for example).
• Staff are legally allowed to have time off for a range of
reasons including trade union activities and because a
dependant person (normally a child) is ill.

Key terms
A part-time employee works for a proportion of the
working week – for example, three days each week, rather
than five.
A trade union is a group of workers who act together to
improve their pay and working conditions.
A contract of employment is a legal document stating
the hours, rates of pay, duties and other conditions under
which a person is employed.

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How businesses are affected by
employment laws
It is easy to think that employment and other laws cause
disadvantages for businesses, for example, by making it more
expensive for them to produce goods and services. However, as
we shall see, legislation can bring benefits to businesses.

Profits
The minimum wage and living wage laws increase the costs of
production for many businesses, especially those that employ
workers who are relatively unskilled, such as cleaners or fruit
pickers. In the UK, a business has to pay at least £7.20 an hour
for a worker aged 25 or over; without this law, the rate of pay
might be lower. This means that the business’s costs are higher
than they might be and it may make the business less profitable.
However, it may be that employees are motivated by higher
rates of pay to work harder for the business. This may lead to a
workforce that is more efficient and less likely to take time off
work. Profits could rise as a consequence.

Key term
Motivation refers to the range of factors which influence
the way a person behaves at work.

Employment
It may be that some businesses decide to employ fewer people
because of the high wage costs they have to face. This is more
likely to happen if the employees are relatively unskilled and it is
easy to use machinery in their place. Research in 2016 suggested

239
that 20 per cent of businesses would employ fewer people
following the introduction of the National Living Wage.
Employment legislation, for example, that relating to
discrimination, affects all areas of employment. This includes
how businesses recruit employees, how they choose who to
promote to a more senior position and the rates of pay they
offer. The owners and managers of businesses have to make
sure that their job advertisements are not discriminatory in any
way. All people must be treated equally. Once people are
employed by the business, they must be paid the same rate for
the same job, irrespective of age, gender or racial group. Laws
on discrimination can lead to extra costs for businesses. For
example, a business may need advice on the law relating to
discrimination and this legal advice may be expensive.
However, discrimination laws may also offer substantial benefits
to businesses. Discrimination against older workers, for
example, may lead to a business not employing someone who is,
in fact, the best candidate for the job. Such discrimination could
result in the business not being as efficient as possible.

240
Employees’ rights
Meeting laws relating to employees’ rights can lead to businesses
paying additional costs. For example, a business has to pay
maternity pay to female employees from the latter stages of
pregnancy onwards. Although much of this pay can be
reclaimed from the government, it remains a major financial
issue for businesses. Having to pay some maternity pay as well
as paying a replacement employee can be costly. Furthermore,
the replacement employee may be unfamiliar with the business
or job and need training. The total effect of this can be to
increase the business’s costs significantly.
Once again, however, there are benefits to businesses from these
laws. The main benefit comes from improved motivation of
employees. For example, if employees can take time off to look

241
after a child or dependent adult in a crisis, then they are likely to
feel respected and valued by the business. This should improve
their motivation and job performance when they return to work.
Equally, giving employees time off for trade union meetings may
not sound like a cost-effective move, but it may help to create a
good relationship with the trade union and its members and help
to form a good working relationship. This might mean that
damaging disputes are less likely to take place.

Study tip
Try to think how employment and the other laws we
discuss in this chapter might affect all aspects of
business activity. For example, how they might affect the
company’s advertising, how it hires its employees or
organises the production of its goods or services.

Health and safety law

Health and safety law prevents businesses putting employees in
danger and so protects the workforce. The laws try to stop
accidents happening in the workplace.

The Health and Safety at Work Act,

1974
The main law in this area in the UK is the Health and Safety at
Work Act, 1974. This Act states that employers must “ensure that
they safeguard all their ‘employees’ health, safety and welfare at
‘work’”. The Act covers many business activities:
• the installation and maintenance of safety equipment and
clothing

242
• the maintenance of workplace temperatures
• giving employees sufficient breaks during the working day
• providing protection against dangerous substances
• fitting guards on dangerous machinery
• writing and displaying a safety policy.
The Act also requires employees to follow all health and safety
procedures and to take care of their own and others’ safety. The
Health and Safety Executive (HSE) oversees the operation of the
Act and carries out inspections of businesses’ premises. The
HSE also carries out investigations following any serious
accident in the workplace.
In June 2015, an accident occurred at the Alton Towers theme
park when a rollercoaster crashed causing serious injuries to five
people. The company operating the ride was fined £5 million for
failing to meet health and safety laws.
The Health and Safety Act can be updated at any time to take
account of changes in the way that businesses operate. For
example, it has been extended to cover the health of employees
using computers regularly at work.

243
What does this law mean for
businesses?
Meeting the requirements of this law will increase the costs of
the business. Businesses are likely to have to invest in training
employees in health and safety matters. Installing safety
equipment, carrying out health and safety inspections and
putting up the notices required by this law will also add to a
business’s costs. This is especially true of new small businesses,
or those that are expanding into new areas, which have to go
through these activities for the first time. This can be time-
consuming and costly.
There is a range of benefits to businesses, however, from health
and safety laws. Meeting the requirements of the laws means the
business avoids having to pay large fines (as in the case of
Merlin Attractions Operations Ltd which operates the Alton

244
Towers theme park). As we shall see in Chapter 4, an important
element in motivating employees is to make sure that their health
and safety needs are met. Health and safety law encourages and
guides businesses in meeting those needs.

Business insight
Builders’ merchants fined £2 million
Travis Perkins, a company that sells building materials to
individual consumers and businesses, has been fined £2
million after a customer died in an accident at one of its
yards. The customer was forced to load his car in the
yard, rather than the designated loading bay as a lorry
had parked there. He died after being run over by another
of the company’s lorries. Travis Perkins’ yards are busy
places visited by many lorries and vans.
The judge hearing the case said that it ‘was an accident
waiting to happen’.
Explain why this accident might affect the training
offered to its employees in future by Travis Perkins.
(4 marks)

Consumer law
Businesses can treat their customers unfairly in a number of
ways:
• by selling goods and services that are not as described – for
example, incorrect quantities stated on the packet
• by selling products that are unsafe – for example, toys
containing unsafe chemicals such as lead
• by selling products that do not work properly or at unfair

245
 prices
• by selling information about consumers to other businesses
without their permission.
Consumer laws are passed by the government to protect
consumers by preventing unfair practices taking place. They are
sometimes referred to as consumer protection laws.

Key term
Consumer laws are laws that have been introduced to
prevent businesses from treating their customers unfairly.

Consumer Rights Act, 2015

This law marked a major change in consumer laws in the UK. It
makes consumer laws simpler, stronger and more up to date. It
provides consumers with clear rights and protection when
buying goods and services.
The Consumer Rights Act covers:
• product quality
• returning goods
• repairs and replacements
• delivery rights.

246
This law requires that all products sold to consumers must be of
satisfactory quality (that is, not broken), fit for purpose and as
described. Consumers have the right to reject products that do
not meet these standards within a reasonable time. As many
goods are delivered to consumers’ homes nowadays, this law
protects consumers against:
• products ‘going missing’ before delivery
• late delivery.
Finally, the Consumer Rights Act protects buyers against unfair
terms in contracts between businesses and customers. Examples
include hidden fees and charges, especially when buying
products online. This law is being used to challenge airlines who
attempt to add on additional fees that are not publicised in their
headline fares for flights.
There are a number of other consumer laws that relate to
different aspects of selling products, as shown in Figure 2.17.

247
Labelling of products
Labels provide consumers with a lot of information and help
them to make decisions on whether or not to buy a product.
• Labelling of Food Regulations, 1970. This law states that
packaged food must contain the ingredients listed on the label.
• Weights and Measures Act, 1985. This law states that
weights and measures must be stated on packets or containers.
It also states that the measures must be correct.
• The Consumer Protection from Unfair Trading
Regulations, 2008. This law replaced most of the better-
known Trade Descriptions Act. It makes it illegal to give
consumers incorrect information on packaging and labels. It
also outlaws aggressive selling tactics by door-to-door
salespeople.

Buying products using loans

The Consumer Credit Act of 1974 stops businesses charging
very high rates of interest to consumers if they take out a loan
when buying expensive products such as cars. It also allows
consumers a week during which they have the right to change

248
their minds about agreeing to a loan.

Using information incorrectly

Modern businesses collect enormous amounts of data about
their customers and much of this is held on computers. It is
normal for businesses to have customers’ names, addresses,
credit card details and telephone numbers. This information has
to be used properly.
• Computer Misuse Act, 1990. This Act prevents people
looking at information stored on computers that they have no
right to read.
• Data Protection Act, 1998. This is an important law that
controls the use of consumers’ information. Businesses that
store information about consumers must do so securely and
avoid any theft or loss. It prevents consumers’ personal details
being sold or given to other businesses without the
consumers’ agreement.

Safety of products
A number of laws protect the safety of consumers:
• Food Act, 1984. This law lists those things that can, and
cannot, be added to food products. The law also makes it
illegal to make or sell food in unclean buildings.
• Consumer Protection Act, 1987. This law prevents firms
from selling dangerous products to consumers. It makes
businesses liable for any illness or injury to consumers caused
by using their products.
• Food Safety Act, 1990. This law makes it illegal to sell food
to consumers that is unsafe and may cause illness. The Act
covers farmers as well as restaurants and shops.

249
Business insight
The Body Shop
The Body Shop is a UK company which sells over 900
cosmetics products, such as body lotions and shampoo. It
operates throughout the UK, selling its products in 263
stores as well as through its website.

The company is well known for its commitment to

protecting the environment while supplying consumers
with high-quality cosmetics. Among its many
commitments, the company intends to:
• use resources in its products that can be traced and
seen not to damage the environment
• use resources in products that sustain specific species
of plants and animals and the livelihoods of local
communities.
The Body Shop uses its commitment to protecting the
environment in its advertising campaigns.
Explain one way in which consumer law might
affect The Body Shop’s advertising.

250
 (4 marks)

How businesses are affected by

consumer laws
Consumer laws also offer businesses benefits as well as
drawbacks. They increase businesses’ costs of production by, for
example, imposing standards regarding the quality that products
must maintain and requiring businesses to deliver products
promptly. Consumer laws also prevent businesses from finding
extra sources of revenue by, for instance, selling lists of
customers’ details to other organisations without permission
from the customers concerned.
However, consumer laws do offer benefits to businesses. Firstly,
the protection offered by laws can make consumers more
willing to make decisions to buy expensive and complex
products such as cars, computers and televisions. Without the
protection of the law, consumers may be concerned to buy
products about which they know relatively little and where they
rely on what businesses tell them about the products. As a result,
sales are higher than they may be otherwise.
Secondly, consumer laws encourage businesses to produce
goods that are safe, fit for purpose and as described. These laws
give businesses a clear framework in which to operate and mean
that rivals are limited in the same ways. As a consequence,
businesses compete on a level playing field when selling
products to consumers.

Summary
All businesses are affected by legislation. Legislation can

251
restrict activities as well as offer benefits. Legislation
affecting businesses covers the employment of people,
health and safety and businesses’ relations with
consumers.

Quick questions
1 What is meant by the term ‘legislation’?
(2 marks)
2 Which of the following factors is not covered by
employment laws relating to discrimination?
(a) Gender
(b) Race
(c) Sexual orientation
(d) Body art such as tattoos
(1 mark)
3 Which of the following statements about employment
law is the correct one?
(a) Only full-time employees are entitled to paid
holiday.
(b) Staff are entitled to time off when a dependent
(usually a child) is ill.
(c) There is no legal limit to the number of hours an
employee may be asked to work each week.
(d) Employees can only join a trade union with
permission from their employer.
(1 mark)
4 Explain one way in which employment laws in the UK
might affect the profits of a coffee shop chain such as
Starbucks.

252
 (2 marks)
5 Explain one way in which employment laws in the UK
might affect the types of people employed by a
supermarket.
(2 marks)
6 Explain one way in which a business might benefit
from the existence of the UK’s employment laws.
(2 marks)
7 State one example of a business’s activities that are
covered by the Health and Safety at Work Act.
(1 mark)
8 State two ways in which a business can treat its
customers illegally.
(2 marks)
9 Explain one way in which consumer laws might
increase a business’s costs.
(2 marks)
10 Explain how the Data Protection Act helps to protect
consumers.
(2 marks)

Case study
easyJet plc
easyJet plc is one of the UK’s best-known low cost
airlines. The company operates flights from the UK to 134
destinations in Europe. In 2016, the company had over
10,000 employees and employment costs are a major part
of its overall costs. The airline has a fleet of 233 aircraft
and 24 bases throughout Europe of which the largest is at
Gatwick. In 2015, it carried 70 million passengers. The

253
company has grown quickly and operates in a highly
competitive market with rivals such as Ryanair.
easyJet plc advertises heavily to win customers and
promotes its flights on the basis of low fares. In 2016, it
was possible to fly from the UK to many of the company’s
destinations for less than £40 per person. However, this
means that it is important for the company to control its
costs tightly. Many laws make it more difficult for easyJet
to do so.
The company is under pressure, along with other airlines,
to remove hidden fees from its charges. One example is
charging significant fees to change names on tickets.
These may be in breach of the Consumer Rights Act.
1 Identify two employment laws which might affect
easyJet plc’s business activities.
(2 marks)
2 Explain why employment laws might increase easyJet
plc’s costs.
(4 marks)
3 Analyse the possible benefits to easyJet plc from
having to conform to UK laws.
(6 marks)
4 nalyse the effects of legislation on easyJet plc. In your
answer you should consider:
• the effects of employment legislation on the company
• the effects of consumer laws on the company.
Decide whether employment legislation or consumer
laws have greater effects on the airline. Justify your
answer.
(12 marks)

254
Topic 2.6

The competitive
environment
Most businesses face competition from other businesses
which may be larger or smaller. Competition from rivals,
along with other factors, can make it risky to run a
business, and many fail each year. Despite the risk, an
increasing number of entrepreneurs are prepared to start
businesses.
By the end of this topic, you should know:
• what is meant by a market and competition, and be able
to analyse the impact of different levels of competition
on businesses
• the risks and uncertainties faced by businesses
• how businesses can minimise the risks that they face
• why entrepreneurs start businesses.

Markets and competition

What is a market?
255
A market exists where there are buyers and sellers. Buyers and
sellers come together to exchange goods and services and to set
prices for goods and services. For example, at any time in the
UK, many thousands of people are selling their houses, while
others are wanting to buy houses. Buyers and sellers exchange
information such as details of the house for sale and how soon
the buyers would like to move in. This and other information
(such as the price of similar houses locally) are used to set a
price for the house.

Key term
Markets exist where there are buyers and sellers.

256
Markets can be geographical – that is, a specific place where
buyers and sellers would meet. Bluewater shopping centre is an
example of this type of a market. However, many markets
nowadays are online. Buyers and sellers use technology to
exchange information and to agree prices. For example, music is
commonly bought and downloaded from the internet.
Some markets are local. When someone buys a haircut, they are
likely to buy the service from a business nearby. In contrast,
other markets are national or global. Car manufacturing
companies such as Volkswagen sell vehicles throughout the
world. At the same time, someone wishing to buy a new car can
buy from producers based in many different countries.

What is competition?
Competition exists when more than one business is attempting
to attract the same customers. Markets are normally competitive
because most businesses that sell goods and services face rivals

257
who are selling similar goods and services. Businesses selling in
local markets can face competition from other local firms as well
as national and international competitors. For example, a local
coffee shop may have a number of small rivals but also face
competition from multinational businesses, such as Starbucks.
Many businesses selling globally, for instance Apple, face
competition from other large businesses, such as Samsung.

Key terms
Competition exists when more than one business is
attempting to attract the same customers.
A monopoly exists when a business does not face any
competition in a particular market.

Different levels of competition

Businesses face different numbers of competitors. Some
businesses trade in markets with many competitors; others face
few rivals, although they can offer very strong competition. Very
few businesses face no competition. Many companies that
supply water to homes and businesses in the UK do not face
competition, as each region has its own supplier. Table 2.8
summarises the different types of competition that exist.

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A competitive firm is able to attract and keep its customers. The
customers of a competitive firm are normally satisfied and feel
that they are getting value for money. At the same time, a
competitive firm normally aims to make a profit.

Competition in markets with many

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businesses
Some markets have many small or medium-sized businesses. An
example of such a market in the UK is estate agents, who sell
houses for their customers. Many estate agents are small
businesses, with just a few branches. However, the UK has some
larger estate agents, such as Countrywide Estate Agents.
Businesses selling in markets made up of many small firms may
compete on price, especially if they provide similar products.
Painters and decorators, for example, may try to keep prices to a
minimum to give an advantage over rivals. In other cases, prices
may vary because the products sold are different. Many
restaurants are small businesses, and the price of their meals can
vary because they sell different products. A pizza restaurant sells
very different food to a Michelin-starred restaurant.
Globalisation is the trend for markets to become more
worldwide in nature. It has changed many markets that once had
mainly small firms. Nowadays, multinational firms have entered
some of these markets, and sometimes dominate them. The
coffee shop market in the UK has changed. Global businesses
such as Starbucks have become major sellers in this market.
Smaller coffee shops try to compete with multinational rivals by
providing something different. This may be a distinct range of
products or very high standards of customer service.

Business insight
Premier Inn opens new hotels in Edinburgh
Premier Inn operates more than 700 budget hotels
throughout the UK. It is known for its competitive prices: it
advertises its rooms for as little as £29 per night. Premier
Inn was the first major budget hotel chain in the UK to
advertise its hotels on prime-time television.

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 In 2016, Premier Inn announced that it was opening three
new hotels and updating two others in Edinburgh. The
hotels are in locations across the city. Following this
investment, Premier Inn now operates 14 hotels in
Edinburgh. Edinburgh has several small independent
hotels, as well as other chains of hotels, for example,
Holiday Inn.
Analyse how other hotels in Edinburgh might
compete with Premier Inn.
(6 marks)

Competition in markets with few

businesses
Many UK markets are dominated by a small number of large
businesses. Partly, this is a result of globalisation, which has led
to many businesses selling their products worldwide. Many UK
markets are dominated by a small number of businesses, which
each hold a large market share. These markets include
banking and mobile telephone services. Figure 2.19 shows that
the UK market for broadband services to landlines is dominated
by four firms.

Key term
Market share is the percentage of sales in a particular
market recorded by a business.

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 Maths moment
In 2015, there were 23.7 million customers in the UK with
a broadband service.
Use the data in Figure 2.19 to calculate the
difference between the numbers of customers who
buy broadband services from BT and Sky.

Firms in markets with a small number of rivals compete in

different ways:
• Price competition. Facing other large rivals in a market might
mean that firms avoid competing too strongly on price. They
may do this because they wish to avoid a price war (where
businesses aggressively lower prices), as the outcome is likely
to be lower profits for all businesses.
• Competing by developing new products. In some markets,
businesses will compete by introducing new products

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 regularly to win customers. This is very common in markets
based on technology or where fashions are important. For
instance, companies such as Apple and Samsung regularly
introduce new mobile phones.
• Competing through advertising. Some businesses respond
to a small number of competitors by advertising heavily. This
is more effective in markets where consumers change brands
or suppliers frequently. Suppliers of gas and electricity, such
as npower and EDF, make a lot of use of advertising and
special offers to attract new customers.

Markets where businesses face little

or no competition
A business that is the only supplier to a market is called a
monopoly. There are few markets in the UK where monopolies
exist. An example is the supply of water to homes and
businesses. Each region in the UK has a single supplier of water.
Thus, most people who live in East Anglia buy their water from
Anglian Water. The London Underground and the National Grid
(which operates the national networks used to supply gas and
electricity in the UK) are other examples of markets supplied by
a monopoly. Local monopolies can also exist. A small village
may only have one shop, or a town may have just a single hotel.

Study tip
Try to think of examples of markets which have different
levels of competition. Consider which ones are best for
important stakeholders such as employees or customers.
This will help you to understand the differences.

In other markets a single business may dominate the market and

only face competition from much smaller rivals. In 2016, Google

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had a 71 per cent share of the market for search engine usage by
desktop computers.
Dominating a market in this way offers businesses the chance to
set high prices as they face little or no competition. Consumers
could potentially be charged very high prices. For this reason,
the activities of monopolies are controlled by governments. For
example, businesses supplying water in the UK can only raise
their prices with the approval of Ofwat. Ofwat is a government
watchdog that makes sure that water companies look after their
consumers and do not, for example, charge prices that are too
high.

Businesses, uncertainty and

risk
Uncertainty and risk are different things. Risk is the
possibility of something going wrong and this possibility can be
measured. Businesses often take decisions which are risky. In
2016, a company called Dong Energy took a decision to invest
£6 billion to build a series of large offshore wind farms near the
coast of Yorkshire. The company will have measured the risks
associated with this investment. For example, it will have judged
the risk of electricity prices falling. If a decision is judged to be
risky, a business may only go ahead if it is likely to be very
profitable. Profits are the rewards for taking risks.

Key terms
An uncertainty occurs where there is a lack of
information about a situation. This means the outcome or
consequences are very difficult to predict.

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Risk is the possibility of something going wrong.

Business insight
Small shops, risk and uncertainty
Small shops in the UK face several challenges over the
next few years. A survey in Cambridge, in 2016, showed
that high and increasing rents threaten the survival of
many of the city’s small shops. High parking charges and
more online shopping are other challenges to small
shopkeepers.
Research by Retail Futures 2018 forecasts that high
streets throughout the UK will change:
• Total shop numbers will fall by 22 per cent by 2018.
• Online retail sales will rise from 12.7 per cent of total
sales (in 2012) to 21.5 per cent by 2018.
The decision by the UK to leave the EU (Brexit) led to a
mixed response from owners of small shops. For many
the consequences of the decision are difficult to forecast.
The situation will remain unclear until the negotiations
between the UK government and the European Union are
finished. For example, if leaving the EU causes job
losses, spending in small shops may fall.
Using examples from the text above, explain the
difference between risks and uncertainty.
(4 marks)

Uncertainty occurs when there is a lack of information about a

situation. Following the decision to leave the European Union,
many businesses in the UK have delayed major decisions. These
may be on whether to open new factories or whether or not to
start a business. Until the terms under which the UK leaves the

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EU are negotiated and made public, businesses lack information
on key issues. Managers do not know, for example, how easy it
will be for them to sell goods and services to consumers in the
EU after the UK leaves. They will take these decisions when they
have more information and can judge the risk involved.

The risks faced by businesses

Businesses face many risks. These can be separated into two
groups: internal risks and external risks.

Internal risks
Internal risks come from within the business itself. These types
of risk are easier to manage. The following are examples of such
risks:
• A business’s employees may refuse to work – known as
‘going on strike’. This happened to Southern Railways in 2016
when the trade union RMT announced strikes over the
number of employees staffing each train.
• A business may suffer fire or theft. Many businesses are
concerned about the security of their IT systems. There have
been a number of instances of hackers stealing the personal
and financial data of businesses’ customers. These are
sometimes sold to criminals. In 2015, the telecommunications
company TalkTalk had the data of more than 150,000 of its
customers stolen.
• A company may suffer falling profits due to bad publicity.
This may be for many reasons, such as treating employees
badly. Sports Direct, which sells sports clothing, announced in
2016 that its profits had fallen by 8.4 per cent compared to the
previous year. The company had been heavily criticised over
working conditions in its warehouses.

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• Businesses can lose their most talented employees to
competitors. This can reduce their efficiency. It is common,
for example, for highly paid entertainers to move to a
different television company.

External risks
These are risks that arise outside the business. They are more
difficult for businesses to control.
• A business may be faced by a new competitor. Businesses tend
to enter markets which are growing and where existing
businesses are very profitable. In 2016, Apple and the motor
racing company McLaren announced they were in talks to
jointly produce luxury cars. This would provide new
competition for companies such as Ferrari.
• Natural disasters such as floods and earthquakes can pose
serious risks for businesses. In December 2015, Storm Frank
caused severe flooding in northern England and southern
Scotland. Many small and large businesses had to cease
trading temporarily as a result.
• Governments can pass laws that can impact adversely on
businesses. For example, the introduction of the National
Living Wage in 2016 increased the costs of many UK
businesses.

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How businesses can minimise risks
There are a number of actions that businesses can take to
minimise risk. These actions cannot remove all risk, however.

Prepare business plans

A business plan sets out what a business does currently and
what it hopes to achieve in the future. To prepare a business

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plan, managers will research the views and opinions of
customers as well as the expected behaviour of competitors.
This will provide greater understanding of what might happen in
the market in the future and allow the business to be prepared
for likely events. This will reduce the chance of something going
wrong in the future.

Key term
A business plan is a document setting out what a
business does and what it hopes to achieve in the future.

Invest in training
Businesses can reduce risks by investing in training their
employees. This training might be used to reduce a number of
risks:
• to deal with insecure IT systems and cybercrime

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• to deal sensitively with dissatisfied customers
• to manage crises such as flooding.

Using experts and consultants

An important part of minimising risks is to identify them. Using
experts or consultants with specialist knowledge can help to do
this. This reduces the chance of businesses making major errors.
For example, a business might use public relations experts to
improve its reputation. This can help to reduce the risks of
falling sales as a result of bad publicity.

Selling in different markets

A business that sells in just one market is at risk of sales falling
if a new competitor emerges or if consumers’ tastes or fashions
change. This risk can be reduced by moving into new markets.
This is known as diversification.

Key term
Diversification occurs when a business starts selling
new products in new markets.

Samsung is probably best known for its smartphones, tablets

and televisions. However, Samsung’s managers have reduced
the company’s risk from falling sales by selling goods and
services in other markets. The company also makes military
equipment and ships, and it operates an amusement park.

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Why all businesses face uncertainty
Most businesses face uncertainty as the factors that cause it are
becoming more common. A number of forces can cause
uncertainty.

Economic uncertainty
In early 2008, the UK experienced an unexpected financial crisis.
This caused a major recession for the economy, and the value
of goods and services produced by businesses in the UK fell.
The recession was not forecast and was very severe. Most
businesses in the UK are affected by this type of economic
uncertainty.

Key term

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A recession occurs when the value of an economy’s
output of goods and services falls for six months or longer.

The decision in June 2016 to leave the European Union added to

the uncertainty felt by most businesses in the UK. A major cause
of this uncertainty is the lack of knowledge about the UK’s
future trading relationships, especially with the European Union.
UK businesses are unsure whether they will be able to sell goods
and services freely to customers in the European Union.

Competitors and uncertainty

We saw earlier that most businesses are subject to some
competition. Businesses have great difficulty in predicting what
their competitors will do. A business’s competitors might:
• cut their prices significantly
• introduce a new and popular product
• attempt to buy their rivals.
Actions such as these by competitors can cause difficulties for
any business. It is hard for any business to be prepared to
respond to so many possible challenges.

Social changes and uncertainty

Changes in society are not always easy to predict. Changes in
tastes and fashions can have major implications for a wide range
of businesses. Social changes are not always easy to forecast,
making it difficult to estimate future sales accurately. Soft drinks
manufacturers such as Coca-Cola have experienced falling sales
of many products as consumers have become more aware of the
dangers of sugary products.

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Entrepreneurs and new
businesses
Entrepreneurs have to be able to manage risks. They also
have to show determination and motivation, as well as having a
good idea for a new business. Entrepreneurs start businesses for
a variety of reasons, including the desire to be their own boss,
the need to have work or just because they want to develop an
interest or a hobby.

Key term
An entrepreneur is someone who is willing to take the
risks involved in starting a new business.

Starting a new business can be very risky and many do not

survive beyond a year or two; only 50 per cent are still trading
after five years. Entrepreneurs who plan their new enterprise
carefully and have previous experience of running a business
are more likely to succeed. We looked at entrepreneurs in more
detail in Chapter 1.

Business insight
Peter Roberts and Pure Gym
Peter Roberts started his chain of gyms in 2009. At first,
the business had four sites in Edinburgh, Leeds,
Manchester and Wolverhampton. As of 2016, it has more
than 170 gyms throughout the UK. Pure Gym has
822,000 members. Gym fees are very low compared to
competitors. Pure Gym members pay between £11.99
and £34.99 each month.

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Peter Roberts has set up other businesses in the leisure
industry, including nightclubs and hotels. He came up with
the idea of Pure Gym when he saw low cost gyms
operating overseas. He said that he spotted a gap in the
market as most other gyms charged much higher fees.

Many new businesses fail. Explain one reason why

Pure Gym has survived.
(4 marks)

Summary
All businesses trade in markets and most compete with
other sellers to attract buyers (or customers). The amount
of competition a business faces can vary and this has
significant implications for how the business operates.
Businesses face both risks and uncertainty, and
managers take a variety of actions to minimise risks.

274
Despite the existence of risks, a large number of
entrepreneurs start businesses each year in the UK.

Quick questions
1 What is meant by the term ‘market’?
(2 marks)
2 Explain, using an example, why most markets in the
UK are competitive.
(3 marks)
3 A monopoly exists in which of the following situations?
(a) There are a small number of large businesses
selling products in a market.
(b) There are many small businesses selling products
in a market.
(c) There are a few large businesses and some small
firms selling products in a market.
(d) There is a single business selling products in a
market.
(1 mark)
4 Explain one way in which businesses may compete in
markets made up of a few large firms.
(2 marks)
5 Explain one reason why selling products that are
similar or identical to those sold by rivals makes prices
an important form of competition.
(2 marks)
6 Identify one market supplied by businesses facing little
or no competition.
(1 mark)

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 7 Explain the difference between risk and uncertainty.
(3 marks)
8 State one internal risk and one external risk that a
business may face.
(2 marks)
9 Explain one way in which a business might minimise
the risks it faces.
(2 marks)
10 Explain what is meant by the term ‘entrepreneur’.
(2 marks)

Case study
Mercia Probiotic Skincare (MPS)
Sarah Marsh likes taking decisions (and not orders from
others!). She recently became unemployed and has
decided to set up Mercia Probiotic Skincare (MPS) - her
first business! She plans to create beauty products from
all-natural ingredients, guaranteed free from harmful
substances.
Sarah has not researched the opinions of possible
customers before starting her business. The market for
skincare products is very competitive with large firms
(L’Oreal, for example) and many small ones selling
products. She was worried how competitors might respond
to her business. There are also many safety laws relating
to making and selling skincare products.
Sarah knows little about how to raise money to start a
business. She hopes to be able to use the internet to sell
her products. However, she wants to minimise the risks in
starting her business. She is considering preparing a

276
business plan and asking an experienced consultant to
give her advice.
1 State two reasons why Sarah wants to set up her
business - Mercia Probiotic Skincare (MPS).
(2 marks)
2 Explain why Sarah faces some uncertainty before
starting her business.
(4 marks)
3 nalyse how Sarah might be able to compete with
established businesses that produce skincare products.
(6 marks)
4 Analyse how Sarah might minimise the risks involved in
starting her business. In your answer, you should
consider:
• the benefits of creating a business plan
• the possible use of a consultant with experience of
the skincare products industry.
You must evaluate which factor will be most effective in
reducing the risks she will face. Use evidence to
support your answer.
(12 marks)

Chapter review – Influences on business

Read question 1, the sample answers and the comments.
Then try question 2.
1 Read Item A and answer the questions that follow.
Item A
D&C Ltd operates bus and coach services in Devon and

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Cornwall. The company offers two types of services:
• regular bus services throughout the two counties – used
mainly by people for essential reasons such as going to
work, school or shopping in local towns
• holidays – coach tours to all parts of the UK and
Europe.
D&C Ltd has had to pay the National Living Wage since
April 2016. A number of its employees have received a
pay rise. Several commented that a pay rise was overdue.
The company’s profits have been very low and the very
competitive market makes it difficult to raise prices. At the
same time, it is forecast that the level of unemployment in
Devon and Cornwall will rise significantly over the next two
years.
D&C Ltd is considering converting its fleet of buses and
coaches to use hydrogen as a fuel. This will be more
environmentally friendly and will reduce fuel costs by £1
million a year. Research shows the plan is approved by 95
per cent of local people. The company will have to borrow
£5 million to pay for the conversion.

(a) Identify two ways in which D&C Ltd’s activities

affect the environment.
(2 marks)
(a) The company affects the environment in lots
of ways. Its buses and coaches can cause
congestion as they are likely to run at busy
times in the morning and evening. Also D&C
Ltd’s buses and coaches will cause air and
noise pollution as they travel through towns
and cities in Devon and Cornwall which could
cause some health problems for local people.

278
 The response does contain all the necessary
information, but is much too long for a question
only worth two marks. Also the question only
asked for two ways to be identified whereas
this answer explains them. It is important to
understand that questions ask for different
types of responses. If a question asks you to
identify or state something, it does not need an
explanation.

(b) Explain one effect that paying the National Living

Wage might have on D&C Ltd.
(4 marks)
(b) Those employees who have received a pay
rise because of the National Living Wage will
be happy and may be more motivated and work
harder. This could improve the performance of
the workforce. This could have quite a big
impact as the employees felt that they should
have had a pay rise earlier, so might be quite
motivated by this increase.

This answer is of a suitable length and has

done exactly what was called for. It has
explained just one effect and has used
information from the case study to help to
develop the explanation. It is an effective
answer in that it combines relevant knowledge
with evidence from the Item.

(c) Analyse how the demand for D&C Ltd’s bus and
coach services might change if unemployment does

279
 rise.
(6 marks)
(c) If unemployment in Devon and Cornwall rises
as forecast, the incomes of people in the area
can be expected to fall. This will reduce
demand for bus and coach services as people
will have lower incomes. As they have less
money to spend, they will reduce spending on
most things, including travel.
But D&C Ltd has two services. It provides bus
services, which are essential for many people.
So this might not be affected as much as
coach services which are for people going on
holiday. If people lose their jobs and incomes,
they stop buying luxuries like holidays.
Demand for coach travel could fall a lot, while
that for bus services may only fall a little.

The answer also uses relevant and carefully

selected knowledge and uses the correct
information from the Item to support it. One
particular strength is recognising that the
impact on demand for the company’s services
will be different for bus and coach services.
This is a thoughtful answer. Thinking carefully
and planning before writing answers is always
a good idea.

(d) Recommend whether or not D&C Ltd should

convert all its buses to run on hydrogen. Give
reasons for your advice.
(9 marks)

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(d) There are reasons why D&C Ltd should
convert its buses. It is not earning high profits
as it faces tough competition, and it cannot
increase its prices. The conversion to
environmentally friendly hydrogen as a fuel is
supported by 95 per cent of local people.
Making this conversion may allow the
company to increase prices without losing too
many customers. It might be able to increase
its prices significantly for its coach tours
which would help to improve its profits.
On the other hand the company might
struggle to pay for the conversion as it will
require it to borrow £5 million. It may be
difficult for the company to do this when it is
only making small profits, and the policy may
be too expensive. If it has to repay the loan, it
may not be able to pay its employees more
wage increases.
Overall, I recommend that the company should
make this investment. It will improve the
company’s image and is popular with local
people and could be used in adverts. Most
importantly it is financially sensible. As using
hydrogen will reduce the company’s fuel costs
by £1 million a year, it will pay for the
investment within five years.

The arguments made are clear, developed fully

and think about how a decision to convert the
buses and coaches to run on hydrogen will
affect different parts of the business, such as

281
 advertising and employees’ pay. It also
includes some valuable numerical data by
calculating the time taken to repay the
investment. It is always answering the
question. It makes effective use of the
information given in the Item to develop its
arguments. Finally, the recommendation that is
offered is sensible given the earlier arguments
and is justified fully.
2 Read Item B and answer the questions that follow.
Item B
Reston Ltd in the UK manufactures electric bicycles. It
sells about 60 per cent of the bicycles it makes in
America, where its brand is very fashionable. The rest are
sold in the UK, where many are bought using loans.
Reston Ltd buys its steel and other components from
China.

It is facing a major decision. Its current factory is old and

expensive to operate. It is not large enough if the company
achieves the 25 per cent increase in sales it hopes for
over the next two years. It would need to recruit 25 new
employees and is keen to increase the number of females
in its workforce.

Its new factory would be large enough to allow it to

produce twice as many electric bicycles as is currently
possible. However, the company would need a large loan
to pay for the factory.

Two economic issues need to be considered by the

company. The exchange rate of the pound has recently
fallen by 10 per cent against other major currencies such

282
as the American dollar and the Chinese yuan. Interest
rates are also forecast to rise by 3 per cent over the next
year.

(a) Explain two ways in which employment laws might

affect Reston Ltd.
(4 marks)
(b) Analyse one way in which the change in the
exchange rate might affect Reston Ltd’s profits and
sales.
(6 marks)
(c) Analyse whether Reston Ltd should build its new
factory. In your answer, you should consider:
• the effects on Reston Ltd’s costs of production
• how the economic changes might affect demand
for Reston Ltd’s bicycles.
Should Reston Ltd’s managers decide to build the
new factory? Justify your answer.
(12 marks)

283
3 Business operations

In this chapter, we look at production and production

processes, procurement, customer service and quality.
We look at the different methods of production and
examine the advantages and disadvantages of each
method. We consider how the right (or the wrong)
suppliers of goods can have an impact on businesses,
and how a business might choose the right supplier for
them. Linked to this, we examine the concept of quality –
and how good quality can be achieved. Finally, we look at
the importance of customer service, and the benefits that
good customer service can bring to a business.

284
Topic 3.1

Production processes
All businesses produce something. Manufacturing
businesses produce goods, such as furniture, clothing or
clocks. Other businesses provide services, such as
hairdressing, dental care or cleaning. All types of business
involve production – bringing together the resources
needed to supply the good or service. This topic
introduces you to the production methods and looks at
how operations can be undertaken efficiently, using as few
resources as possible. We will look at the issue of quality
and consider how businesses can produce goods and
services that satisfy their customers. We will also
consider the factors influencing good customer service
and how this can help a business.
By the end of this topic, you should know:
• the advantages and disadvantages of different methods
of production, such as job and flow production
• how production can be made more efficient
• how lean production can increase efficiency.

Production management
285
Production (or operations) management refers to all the
activities in managing the transformation process. Production
takes inputs and turns them into outputs and delivers these to the
customer.

Methods of production
Production is the process of changing inputs, such as raw
materials, energy and labour services, into goods and services
that can be sold. We often think of production in the sense of
manufacturing, but it is also a central part of supplying services.
To supply a service, such as office cleaning, it is necessary to
bring together the following resources:
• people to organise the business and to do the actual cleaning
• cleaning materials and equipment, such as vacuum cleaners
• vans or cars to transport cleaners to the offices that need to be
cleaned
• fuel to put in the vans or cars.

Key terms
Production (or operations) management refers to all
the activities in managing the transformation process.
Production is the process of changing inputs such as
labour services into goods and services that can be sold.

The production process brings together these resources and

286
gives the result of a clean office.

Job production
Job production is a method of production in which a product
is supplied to meet the exact requirements of a customer. For
example:
• Garden design. Businesses designing (or redesigning)
gardens will discuss the customer’s needs, offer their own
ideas and supply a product that is unique to that customer.
• Tailors. Many tailoring businesses will make clothes, such as
suits, to meet the needs of their customers. Clothing is made
to the customer’s size and choice of design and material.
• Personal trainers. Some people have personal trainers to
improve their individual fitness and health. The trainer will

287
 provide a diet and exercise programme to suit the individual
customer’s needs.
• Restaurants. In many restaurants, meals are prepared and
cooked to meet specific customers’ needs. For example,
someone ordering a steak would say how they want it cooked
and might choose a particular combination of vegetables to go
with it.

Key term
Job production is a method of production in which a
product is supplied to meet the exact requirements of a
customer.

Job production is used by businesses to gain an advantage over

larger rivals. For example, a small tailoring business cannot
expect to supply clothing as cheaply as a large company.
However, the business may be able to justify its higher prices
because it supplies a personal service. Job production is also an
appropriate way to supply some personal services, such as
hairdressing, dental care and healthcare, where each customer’s
needs are different. Job production may also be the best
approach when it is not possible to use technology to produce
large quantities of similar products.
Job production is an expensive method of production as each
product is different and may involve changes in the production
process. Unless the business is sure that it can charge high
prices, it may find it difficult to make a profit. A further
disadvantage of job production is that it often requires skilled
employees and, therefore, considerable amounts of training.

Business insight
The Flower Shop

288
 The Flower Shop provides flowers for special occasions
such as weddings, birthdays and anniversaries.
According to its website:

‘We are a family run business located in Codsall,

Wolverhampton. The Flower Shop is a well-
established business within Codsall, and has been
trading since 1951.

We’re sure that our continued effort and passion for

floristry enables us to continue designing your floral
gifts to the highest level and assuring you of our
quality assurance at all times. We aim to take every
care in each order, ensuring that it is unique and
designed to suit the occasion. By keeping up to date
with modern designs, techniques and expertly gift-
wrapped in our signature presentation packaging, we
aim to ensure that your order surpasses your
expectations.’
Source: www.theflowershoponline.co.uk

Analyse why this business uses job production as

its method of production.
(6 marks)

Flow production
Small businesses often use job production, producing one-off
items that are made specifically for their customers. For
example, a business may produce kitchens made exactly to each
customer’s requirements or a personalised birthday cake. This
approach to production is flexible and can meet customer needs
very precisely, but tends to be quite expensive.

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As demand increases and businesses have to produce thousands
or millions of items, a different approach to production is
required. McDonald’s could make a different meal for each of
its customers tailored to each individual’s taste, but this would
slow up the production process and the business would no
longer be producing fast food. Innocent Drinks could have
someone personally filling each bottle, but it wouldn’t be able to
produce many bottles a year. Typically, when firms are
producing on a large scale, they will use flow production
techniques. This involves continuous production; each item
moves continuously from one stage of the process to another.
Imagine a bottling plant filling thousands of bottles with juice
every day. Each bottle is cleaned and filled, a cap is fitted, a label
is added and it moves on to be packaged without stopping.

Key term
Flow production occurs when an item moves
continuously from one stage of the process to another.

Advantages of flow production

Advantages of flow production include:
• It allows firms to produce huge volumes of output and,
therefore, enables them to sell in large numbers (assuming the
demand is there).
• It allows for specialisation. This means the process is
broken down into a series of stages and individuals specialise
in each one. By specialising, individuals can become more
efficient at what they do through repetition. This can speed up
the process and make people more productive. Specialisation
is also called ‘division of labour’. Specialisation can make it
easier to recruit and train people because recruits have fewer

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 tasks to learn.
• It is relatively cheap per unit. Although it is expensive to buy
the equipment to begin with and to set up the process, the
costs are spread over millions of units of production so the
cost of each one is actually low. Imagine you spend £5 million
on a flow production process and produce 50 million units;
the cost for each unit is only 10p.

Key term
Specialisation occurs when individuals focus on a limited
number of tasks.

Disadvantages of flow production

The disadvantages of flow production include:
• The initial costs are high. A production line can cost millions
of pounds and the business may not be able to afford this.
• It is risky. Businesses need to invest a lot of money to be able
to produce on a large scale. The danger is that demand will
fall and the expensive equipment will not be used efficiently.
If the business ends up producing only a few items, the
process works out as being very expensive per item.
• It may lack flexibility. A flow process can produce millions of
items, but these are all fairly similar. However, recent
advances in technology do mean that, even with flow
production, it is possible to make slightly different products to
meet customer orders (for example, different colours and
different features). Even so, flow production is not as flexible
as job production, and it is not possible to produce to the
particular tastes of each customer.
• Specialisation and division of labour can lead to boredom and
dissatisfaction. Employees may tire of doing the same limited

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number of tasks and may leave the business. Absenteeism and
a high proportion of people leaving can be expensive and
disruptive for a business.

Study tip
When considering whether a business should introduce
flow production, you need to consider issues such as:
• the cost
• the likely level of demand
• the need for flexible production.

Maths moment
A business uses a production line with high fixed costs.
Assume that the variable cost per unit is £2.

Complete Table 3.1 and calculate the impact on unit

cost as it increases the scale of its production.

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 Business insight
Model T Ford.

One of the most famous cars ever made is the Model T

Ford, which was produced by Ford from 1918. The car is
famous because it was the first to be made using flow
production techniques. The cars moved along the
assembly line and at each stage another part of the car
was fitted. The introduction of flow production increased
the number of cars being made and meant they were
much cheaper to produce. Ford cars were sold at a price
much lower than anyone else’s and meant this was the
first car that was affordable for millions of people.
Analyse how flow production helped the success of
the Model T Ford.
(6 marks)

Efficiency
The efficiency of a business refers to how well it is using its

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resources to produce. If a business uses a high level of inputs to
produce its output, it is inefficient compared to another business
that uses fewer inputs to produce the same output. If it produces
its output using relatively few inputs, then it is regarded as
efficient. The efficiency of a business can be measured by
looking at the cost per unit. If a business does not use many
resources to produce, then its cost per unit should be low. An
inefficient business will have higher unit costs.
The efficiency of a business will depend on factors such as:
• how well employees are managed – if they are managed well
and motivated they should produce more and, therefore, the
cost per unit should be lower
• how good suppliers are – if suppliers are reliable and provide
good-quality supplies, then this helps to keep costs lower
• investment in machinery and technology – if a business has
good-quality equipment and up-to-date technology, this
should help to keep the costs of production low
• the way in which the products are produced – if items are
handmade, this is likely to be expensive; if products are made
on a mass scale using flow production, this can mean
production is much more efficient. Businesses can also reduce
the cost per unit by reducing the amount of waste; this is
called lean production.

Key term
Lean production is an approach to production that aims
to minimise waste.

Lean production
Lean production techniques aim to reduce the amount of waste

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in a business. Waste is inefficient; if a business can reduce waste,
it can reduce costs. There are many forms of waste in a
business:
• If production exceeds demand, then items may have to be
thrown away.
• Wasted time is inefficient and costs money. In flow
production, if workers have to wait to start work because the
stage before has not been finished, they are wasting time.
• Any faulty products will have to be re-made, costing money.
• Holding stocks can be wasteful because they can get damaged
or stolen. In addition, holding stocks costs money (for
example, warehouse costs for storage of materials and
components) that could otherwise have been earning interest
in the bank – so there is an opportunity cost.
Lean production techniques were first developed by Toyota, one
of the world’s largest car companies, in Japan. They include
just-in-time production and kaizen production.

Key terms
Just-in-time (JIT) production holds as little stock as
possible. Items are ordered just in time to be used.
Kaizen means ‘continuous improvement’. It is an
approach to production that aims to achieve change from
a series of small steps.

Just-in-time production
Just-in-time (JIT) production means producing to order – the
business only makes an item when there is a customer for it.
This reduces the waste caused by throwing unwanted items
away and also means the business should not hold any stocks

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(or at least as few as possible). When a customer places an
order, the business orders from suppliers and starts producing.
However, for just-in-time to work, suppliers must be able to
respond very quickly to orders and must deliver products that
work – to respond to customers’ orders quickly, you cannot
afford for anything to go wrong.

Kaizen
Kaizen means ‘continuous improvement’. It is an approach in
which all employees are involved in improving how things are
done. Every day, employees (usually in teams) think about what
happened the day before and look for ways of improving the
production process. The changes that come out of these
discussions are often very small, but over time they can add up
to significant improvements in the way that work is done. By
involving employees, a business learns from the people who
actually do the work and who are most likely to know how to
improve things.

Lean production and employees

A lean approach to production requires employees to be
involved in helping the business to improve. For example:
• There will be no stocks with just-in-time production so any
disruption by staff (for example, a strike) can be very
damaging. Managers must work closely with employees to
make sure that relations between them are good and there are
no stoppages.
• Kaizen requires employees to find better ways of doing things.
This means they need to be motivated and want to help.
Again, this means relations between managers and staff need
to be good.
• To avoid waste, employees need to check the quality at every

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 stage of the process. This means they must be trained in how
to check the work properly, and they must be willing to send
work back if it is faulty.

Study tip
To be effective, lean production needs a workforce that is
co-operative and wants to help the business. This means
the management style must encourage involvement and
participation. The business will also need to focus on
preventing mistakes rather than fixing them and on
working with suppliers that can produce just in time.
Adopting a lean approach is not easy – it requires
everyone to focus on reducing waste.

Overall, the lean production approach requires employees to be

committed to the same goals as managers, to feel part of the
business and to want its success. Being more involved in
improving and checking things can motivate employees,
although some may resist the approach and think it represents
more work.

Business insight
Toyota
Toyota is known worldwide as a lean producer. It has
pioneered many techniques to reduce waste. It produces
cars to order. It aims to build and deliver a car that has
been ordered by a customer as quickly as possible.
Its process is:
1 A vehicle order is received and a production instruction
is issued.
2 The assembly line has the parts needed to assemble
the vehicle.

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3 The assembly line replaces the parts used (by the
preceding process).
4 The preceding process is stocked with small numbers
of all types of part.
Analyse why the Toyota production process
described above is lean.
(6 marks)

Summary
As businesses grow, they might introduce flow production
techniques. These have advantages, such as low unit
costs, but also disadvantages, such as less flexibility than
job production. Flow production can help a business to
become more efficient. Lean production can help
efficiency by reducing waste.

Quick questions
1 What is meant by ‘job production’?
(2 marks)
2 Explain one advantage of job production.
(2 marks)
3 Explain one disadvantage of job production.
(2 marks)
4 What is meant by ‘flow production’?
(2 marks)
5 Explain one advantage of flow production compared to
job production.
(4 marks)

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 6 Explain one disadvantage of flow production
compared to job production.
(4 marks)
7 What is meant by ‘efficiency’?
(2 marks)
8 What is meant by ‘lean production’?
(2 marks)
9 What is ‘just-in-time production’?
(2 marks)
10 What is meant by the term ‘kaizen’?
(2 marks)

Case study
Bonobos
The Bonobos store in Manhattan is located next to well-
known brands such as Zara and Gap. Shoppers can look
at the rows of clothes before deciding what to buy.
However, the difference with Bonobos compared to most
stores is that customers cannot take the clothes they want
to buy home! The company has no stock, apart from
display items. This business model has been used for big
items that are difficult to take home such as furniture;
however, it has not been used a lot by clothes retailers.
Bonobos now has 20 shops like this in the USA. It plans to
open at least seven more. Its outlets have many different
styles of clothing in many sizes, but not every style in
every size. Sales staff have the sole job of helping each
shopper find clothes he or she likes, identify the proper fit
and help customers order the clothes online.
All of Bonobos’ stock is held at one central warehouse.

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This allows Bonobos to rent far less store space because
it does not need an area for stock. It also does not:
• need staff to unpack deliveries and spend lots of time
refilling the shelves
• get left with stock that it then has to discount to sell,
reducing its profit margins.
Other stores like Bonobos are Paul Evans and Jack
Erwin, two shoe companies which have showrooms in
York, where shoppers can inspect the shoes and then
order online. Warby Parker does the same for glasses.
The companies that are testing out such showrooms
began online. Big, established retailers are unlikely to
convert stores to showrooms, at least in the foreseeable
future. They have customers used to seeing and buying
rather than ordering and waiting. Delivering to individuals
rather than shipping in large quantities to stores would also
require the established retailers to change their
distribution networks significantly. However, because
these showrooms are cheaper to run than conventional
shops, they can open more of them, more quickly. Will this
be the future of retailing?
1 What is meant by ‘stock’?
(2 marks)
2 Explain why a clothes retailer may want to hold stock.
(4 marks)
3 Analyse the potential benefits of holding relatively little
stock.
(6 marks)
4 Evaluate whether it is better for a business to hold high
levels of stock or low levels. Justify your answer.
(12 marks)

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Topic 3.2

The role of procurement

This topic will examine the relationship between a
business and its suppliers. We will analyse the importance
of suppliers and how significant it is for a business to
manage them effectively.
By the end of this topic, you should know:
• the difference between just-in-time and just-in-case
approaches to managing stock
• the factors that might influence the choice of suppliers
• the effects of procurement and logistics on a business
• the value of effective supply chain management.

Managing stocks
All businesses hold stocks of some form. These may be day-to-
day supplies, such as paper and pens, raw materials,
components or semi-finished products. The nature and
importance of stock will vary from business to business. A
supermarket, for example, will hold significant amounts of
products on its shelves. This represents money that is tied up in
stock – there are millions of pounds worth of goods on the

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shelves of Tesco and Sainsbury’s at any moment. In a school by
comparison, the stock may be items such as paper, printer ink,
and light bulbs. In a car factory, there will be stocks of
components needed to produce the cars, as well as many cars at
different stages of the production process and even some that
are finished and ready to sell.
Stocks are important because a business needs them to operate
and produce. A sandwich shop without any sandwiches will
have difficulty operating. A car manufacturer without any
engines to install in the cars would also be in trouble. Having
stocks can also be attractive because it may mean you have a
wide range of products to show customers. Customers can
wander up and down the aisles of the supermarkets enjoying the
amount of choice they have.
At the same time, they do represent an investment – all the
money that is invested into stock could be in the bank earning
interest; this means stock has an opportunity cost (see Topic
1.1). Businesses also worry that they may get left with stock they
cannot sell. Imagine you are managing a fashion retailer and
decide that the ‘in’ colour this year is green and, therefore, buy
in thousands of clothes coloured green. It turns out you misread
the market and the ‘in’ colour is red, leaving you with millions
of pounds of unsold stock. You either have to discount it or
simply get rid of it, leading to far less profits than you had
imagined. There are, therefore, reasons why businesses might
not want to hold stock or, at least, want to hold as little as
possible.

Study tip
Remember the importance of context. In some industries,
such as manufacturing, retailing and restaurants, stocks
are extremely important. In an accountancy or design
business, they are probably less significant.

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Just-in-time stock control
As we saw in Topic 3.1, one approach to stock control is known
as just-in-time (JIT). This attempts to minimise the amount of
stock held. Stock arrives just in time to be used in the
production process. In manufacturing, for example, this means
there are very regular deliveries of supplies which are used in
the process rather than buying in large quantities and stockpiling
components.
This approach means there is less stock held and so:
• there is less money tied up and a lower opportunity cost
• there are fewer materials to be damaged (or even stolen) while
waiting to be used
• less space is needed to warehouse the stocks, so this land can
be sold off or put to another use.
However this approach does mean that:
• there are more deliveries, so this may have an environmental
impact and cost more
• the business is vulnerable to any delays from suppliers, as this
will halt production.

Just-in-case stock control

In the past, businesses have tended to adopt a just-in-case
(JIC) approach. They have held stocks just in case they might be
needed. This is good in terms of always having stock available
for production or sales. It also means the business is likely to be
buying large quantities of supplies in bulk. This may lead to
lower prices due to purchasing economies of scale and
may mean there are fewer deliveries, leading to lower delivery

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costs. However, a just-in-case approach may be quite inefficient
in terms of factors such as storage costs. The trend in recent
years has been towards a JIT approach.

Key terms
Just-in-case (JIC) production holds stocks just in case
there is a delay from supplies or a sudden unexpected
increase in demand.
Purchasing economies of scale occur when the cost
per unit falls if large orders are placed with suppliers due
to a bulk discount.

Just-in-time v. just-in-case
Businesses need to balance the advantages of a just-in-time
approach (which means the business is leaner) with a just-in-
case approach (which means the business has spare stock if
demand suddenly increases). Businesses will adopt different
strategies. For example:
• Zara orders smaller amounts of stock very frequently. This
means it can respond quickly to changes in fashion and
change its stocks regularly. It has very little stock at any
moment so rarely has to reduce the price to sell it. This helps
improve profits. However, it does have to pay for frequent
deliveries. This is a just-in-time approach.
• Uniqlo holds large quantities of relatively few product lines. It
orders ‘classic and timeless’ items in bulk, enabling it to
benefit from economies of scale and relatively few deliveries.
This is more of a just-in-case approach.
Neither of these approaches is necessarily better, but they are
different approaches to stock.

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Business insight
The Toyota Production System
The Toyota Motor Corporation’s way of making cars,
known as the Toyota Production System (TPS), has the
objective of ‘making the vehicles ordered by customers in
the quickest and most efficient way, in order to deliver the
vehicles as quickly as possible’. It is based on:
• Jidoka. This means that when a problem occurs, the
production line stops immediately, preventing defective
products from being produced.
• Just-in-time. This occurs when each process
produces only what is needed by the next process in a
continuous flow.
Based on the basic philosophies of jidoka and just-in-time,
the TPS can efficiently and quickly produce vehicles of

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 sound quality, one at a time, that fully satisfy customer
requirements.
See www.toyota.co.jp for more about the TPS.
Analyse the benefits to the company of the Toyota
Production System.
(6 marks)

Working with suppliers

The success of a business depends on many factors including
the choice of its suppliers.
All businesses will use supplies. These supplies may be:
• general items used to keep the business going, such as energy,
telephones and cleaning products
• materials used in the production process – for example, a car
will include thousands of different supplies, such as engine
parts, tyres, paint and seats
• major purchases used to create the production process – for
example, the production line equipment in the car factory.
The purchase, or procurement, of supplies is an important
part of operations management. In big business, millions of
pounds may be spent on suppliers, and there will be specialist
managers responsible for the procurement of supplies. Managers
will want to make sure their money is used wisely and not
wasted and that the right suppliers are chosen. Procurement
involves selecting suppliers, establishing the terms of payment
and negotiating the contract.

The supply chain

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The supplier of a business will also tend to have its own
suppliers and this creates a supply chain.

Key terms
Procurement (or purchase) involves selecting suppliers,
establishing the terms of payment and negotiating the
contract.
The supply chain refers to all the businesses, people
and activities that take part in the production processes
from the start until it gets to the customer.

The supply chain refers to all the businesses, people and

activities that take part in the production processes from the start
until it gets to the customer. For example, a supermarket may
sell a packaged meal that was produced by a business that
bought its vegetables from another business that bought this
from a farmer who bought tractor equipment from another
supplier. These businesses are all part of the supply chain.
Businesses now trade all over the world and so the supply chain
can be very complex. Just look at the shelves of your local
supermarket and think of how many different businesses have
been involved all over the world to get those products on the
shelves. Deciding what to stock, where to buy it from and then
co-ordinating the orders and deliveries with what needs to be on
the shelves on any given day is a very complex business.

Why suppliers matter

The suppliers of a business can affect its success in many ways.
For example:
• If suppliers can deliver products on time, this means the
business has the stocks that it needs and can meet its own

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 customer requirements. It will not run out of supplies or be
unable to produce or sell. The reliability of suppliers is,
therefore, very important as it helps a business to plan its own
activities effectively.
• If suppliers can produce and deliver quickly and reliably, a
business can hold relatively little stock because it can be
replaced; this reduces its stockholding costs.
• If a supplier provides good-quality products, this will help the
reputation and quality of the business. It will not have
problems with defects and returned items.
• If the supplier can produce efficiently, this will help reduce the
costs of the business and enable it to provide its products at a
better price or increase its own profit margins.

Choosing suppliers
The choice of suppliers is a critical one for businesses because it
will affect the success of what they do. The choice will involve a
number of factors, such as:
• the costs
• the quality
• the range of products that can be supplied
• the speed of delivery
• the flexibility of the supplier (for example, in terms of the
quantities that can be produced and the time of deliveries)
• the reliability (that is, the ability to deliver within a given time
slot)
• the reputation (that is, what have others said about working
with this business)
• the payment terms (for example, how long would the business
have to pay)
• the contract terms (for example, what financial compensation

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would be paid if deliveries were late).

Business insight
Unilever and Tesco
In 2016, Unilever and Tesco were in a dispute over the
price of many leading brands, such as Marmite. Unilever
produces a range of very well-known brands, such as
Persil washing powder, Ben & Jerry’s ice-cream, Dove,
Lipton and Marmite. Unilever is the UK’s biggest grocery
manufacturer, but many of its products are made outside
the UK. Unilever argued that the fall in the value of the UK
exchange rate made it more expensive to buy many
supplies from abroad and that this meant that higher
prices needed to be charged to supermarkets. Unilever
had wanted to raise its prices by about 10 per cent, but
Tesco refused to pay. This led to Unilever stopping
supplies for a while and this resulted in a shortage of their
products in some Tesco stores. After negotiations, the
companies reached an agreement.
Analyse the factors Tesco might consider when
deciding whether to carry on buying from Unilever.
(6 marks)

Business insight
Inditex’s supplier code of conduct
Inditex is the company that owns clothes shop Zara.
Inditex has a code of conduct for all of its suppliers. It
wants its suppliers to work ethically and responsibly.
The code covers many areas including:
• no forced labour

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 • no child labour
• no discrimination
• respect for freedom of association and collective
bargaining
• no harsh or inhumane treatment
• workplace health and hygiene
• the right to remuneration
• reasonable working hours
• documented employment
• production traceability
• product health and safety
• an environmental pledge.
Source: www.inditex.com

Analyse why Inditex has a code of conduct for its

suppliers.
(6 marks)

Logistics
Logistics refers to the movement of goods, services,
information and money throughout the production process. It
involves managing and ensuring everything is in the right place
when it should be. Think of the importance of logistics to a
business such as Amazon. It has to get items from producers to
its warehouses and from there to customers. It aims to do this in
an efficient and as fast a way as possible. Consider what is
involved to get the product you ordered from Amazon delivered
to your door 24 hours later and you can imagine what logistics
involves. When your order is placed, Amazon will find the
relevant items in one of its huge warehouses as quickly as
possible, dispatch it to a local distribution centre and then

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organise for it to be picked up and delivered to you. Effective
logistics is time-efficient, cost-efficient and reliable.

Key term
Logistics refers to the movement of goods, services,
information and money throughout the production process.

Business insight
Amazon’s fulfilment centres
Amazon has 12 fulfilment centres in the UK. This is where
orders come to and are then distributed from (fulfilled).
These fulfilment centres have the capacity to ship up to
1.5 million items a day.

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 Analyse the factors that might influence where
Amazon locates its fulfilment centres.
(6 marks)

Trade-offs in the supply chain

Deciding which suppliers to work with may have trade-offs. For
example, it may cost more to get better quality (although this
may save money later on as it may lead to fewer problems with

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customers). It may cost more to get supplies quicker.
For example, the Emma Maersk carries thousands of containers
around the world. It does this very efficiently, but slowly. If a
business wanted supplies more urgently, it might fly them in; this
would be quicker but more expensive.

Suppliers and quality

A quality production system is one that meets its targets
consistently. A poor quality system does not meet its targets.
McDonald’s, for example, develops processes that enable it to
deliver burgers that meet set standards time and time again all
over the world. This is a high-quality process. Amazon can
promise to deliver within a set time frame, and if it achieves this
consistently, it is achieving quality in its operations.
The role of suppliers in helping a business meet quality targets
should be clear. A poor supplier may be late or may send items
that have defects. This can lead a business to run out of stock or

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sell items that are not as good as promised.

Summary
All businesses buy in supplies and the nature of these will
affect many aspects of the performance of a business,
such as its costs and the quality of what it does.
Businesses need to consider carefully which suppliers
they work with and how they manage them. They need to
weigh up factors such as the price charged by suppliers
with the quality and flexibility of what they do.

Quick questions
1 What is meant by ‘procurement’?
(2 marks)
2 State two factors a business might consider when
choosing a supplier.
(2 marks)
3 Explain one way in which suppliers affect the quality of
a business.
(3 marks)
4 What is meant by ‘logistics’?
(2 marks)
5 Why might there be a trade-off when choosing
suppliers?
(2 marks)
6 Explain two ways suppliers might affect the
performance of a business.
(4 marks)
7 State two types of supplies a car manufacturer might

315
 buy.
(2 marks)
8 Explain what is meant by ‘purchasing economies of
scale’.
(2 marks)
9 What is the difference between the just-in-time and
just-in-case approaches to managing stock?
(4 marks)
10 Explain one benefit of a just-in-time production
system.
(2 marks)

Case study
The production of Wimbledon’s tennis balls
To produce a product that is seemingly so simple as a
tennis ball actually involves a number of producers all over
the world. The complex supply chain involves clay being
shipped from South Carolina in the USA, silica from
Greece, magnesium carbonate from Japan, zinc oxide
from Thailand, sulphur from South Korea, glue and rubber
from the Philippines and rubber from Malaysia to Bataan,
where the rubber undergoes a chemical process that
makes it more durable.
Wool travels from New Zealand to Stroud in
Gloucestershire, where it is turned into felt and then sent
back to Bataan in the Philippines.
At the same time, petroleum naphthalene from Zibo in
China and glue from Basilan in the Philippines are brought
to Bataan, where Slazenger actually manufacture the ball.
Lastly, tins are shipped in from Indonesia, and once the

316
balls have been packaged, they are sent to Wimbledon.

1 What is meant by a ‘supply chain’?

(2 marks)
2 Explain why logistics is important in the production of a
tennis ball.
(4 marks)
3 Analyse the factors considered when choosing
suppliers used in the production of a tennis ball.
(6 marks)
4 To what extent do you think managing the supply chain
affects the success of a business?
(9 marks)

317
Topic 3.3

The concept of quality

This topic considers the meaning and importance of
quality in business. We will also examine how quality can
be achieved and the costs involved in doing so.
By the end of this topic, you should know:
• the meaning of quality
• the importance of meeting customer expectations
• how businesses measure quality and identify quality
problems
• the consequences of quality problems
• the methods of maintaining consistent quality: Total
Quality Management (TQM)
• the costs and benefits of maintaining quality.

The meaning of quality

To achieve quality, managers must define what they are trying to
achieve, and this means they must define what they think the
customer wants. A quality product is one that meets the
customer’s requirements. A business should set targets for it
operations: for example, it will be produced by a set time, it will

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have certain features, and it will be delivered by a given day
within a given slot.

Meeting customer
expectations
Achieving quality involves hitting targets that have been set by
the business in order to meet customer expectations. The targets
set will depend on the nature of the business. For example:
• A hospital might set targets for the length of time patients are
kept waiting before being seen, how long it takes to treat
patients and how many operations are successful.
• An airline might set targets relating to the percentage of planes
taking off on time, the percentage of planes landing on time,
the percentage of people who have their bags lost and
customer satisfaction ratings of the quality of the service on
the plane.
• A chocolate manufacturer might measure the number of
products meeting the right weight targets, the number of
products meeting the taste targets, the number of deliveries
leaving the factory on time and the number of customers who
were billed correctly.

Measuring quality and

identifying problems
Once a business has set standards for quality, it can then
measure whether or not these have been achieved. To measure
performance it may ask different groups. For example:

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• Customers. Many businesses ask their customers to complete
surveys. Many also have telephone lines that customers can
ring to let them know what they have done well or badly.
Businesses like Starbucks and Pret A Manger encourage
customers to speak to the store manager if they have a
complaint or an idea for improvement. This way the business
finds out directly what its users think. If the number of people
filling in these forms or making contact is not enough, the
business might undertake other forms of primary market
research to find out what they think.
• Mystery visitors. Some businesses, such as hotels and
restaurants, employ mystery visitors to use the product in
secret to test the quality of service. This may give a good
outsider’s view of the business, although staff may feel that
they are being spied on.
• Staff. Staff can be asked to check the quality of the work
done, either at each stage of the process or at the end. Staff
can check to see if any mistakes have been made. A quality
control system, for example, checks products to see if there
are any defects. This might involve taking samples of the
product to check how well they work. Quality assurance
focuses on preventing mistakes occurring. This involves
training employees to inspect their own work, choosing the
right suppliers to make sure the supplies have no faults and
checking the work at each stage to make sure faulty work is
not passed on.

The consequences of quality

problems
If products do not meet the standards set, this will lead to:

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• customer dissatisfaction – customers may not buy the product
again or recommend it to others; if customers are unhappy,
they tend to tell others and this damages the brand
• the cost of recalling faulty products – customers need to be
told about any mistakes, and the business must pay to get the
products handed back in
• the cost of replacing goods – new items may have to be
produced to replace the old ones
• the cost of waste – if there is poor quality, then items may
have to be thrown away
• the cost of goods that are produced but no one wants
• the cost of legal action if the business is sued for poor quality.

Maintaining consistent quality

To maintain quality, a business should:
• make sure its suppliers are reliable and that the products they
use are of good quality and meet their needs
• train staff so they know how to do their jobs properly and
what the desired standards are
• invest in equipment so that staff have the equipment they need
to do the job well
• inspect the products at each stage of the process to make sure
there are no defects – it is easier and cheaper to catch any
problems along the way than to rely on finding them at the
end
• involve staff in improving the process (for example, through
kaizen groups) to find ways of doing things better and
removing errors.

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Total Quality Management
One approach to achieving better quality is to focus on
inspection. If faults are there, you make sure you find them.
This is known as quality control.
Another approach is known as Total Quality Management
(TQM). TQM requires everyone in the business to be working
towards ensuring the quality targets are met. It focuses on
preventing any mistakes occurring rather than fixing them later.
It is called ‘total’ quality because it regards quality as everyone’s
job. You cannot produce something and expect someone else to
check whether it is acceptable – you need to do this yourself.
This approach stresses that everyone has a customer – whatever
you do, you pass your work on to someone else and they are
your customer. Customers may be internal (that is, colleagues
within the business) or external (customers who buy the
product), but whoever your customer is, you need to give them
work that meets their requirements. This means that everyone
needs to be clear what the targets are and have the training and
resources to be able to meet them. TQM recognises that all
employees can help the business to improve and that quality is
not just something that the quality control department should
worry about.

Key term
Total Quality Management (TQM) is an approach to
quality in which everyone is focused on preventing errors
occurring and ensuring quality at each stage of the
production process.

However, not every employee will like the introduction of a

TQM approach because this means they have to monitor their

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own work and be prepared to send work back to the person
who passed it on to them if it is not good enough. Not everyone
will want this extra responsibility.

The costs and benefits of

maintaining quality
The costs of improving quality
Poor quality can be very expensive. However, it may be worth
spending more to improve quality and prevent problems
occurring later.
The costs of achieving better quality include:
• the costs of inspection and checking – known as quality
control
• the costs of training staff to check their own quality
• the costs of selecting better suppliers.

The benefits of maintaining quality

Good quality is important for several reasons:
• Customers are more likely to come back and recommend a
business if they know they can trust the quality. One of the
benefits of McDonald’s or Starbucks is that customers know
what they are going to get. By comparison, you are never sure
when you try a new café what the food will be like and
whether it will be the same next time you visit – you are
taking a risk. If you have a bad experience at a business (for
example, your flight is cancelled and you miss a day of your
holiday), you may not use the business again if you can help

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 it. Maintaining quality will make it easier for the business to
launch more products in the future because the brand name
will be known and trusted.
• Avoiding mistakes saves money. If a firm sells a product that
is faulty it has to take the product back and replace it. If there
is a design problem, the firm may have to redesign the
product or change how it is made. If the product is dangerous,
the company may even be sued by customers. It is cheaper to
get it right the first time.
• A business should be able to charge more for a quality
product because customers will pay for reliability and for the
reassurance that what they buy will work and do what it is
supposed to.
• It may improve the brand and reputation of the product.

Study tip
Remember that good-quality products are not necessarily
expensive – they simply do what they are expected to and
are excellent value for money. To achieve quality,
managers must set the targets that customers want and
then make sure they achieve these targets time and time
again. To achieve good quality, the firm may have to
spend money at first, but it can save money in the long
run.

Problems achieving consistent quality

To achieve good quality requires good suppliers, well-defined
ways of doing the work and regular monitoring of performance.
This can be difficult as a business grows because it may
franchise its operations or outsource some of its production. In
order to grow quickly, the business is giving up control over

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some aspects of production and this can mean that quality may
suffer.

Business insight
Samsung’s Galaxy 7
In 2016, Samsung stopped selling its Galaxy 7
smartphone and offered replacements for anyone who
had already bought one. A number of phones had
exploded due to problems with the battery. The company
used several suppliers, and there seemed to be a
problem with one of them. The company introduced extra
quality checks, but ultimately decided to withdraw the
product.
Analyse the possible costs to Samsung of the
problems with its Galaxy 7.
(6 marks)

Summary
The quality of a product depends on whether it meets the
customers’ needs. To achieve good quality, managers
must define what they want, introduce ways of making
sure these targets are achieved and measure how well
they are doing against these targets. It is important to
maintain consistent quality, which can be achieved in
various ways such as training, investment and working
with suppliers.

Quick questions
1 What is meant by ‘quality’?

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 (2 marks)
2 State two ways quality may be measured in a hospital.
(2 marks)
3 State two ways quality may be measured in a car
manufacturer.
(2 marks)
4 State two problems caused by poor quality.
(2 marks)
5 State two costs of improving quality.
(2 marks)
6 State two benefits of having good quality.
(2 marks)
7 What is meant by ‘Total Quality Management’?
(2 marks)
8 Explain one reason employees might resist the
introduction of Total Quality Management.
(2 marks)
9 State two ways in which a business might measure
the level of quality it is achieving.
(2 marks)
10 Why might McDonald’s be described as a high-quality
food provider?
(2 marks)

Case study
Sounds Alive
Johnny Cash is the managing director of Sounds Alive, a
producer of digital radios, which are sold worldwide. The
company produces these using flow production

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techniques. The work is organised using specialisation
and the division of labour. Over the last few years, Johnny
has introduced some aspects of lean production to the
business to improve its efficiency, such as just-in-time
production, but Johnny knows there is more work to do.
His main focus at the moment is to improve the quality of
the company’s products. There has been an increasing
number of products being returned as faulty in the last few
months, and Johnny is determined to sort this out. The
business has a quality control department, but Johnny
wants to introduce a Total Quality Management approach.
Johnny thinks the quality problems might be connected
with the rapid growth of the company in the last couple of
years. Big orders from abroad mean he has expanded
production significantly. While getting bigger has brought
many advantages, there is no doubt it has also caused
some problems.
1 Explain two possible problems to Johnny’s business of
using division of labour.
(4 marks)
2 (a) Analyse the case for Johnny introducing Total
Quality Management.
(6 marks)
(b) Analyse the case for him not introducing Total
Quality Management.
(6 marks)
(c) Recommend whether Johnny should introduce Total
Quality Management. Explain your answer.
(12 marks)

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Topic 3.4

Good customer service

This topic looks at what is meant by customer service and
the ways in which businesses can offer these to a high
standard. It also covers the ways in which the use of ICT
can help businesses to offer high standards of customer
service.
By the end of this topic, you should know:
• what good customer service is
• the methods of good service
• the benefits of good customer service
• the dangers of poor customer service
• how ICT can help businesses to offer good customer
service.

What is good customer

service?
Good customer service means keeping customers happy.
Customer service can occur before you buy an item (for
example, advice online), when you buy (for example, help in-

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store) and after you have purchased an item (for example, when
asking for further help and support).

Key term
Customer service is the part of a business’s activities
that is concerned with meeting customers’ needs as fully
as possible.

Methods of good service

The product
Good customer service depends on the quality of the products
themselves. Businesses can provide high-quality customer
service by making sure that the goods or services they supply
meet the needs of customers. This depends on a number of
factors.

Reliability
Goods should be reliable and do exactly what is expected of
them; for example, customers expect painters and decorators to
paint houses in such a way that the work will last for years
without fading or peeling.

Safety
Customers worry about safety when buying some products; for
instance, airlines have to take great care to protect passengers
who fly with them.

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Customer engagement
Positive customer engagement occurs when the business
build a relationship with the customer by providing a good
customer experience. The customer feels positively about the
business and is therefore more likely to buy from it and
recommend it to others.

Good product information

Customers expect clear information about goods and services.
This helps them to make the right decision about which product
to buy. As an example, many customers expect to read
nutritional information about foods as this helps them to eat a
balanced diet. So, businesses producing products such as jams,
cakes and beers will list nutritional information on the labels. It
is important that customers understand what they are buying.
Customer engagement will also be helped by well-trained staff
who understand the features and benefits of each of the
products and so can provide useful advice and guidance to
customers. Employees should be helpful and respond quickly
and in a friendly way to enquiries from customers. This will
help ensure customers feel positive about their buying
experience.

Post-sales (after-sales) service

Post-sales (or after-sales) service is an important feature
of customer service. Post-sales service includes:
• dealing quickly and fairly with complaints
• delivering products without delays – this is important when
products are perishable, such as fresh foods
• exchanging goods that are faulty or do not meet customers’

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 needs
• repairing goods (free of charge if under guarantee).

Premises
Hotels, shops and restaurants must maintain their premises
well to keep customers happy:
• Premises should be clean, especially where food is prepared,
cooked and eaten.
• Customers should be able to find their way around the
business. For example, it is very important that hospitals
should be clearly signposted.
• Disabled customers will be dissatisfied if they are unable to
use a business’s products. A recent change in the law means
that all businesses have to make ‘reasonable’ changes to allow
disabled people to buy their products.
• Customers expect good facilities, for example, rooms for
changing babies’ nappies in high-street shops.

Key terms
Positive customer engagement occurs when
customers have a good experience from their contact with
the business.
Post-sales (or after-sales) service is the meeting of
customers’ needs after they have purchased a product,
for example, by repairing or servicing the product.
Premises are the buildings used by businesses – these
may include offices, shops and factories.

Different methods of payment

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Businesses may benefit from meeting customers’ needs by
offering a variety of ways of paying for goods and services.
Small businesses can increase sales by accepting cheques and
credit cards and also by providing small quantities of products at
proportionally low prices.

Managing customers’ expectations

An important part of customer service involves managing
customers’ expectations. If you expect a shop to be open at 9
a.m. and it opens at 9.15, you may be annoyed. If you were told
from the start it would be 9.15 you may not have minded. If you
were told in a restaurant that you would be served in 15 minutes
and the food comes in 10 minutes you might be impressed. If
you were told that the food would arrive in 5 minutes and it
came in 10 minutes, then you may be disappointed. Businesses
need to think carefully about what they promise and make sure
they meet or exceed their promises. A golden rule of customer
service is: never over-promise!

Study tip
When answering questions on this topic, try to think of
features of customer service that are relevant to the type
of business on which the question is based. For example,
a restaurant might offer high-quality customer service by
providing attentive waiters and a menu that gives a lot of
information about the food and wine.

Benefits of good customer

service

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Good quality customer service is important because it helps
businesses to be competitive. It is one way in which businesses
can make themselves distinctive and compete successfully with
their rivals.

Business insight
Center Parcs
Center Parcs operates a number of short-break holiday
villages in the UK. It is highly rated for its customer
service. It is rated above world class level for customer
service according to the Institute of Customer Service.
According to the company, it achieves this through
investing in staff training and investment in improving
accommodation, leisure facilities and restaurants.

Analyse the reasons why high levels of customer

satisfaction are important for Center Parcs.
(6 marks)

Increase in customer satisfaction

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Good customer service should increase customer satisfaction
and lead to more repeat business. It should help to:
• attract new customers – if a new business is supplying a
similar good or service to those that are already on the market,
then good customer service can make it distinctive and help it
to gain new customers. New customers may be attracted by
the recommendation of others.
• increase the customer spend – satisfied customers will be
attracted to the business and spend more as a result. They may
buy more of a given product and/or try some other products
produced by the business.
• increase the market share – the market share is the percentage
of sales in a particular market that is achieved by a given
business. If the customers of the business are satisfied (or
more than satisfied) by the service they receive, they may tell
friends about it, and the business may have good publicity.
This may lead to increased sales and a bigger share of the
market.
• increase customer loyalty – a new business that gives its
customers what they want in terms of customer service is less
likely to lose them to other businesses. This is referred to as
customer loyalty.
• increase profitability – if good customer service leads to more
customers, more sales and greater brand loyalty, it should
result in greater profitability for the business.

Key term
Customer loyalty means that a business’s customers
make repeat purchases because they prefer the
business’s products to those of its rivals.

Business insight
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 First Direct
First Direct is an online and telephone banking service
that regularly wins customer service awards.
According to its website, what makes it different is not
what it does (it offers savings accounts and so on, like all
banks), but the way it does it. When you contact the
company, it listens, it talks to you and it is always aware
that it is your money! It does not have an automated
system. It does not ask you to press 1 for X and 2 for Y; it
respects its customers and knows they like talking to real
people.
To make sure customers get the service they need they
are on the phone and online 24 hours a day, including
bank holidays. It has anticipated the growth in phone
banking and internet banking and has been ahead of its
competitors in these areas. And they say they love what
they do!
Analyse the ways in which excellent customer
service might benefit a bank.
(6 marks)

Dangers of poor customer

service
Why does poor customer service
occur?
Poor customer service occurs in the following situations:

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• Businesses promise too much. They raise customers’
expectations and then do not provide. For example, an online
shop promises 24-hour delivery and the item comes after three
days. A business needs to ensure it has the resources it needs
to meet the promises it makes. If it cannot do this, it must
promise less or invest in more resources.
• Poor communication. It may not be made clear to customers
what the level of service is. You may turn up to a theme park
expecting to go straight on the rides. If it is clear there will be
some delays, then you expect that and will not be upset by it.
If the delays are not communicated to you in advance, you
may not expect them and will be upset by queuing.
• Poor management. The business may have the resources to
fulfil its promises and meet the expectations created, but it
may not manage its resources properly. Perhaps staff are not
allocated the right jobs, or the equipment is not scheduled to
be used effectively.
• External factors. Poor service may occur due to external
problems, such as delays from suppliers.

The effects of poor customer service

Poor customer service is likely to lead to:
• dissatisfied customers – they will not return to buy from the
business
• problems attracting new customers
• a loss of revenue and profits
• costs, if a business has to reimburse customers because they
have been sold the wrong items, given the wrong information
or sold the wrong products.

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How ICT can help businesses
to offer good customer service
Information and communications technology (ICT) is
important to businesses. This technology can help businesses to
improve their customer service in many ways, and in many
cases, the amount of money that has to be invested in ICT is
relatively small.

Key term
Information and communications technology (ICT)
are the computing and communications systems that a
business might use to help to exchange information with
stakeholders.

Using websites
Even very small or newly set up businesses can have their own
website. Websites offer customers up-to-date information about
businesses and the products that they sell. They can be a
relatively cheap form of advertising. A website can be set up for
several hundred pounds, and a web designer can be hired fairly
cheaply to spend a few hours each week maintaining and
updating it.
A website can help to offer good customer service in a number
of ways:
• It can give the customer information about the business and
can include pictures and videos to tell them more about the
product and the business. This helps the customer to make a
well-informed decision about whether or not to buy the

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 product.
• It can help to advertise a small business to a much larger
group of customers, leading to increased sales.
• It can include answers to frequently asked questions (FAQs).
This can be a quick way for customers to find out answers to
simple questions such as ‘What are the business’s opening
hours?’
• It can offer advice to current customers if they have problems
with a product that they have bought. They might be able to
find the solution to their problem or can use the website to
contact the business to ask for help. Using email allows
customers to contact businesses immediately with any
problems or complaints..

E-commerce and m-commerce

Many businesses have developed their websites further and use
them not only to advertise their products but also to engage in e-
commerce and m-commerce to sell their products directly to
customers through the internet.
E-commerce and m-commerce offer many advantages to
customers:
• Customers can view products at any time of day from all over
the world.
• Customers can see other peoples’ reviews of the products.
• Customers may be able to ask questions to an online support
team.
• Customers may receive suggestions of other products they
may like from the company.
• Customers may benefit from lower prices as online businesses
do not have to pay high street rents.

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Social media
Social media involves the use of websites and applications
that allow people to create and share content or to participate in
social networking. Examples of social media include Facebook,
Twitter, Snapchat and Pinterest; these are now very important
aspects of communicating about your business, your customers
and your products. It is a way of accessing large numbers of
existing and potential customers and helping build awareness of
the business and its products, informing them about
development and persuading them of the benefits. It is a very
powerful means of communication and promotion. Businesses
can also get feedback from customers and monitor their
satisfaction.

Data analysis
Data analysis involves gathering and examining data to
provide useful information that can be used for decision-
making. Improvements in information and communications
technology mean businesses can now gather much more
information about their customers than ever before. They can
also analyse the data faster and more effectively. Amazon knows
what you have looked at on its site, when, where you searched
from and what you bought in the past. It can identify trends
from this and change its marketing accordingly. For example:
• It can remarket products to you so that when you are using the
internet relevant advertisements about the things you have
been searching for will appear to promote action.
• It can recommend products it knows you will like because it
has tracked your shopping and browsing history.
• It can change the price according to the day, the time or the
month to encourage you to buy based on what you have done

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 in the past.

Key terms
E-commerce (or electronic commerce) is the act of
buying or selling a product using an electronic system
such as the internet.
M-commerce (or mobile commerce) is the buying and
selling of products through wireless handheld devices
such as smartphones.
Global markets are made up of customers from across
the world.
Social media involves methods of online communication
such as websites and applications; they share information
and help to develop social and professional contacts.
Data analysis involves gathering and examining data to
provide useful information that can be used for decision-
making.

Study tip
Remember that the owners and employees of businesses
might not have the skills needed to use new technology.
The costs of using technology can be high at first, as it
may mean that employees need training or outside
expertise may need to be paid for.

By using ICT, businesses can now understand their customers

and their buying behaviour much more than they could in the
past. They can also track the effectiveness of their marketing
activities more closely. For example, businesses can change the
design and content of their website and see exactly what it does

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to how customers use the site and the purchases they make.
Improvements in ICT also allow businesses to combine data sets
and analyse the results in ways that were simply not
technologically possible in the past. A supermarket chain such as
Walmart (which owns Asda), for example, has invested
enormously in ICT. It can bring together data that considers
what day of the month it is, what events are happening in a
region, what the weather will be like and what else is happening
in the business environment (such as competitor actions) in
order to predict sales and, therefore, know what to stock. The
computing ability these days is immense allowing business to get
a much deeper understanding of what drives demand and
behaviour. This can all improve customer service because
businesses can deliver what we want, when we want it, where
we want it and at the price we want. These days, they may even
know what we want, where we want it, when we want it and the
price we are willing to pay before we do!

Summary
Customer service means meeting the needs of customers
as fully as possible and is very important for small
businesses. It helps them to compete effectively with much
bigger rivals. Businesses can improve their customer
service by making products that are reliable and by
offering clear information about their products, by having
well-trained and well-informed staff and by providing
effective post-sales service. Advances in technology have
helped businesses to improve their customer service
through the use of websites and by permitting e-
commerce and m-commerce.

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Quick questions
1 What is meant by the term ‘customer service’?
(2 marks)
2 State two ways in which a business might offer good
customer service.
(2 marks)
3 What is meant by ‘customer engagement’?
(2 marks)
4 What is meant by the term ‘post-sales service’?
(2 marks)
5 Give two benefits of good customer service.
(2 marks)
6 What is meant by ‘m-commerce’?
(2 marks)
7 State two dangers of poor customer service.
(2 marks)
8 Explain one way in which ICT has allowed businesses
to improve their customer service.
(2 marks)
9 What is meant by the term ‘e-commerce’?
(2 marks)
10 Give two benefits to a business of using e-commerce.
(2 marks)

Case study
The Excelsior
Romily Jones did not want to open her emails – she was

342
worried they would contain yet more complaints. For the
last few weeks, she had been receiving customer
complaints almost every day about the quality of the
service or the quality of the food they had received while
staying at Romily’s hotel.
The hotel, called the Excelsior, was (or at least it had
been) one of the top hotels in Oxford. It had been owned
by Romily’s family for several generations and Romily had
taken over as the manager last year. The first few months
had gone well but, in the busy summer months, the
complaints had started to come in. It was difficult to
manage the business at that time because the hotel was
busy and so many extra part-time staff, usually students,
were hired to help out and everyone was very stretched.
At first, Romily thought it was just that customers were
quicker to complain than they used to be, but she
employed a mystery visitor to check how things were. His
report had been scary to read – things were definitely
looking bad. She was even getting terrible reviews online
now. She was offering refunds to anyone who complained,
to try to improve their view of the hotel, but this was hitting
the hotel’s profit margins.
1 What is meant by ‘profit margin’?
(2 marks)
2 Explain two reasons why good customer service is
important to the Excelsior.
(5 marks)
3 Analyse ways in which Romily could improve the
customer service at the hotel.
(9 marks)
4 To what extent do you think poor reviews online matter
to a hotel?

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 (12 marks)

Chapter review – Business operations

Read question 1, the sample answers and the comments.
Then try question 2.
1 Read Item A and answer the questions that follow.
Item A
Samsung, the consumer electronics giant that produces a
wide range of different products, recently had to recall its
Galaxy Note 7 mobile phone handsets because some of
the batteries in them were catching fire. This was a
disaster for the company in terms of its impact on the
brand image. There have been other major incidents of
phone recalls in the industry – for instance, in 2007, Nokia
had to recall 46 million batteries because of concerns that
they may overheat. However, in the past the batteries
could be taken out of the handsets and returned
separately. With the Galaxy Note 7 phones, the whole
handset had to be recalled, costing millions.
Samsung had to shut down its production lines and offer
compensation to customers, who could get their money
back or have a partial refund and get an older model.
Samsung has not been clear as to how many Note 7s
were involved, but it is likely to be around 4 million. Around
35 are said to have overheated but, because of the risk,
they were all recalled. The company had hoped the Galaxy
Note 7 was going to be a big seller and had the capacity to
produce 6 million a year. It had wanted to benefit from
large-scale production.

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Many consumers had also bought cases, keyboard
covers, wide-angle lens attachments and spare styluses
and power packs for their Note 7s; these are now
worthless.
(a) What is meant by ‘capacity’?
(2 marks)
(a) Capacity measures the sales of the business
compared to the maximum output.

This answer is not accurate. Capacity is the

maximum output given existing resources. It is
measured in terms of number of units.
(b) Explain two economies of scale that Samsung
might experience by producing its phones on a
large scale.
(4 marks)
(b) Economies of scale measure the unit cost per
unit. These may be due to bulk buying,
technology, specialisation or division of
labour.

This answer shows an understanding of

economies of scale. It identifies some
economies of scale, but does not explain how
Samsung may experience them. The answer
should be expanded.
(c) Analyse the possible consequences for Samsung
of the poor quality.
(6 marks)
(c) Poor quality means that the product does not

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 meet the targets required in terms of customer
requirements. In this case, it means problems
with batteries that caught fire. This is bad for
the company because it damages its
reputation and brand image. This can lead to
lost sales now and in the future. The poor
quality may also mean that the company has to
take back the phones. It is expensive to co-
ordinate the recall and physically get them
back, and the company may also need to
compensate its customers. All of this can lead
to higher costs and lower profits.
However, it depends on how many phones are
affected and how many have to be recalled. It
also depends on how bad the damage is to
customers and so how much the
compensation will cost. If the company reacts
quickly and effectively, it may be seen to care
about the customers and the brand damage
may not be as much.

The answer analyses the effects of poor

quality well. However, it then goes on to
discuss these effects. It is evaluating the
question set. This is not required for this
question. The question requires analysis only.
The student may have used up time that could
have been used to answer another question.
(d) To what extent do you think this recall of the Note 7
will damage Samsung’s overall profits in the long
run?
(12 marks)

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(d) This product can damage profits because the
company will have to pay to recall the phones.
This will cost money. It will have paid to
develop the phone, but now will have no sales
– so it will have costs but no revenue. The
incident may damage the brand and so this
might affect sales of other products damaging
profit even more.
However the company is a ‘giant’ and has
many products so its overall profits depend on
how its other products, such as its
televisions, its tablets or even its other
phones, are doing. This fall in profits as a
result of the Note 7 may be relatively small
compared to what is being gained elsewhere.
The impact may also depend on how it
handles the incident. If it is seen to act quickly
and generously in terms of compensation,
customers may quickly regain confidence in
the brand and feel secure buying again. If it
proves difficult to return the items, customers
may be more wary. Also, it depends on how far
ahead we are looking. This incident will be in
our minds for some time, but probably will
have been overtaken by an issue somewhere
else in a few years’ time and so the effect will
have diminished depending on the actions
Samsung takes.
Overall, this is a big issue for Samsung and is
likely to damage profits. However, the key now
is how it manages the situation and whether it
can regain confidence and whether it has
other products that it can launch and be

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 successful.

This answer highlights the dangers of the recall

in terms of its impact on profits but also
appreciates that the effect on the overall
profits of Samsung depends on many other
factors.
2 Read Item B and answer the questions that follow.
Item B
A recent Citizens Advice league table shows that SSE
energy company had the lowest level of complaints of any
energy business in the UK at just 22.5 per 100,000
customers. EDF, British Gas and E.ON were second,
fourth and fifth respectively. These are examples of good
customer service.
Others such as npower and Scottish Power were less
successful. One small supplier, Extra Energy, was the
worst of all the 21 firms measured, with a complaints rate
that was 80 times greater than that of SSE.
Extra Energy, which was established in 2014, apologised
to customers and said it was now dealing with more
complaints by its target of the end of the next working day.
Analysts said that Extra Energy appeared to have
struggled to maintain its desired customer service levels
during its expansion. The number of customers rose fast
and analysts say it has been catching up in terms of
having the resources to deal with them.
Complaints are usually about late or inaccurate bills, or the
difficulty some customers experience while simply trying to
contact their gas or electricity supplier.

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According to one commentator, almost 4 million customers
were overcharged due to billing errors last year.
(a) What is a ‘company’?
(2 marks)
(b) Explain the factors that may affect why people
choose one energy company rather than another.
(4 marks)
(c) Analyse the benefits of good customer service to an
energy company.
(6 marks)
(d) To what extent is more investment in training the
key to better customer service?
(9 marks)

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4 Human resources

Every business uses people in some way to produce

goods and services. This chapter will consider how
businesses organise their employees to supply products
in the most efficient ways. The organisational structure is
an important influence on the jobs that people are asked to
do. It affects their freedom to make decisions. We will also
examine how businesses recruit new employees and the
techniques they use to choose the best applicants for
jobs. Once employed, it is important that employees are
motivated to work as hard as possible for the business.
Employee motivation can be an important factor in making
a business successful. Finally, we shall discuss how
businesses can improve the performance of their
workforces through training and analyse the benefits and
drawbacks of different types of training.

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Topic 4.1

Organisational structures
All businesses have organisational structures. This means
that all the employees are given a role in the business and
that these fit together to help the organisation to achieve
its aims. Some people have senior roles and are
responsible for many people; others are more junior. The
structure sets out the relationships between people in the
business. We shall see that different businesses use
different organisational structures and that a business’s
organisational structure may change over time.
By the end of this topic, you should know:
• why businesses have organisational structures
• the different job roles and responsibilities within an
organisation
• the internal organisational structures a business may
use
• why businesses use different organisation structures
• how organisational structures affect the way a business
is managed and communication within it
• the advantages and disadvantages of centralisation and
decentralisation.

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Why businesses have
organisational structures
Businesses have to organise themselves to be able to carry out
their activities effectively. It is important that everyone in the
organisation knows:
• what their duties are
• the person or people that they have to report to
• the other employees in the organisation for whom they are
responsible.
An organisational structure sets this out so that everyone in
the business knows this information. Without this internal
structure, a business would be very chaotic and not very
productive.

Key term
An organisational structure is the way a business
arranges itself to carry out its activities.

Job roles and responsibilities

within organisational
structures
All businesses have an internal organisational structure. The
organisational structure shows the roles played by each
employee in the business and who reports to whom within the
business. The roles and working relationships in a business are

352
shown in an organisational chart (see Figure 4.1).

Key term
An organisational chart is a plan showing the roles of,
and relationships between, all the employees in a
business.

In Figure 4.1, it can be seen that:

• shop-floor workers are responsible to and report to team
leaders, who are their line managers
• in turn, the team leaders report to managers, with each
manager being responsible for a group of team leaders (in this
case, there are four)
• managers report to individual directors who report to the chief
executive or managing director
• the chief executive officer (CEO) or managing director has
ultimate authority (or power) within the business.

Key terms

353
A line manager is an employee’s immediate superior or
boss.
Authority is the power to control others and to make
decisions.

Organisational charts show how each individual employee fits

into the business. They show each employee’s line manager and
the people for whom managers and others are responsible (see
Table 4.1).

Features of organisational structures

There are a number of features of internal organisational
structures that can be altered to suit the business’s particular
circumstances.

354
Spans of control and levels of
hierarchy
The span of control is the number of employees managed
directly by a manager. This means that the manager is the
immediate boss or line manager of these employees. In Figure
4.2, Manager A has a span of control of four and Team Leader 4
has a span of control of five.

355
A director, manager or team leader should not have a span of
control that is too wide. If this happens, he or she will find it
difficult to manage the employees properly as there will be
insufficient time to spare for each employee. Experts
recommend that the maximum span of control for a manager
should be no more than six, though this is commonly exceeded
in many businesses.
Levels of hierarchy are the layers of authority in a business.
The business in Figure 4.1 has five levels of hierarchy. This
means that the employees at the bottom of the organisational
structure have four layers of authority above them.

Key terms
The span of control is the number of employees
managed directly by another employee.

356
Levels of hierarchy are the layers of authority within a
business.

Chains of command
A chain of command is the line of authority within a business
along which communication passes. Thus, directors might
decide on a target for the business and issue instructions to
managers about achieving this target. In turn, instructions will be
passed down to team leaders and eventually to shop-floor
workers on actions to take to meet this target. Similarly, each
level of hierarchy within the organisation will report to the level
above on the progress made in achieving the target. This shows
how communication can flow up and down the chain of
command.

Key term
The chain of command is the line of authority within a
business along which communication passes.

Delayering
When a business delayers, it removes of one or more levels of
hierarchy from its organisational structure. This is most
commonly done to reduce the organisation’s costs. In 2016,
Rolls-Royce plc, a manufacturer of engines for planes and ships,
announced it was delayering its organisational structure as part
of a plan to reduce its costs by £200 million a year. Many
businesses have used delayering to reduce the number of
managers they employ.

Key term

357
Delayering is the removal of one or more levels of
hierarchy from a business’s organisational structure.

Delayering does have consequences beyond reducing costs:

• Junior employees might have to take on some of the duties
previously carried out by employees who were their line
managers.
• Some senior employees may have very wide spans of control
when a level of hierarchy is removed.

Business insight
Delayering at Boots UK
The chemist shops owned by Boots are in most towns
and cities across the UK. They sell health and beauty
products, as well as dispensing medicines. In 2016, the
company announced plans to cut up to 350 jobs in the UK
to reduce costs, especially in its larger stores. The job
losses involve the removal of a layer of management in
the stores – the jobs lost are those of assistant managers
in the stores. These job losses are part of a move to
simplify the organisational structure within the chemist’s
stores.
This move follows a decision by the company to remove
700 office-based jobs just seven months earlier. Boots
was recently bought by an American company which is
seeking to improve its profits.
Explain one advantage and one disadvantage to
Boots from its decision to delayer its organisational
structure in its larger stores.
(6 marks)

358
Delegation
Delegation is the passing down of authority to more junior
employees. In very small businesses, the entrepreneur would
probably take all necessary decisions. However, as a business
grows, this becomes impossible. There are too many decisions
to be made and some might be very specialist, for example, on
creating software for the business’s IT system. Delegation gives
authority to junior employees to take decisions in a specific area.
For example, a store manager in a supermarket might delegate
authority to more junior employees to order supplies of
vegetables or fish when necessary.

Key term
Delegation is the passing down of authority to more
junior employees.

Using organisational
structures
Not all businesses use the same organisational structure. Some
businesses may opt to use ‘tall’ organisational structures, while
others use ‘flat’ structures.

359
Tall and flat organisational structures
The senior managers in a business can choose the structure for
their organisation (see Figure 4.3). The managers might decide
to:
• use a wide span of control. This means that each director,
manager or team leader/supervisor will have a large number
of people reporting directly to them. If the organisation has a
wide span of control, it is likely to have fewer levels of
hierarchy, and the organisation’s structure can be described as
‘flat’.
• use a narrow span of control. In this case, the business gives
each director, manager or team leader a small number of
employees for whom they are responsible. It may be
necessary, therefore, for such a business to have more layers
of hierarchy. This type of organisational structure is called
‘tall’, for obvious reasons.

360
Study tip
Try not to forget that a span of control refers to the
number of employees who are directly managed by a
more senior employee. This means that these employees
are on the next level of hierarchy down and report to this
particular manager.

Management styles and

organisational structures

361
The managers of a business can use different approaches to
manage their employees. Some give little freedom to junior
employees to take decisions at work and control them closely.
This means that most important decisions are taken by senior
employees.
On the other hand, some businesses take a completely different
approach to managing staff. Employees are given greater
freedom within their job roles to take decisions and to organise
their work. Line managers, therefore, give up some control over
their team.

Business insight
Martin’s coffee shops
Martin Fisher’s business has grown steadily. He started
by running one coffee shop in London. This coffee shop
had four employees – as do most of the business’s
shops. Martin has opened 11 more around the city, giving
a total of 12 shops. When he only had three coffee
shops, he managed them all himself. He took the major
decisions and his employees followed his instructions.
However, the business is now so large that he has had to
appoint branch managers for each of the coffee shops
and a senior manager to be responsible for half of the
branch managers. Martin is the line manager for the other
branches. He has found that he is less involved in day-to-
day issues in his coffee shops.
Analyse the effect of the growth of the business on
Martin’s span of control.
(6 marks)

We have seen that organisations can have two different types of

structures: flat and tall. The type of structure used has

362
implications for the management style that is used in the
business:
• Delegation. As we saw earlier, a flat structure means that
managers and team leaders have to work with wide spans of
control. This means that they have to be responsible for a
relatively large number of junior employees. As a result of this
heavy workload, those responsible for managing people have
to give them more independence in their working lives. This
means that junior employees are able to take more decisions
on their own and are not controlled so closely by their line
managers. Passing down authority to more junior employees
in this way is called delegation.
• Authority. Using a tall organisational structure means that
most line managers have narrow spans of control and are able
to monitor the work of their juniors very closely. This means
that juniors have little independence or authority at work.
Senior managers have the authority to control decisions that
are made in the business, and little freedom is given to junior
employees on how to organise themselves at work.
A tall organisational structure is usually associated with a
management style where little use is made of delegation and
managers take most decisions. In contrast, a flat organisational
structure encourages a management style which relies on
delegation, giving more authority to junior employees.

Using the appropriate organisational

structure
There are a number of factors which might influence a decision
by managers on whether to use a tall or a flat organisational
structure:
• The skills of the workforce. Skilled workers are more able to

363
 take decisions on their own and need less supervision from
managers. Thus, if a workforce is highly skilled, managers
may choose a wider span of control and a flat organisational
structure. This approach may be used in a hospital where
many employees are highly skilled.
• The management style used in the business. We saw earlier
that organisational structures have implications for the
management style that is used. Managers that like to retain
control over employees will be more likely to use a tall
organisational structure. This gives a smaller span of control,
making close supervision easier. Those managers who do not
wish to control employees closely will delegate and use a
flatter organisational structure.
• The business’s competitive environment. A business in a
competitive environment may wish to keep its costs to a
minimum and to have the best possible performance from its
workforce. This may lead to the use of a flat organisational
structure. This type of structure requires fewer managers,
helping to reduce wage costs. Flat structures can also motivate
workforces as junior employees are given more authority and
possibly more interesting jobs.

364
Organisational structure and
communication
There are numerous ways in which individuals and groups
within organisations communicate with one another. These
include:
• meetings, such as a meeting of a company’s board of directors
to agree its long-term plans
• video-conferencing in which video links are used, for
example, to allow a business’s employees in different
locations to talk to and see one another
• telephone conversations, for example, an employee might use
this method to place an order with a supplier
• emails are increasingly used for many communication
purposes, for instance advising customers of special offers
that are available

365
• business intranets – a form of internal internet – to
communicate within the organisation and with suppliers
• other forms of written communications, such as letters, which
are still widely used.

Key term
Communication is the exchange of information between
two or more people.

There are three types of communication that take place within a

business:
• downward communication from senior employees to more
junior ones
• upward communication from junior employees to their line
managers and other more senior employees
• horizontal communication, which takes place between
employees at the same level in the organisation, for example, a
discussion between managers.

366
Flat organisational structures can have the following effects on
communication:
• Downward and upward communication may become easier as
there are fewer levels of hierarchy for messages to pass
through.
• However, wider spans of control may mean that line managers
are responsible for large numbers of people. This may result
in more emails and fewer meetings. The quality of
communication may suffer as a result.
• Giving employees greater authority within a flat organisational
structure can encourage upward communication as they are
more likely to exchange information with line managers.
• Horizontal communication may become more difficult as there
are more people on each of the levels of hierarchy.
Tall organisational structures may have the following effects on
communications:

367
• Organisations with many levels of hierarchy often experience
problems in passing information through these levels.
Messages can become garbled or may not be passed on.
• Tall organisational structures operate with smaller spans of
control. This can lead to good communication between line
managers and subordinates as the manager is directly
responsible for relatively few employees.

Centralisation and
decentralisation
Many businesses in the UK have become larger over recent
years. Larger businesses normally have more employees, more
sales and possibly operate in more locations. These changes
might make it difficult for a small number of senior managers to
take all the decisions needed to keep the business running
smoothly. Senior managers might decide to decentralise the
organisation because the business is getting larger or for other
reasons, such as improving the effectiveness of the workforce.
Decentralisation is illustrated in Figure 4.5.

Key term
Decentralisation allows employees working in all areas
of the business to take decisions.

368
369
Decentralisation means that employees working in branches,
departments or factories across the business are given more
authority to take decisions at work. For example, a manufacturer
with a number of factories might allow the managers in each
factory to take decisions about hiring new employees, which
products to manufacture on a particular day and how to look
after the needs of certain customers.
Decentralisation can lead to some major changes in a business.
Some employees may have to move to work in another part of
the business. For example, decentralisation might mean that
managers who understand finance must work in each of the
business’s branches or divisions, rather than together at the
business’s head office. This can mean that those employees with
financial skills move to a different part of the UK.

Advantages of decentralisation
• Decentralisation can reduce the pressure on the senior
managers in a business. This can let them concentrate on the
key issues, such as raising finance and negotiating with
customers.
• It can motivate employees throughout the business if they are
given the authority to take decisions. This may mean that the
employees become better at their jobs and that the whole
business performs better as a result.
• Decentralisation may also lead to better decisions. For
example, a retailer with many shops in different parts of the
UK may benefit from employees taking decisions that are
correct for their area. So, if some products are selling well in a
certain area, local employees would know to order more from
suppliers.
• It can also allow faster decision-making. Employees do not
have to consult with senior managers and can take decisions

370
 immediately. This might benefit a business by, for example,
allowing it to buy supplies at a bargain price.

Study tip
Try not to confuse decentralisation and delegation – many
students do. Delegation means giving authority to junior
employees. Decentralisation means senior managers
passing authority out to branches, shops, offices or other
divisions of the business.

Challenges of decentralisation
Businesses need to plan for the introduction of decentralisation.
The managers of a business thinking of decentralising should
consider a number of important issues if the change is to be a
success:
• All the business’s employees must understand its aims or
goals. This will help ensure that they take decisions in the best
interests of the whole business and not just their branch,
factory or shop.
• Training may be needed. If employees are asked to take on
new duties such as negotiating with suppliers, they may not
have the skills they need. The business may have to invest in
the necessary training, which can be costly.
• Good communication is very important. Senior managers
must be aware of key decisions taken in all parts of the
business and must be able to send messages to all employees
in the business.

Business insight
La Redoute
La Redoute is a French-owned company that sells

371
 fashion clothing online and through mail-order catalogues.
It has 10 million customers and operates in 26 countries
including the UK. The company has recently opened its
first store in the UK in Liverpool. This may be followed by
stores elsewhere.

Explain one reason why La Redoute may decide to

decentralise if it opens a large number of stores.
(4 marks)

Businesses often decide not to decentralise. There are reasons

why they may choose to remain centralised instead. For
example, it may be that the business’s employees do not have the
right skills to make a decentralisation policy successful.
Alternatively, the business may not be able to afford to pay for
training. In addition, if the senior managers believe that they will
not be overworked if the business remains centralised, they may
choose to retain control over the important decisions in the
business.

Key term

372
Centralisation occurs when a small number of senior
managers in a business take all the important decisions.

Summary
Businesses have to organise their employees to make the
most effective use of them. Key parts of a business’s
structure are spans of control and levels of hierarchy. A
business with a wide span of control is likely to have a flat
organisational structure. One with a narrow span of
control will probably have more levels of hierarchy and a
tall structure. It is common for a growing business to
decentralise, though not all choose to do so.
Decentralisation can offer a business a number of
advantages, but it also poses challenges for managers.

Quick questions
1 What is an ‘organisational structure’?
(2 marks)
2 A business has four levels of hierarchy: a CEO, 4
directors, 16 managers and 64 team leaders. Which
of the following is the CEO’s span of control?
(a) 84
(b) 20
(c) 4
(d) 5
(1 mark)
3 Explain the difference between a narrow and a wide
span of control.
(4 marks)

373
 4 Explain the difference between a tall and a flat
organisational structure.
(4 marks)
5 A business has moved from a tall to a flat
organisational structure. Which of the following
statements will be true?
(a) Its typical span of control will be wider.
(b) Its typical span of control will be narrower.
(c) It will have more levels of hierarchy.
(d) It will have more employees.
(1 mark)
6 Explain one reason why a business with a tall
organisational structure might have a narrower span
of control.
(3 marks)
7 Explain why the use of delegation is more likely within a
flat organisational structure.
(3 marks)
8 Explain the difference between centralisation and
decentralisation.
(4 marks)
9 State two benefits of decentralisation.
(2 marks)
10 State two challenges that might be faced by a
business that is decentralising.
(2 marks)

Case study
Apple’s organisational structure

374
Apple sells a range of technology products (laptops,
watches and mobile phones, for example) in markets
throughout the world. It is famous for developing many
successful new products.
Since Tim Cook became the leader or CEO of Apple in
2011, his span of control has increased significantly.
When first appointed as CEO, Tim Cook had a span of
control of nine. By 2016, this was 17, according to
information on Apple’s website. The CEOs of many other
major companies have wide spans of control. Recent
research suggests the average CEO’s span of control
has risen from about five in the 1980s to ten.
Apple is more decentralised nowadays, an approach
favoured by Tim Cook. He has decentralised to make the
best use of the company’s skilled and creative employees.
Apple’s employee numbers have doubled from around
60,000 at the start of 2012 to approximately 120,000 in
2015.
In 2016, Apple announced profits of £14.15 billion over
just three months’ trading – the highest profit figure for
three months ever achieved by a company!
1 State two ways in which Tim Cook might communicate
with the people for whom he is directly responsible.
(2 marks)
2 Explain one benefit that Apple might gain from operating
a flat organisational structure.
(4 marks)
3 Analyse why Tim Cook may have decided to make the
company more decentralised.
(6 marks)
4 Recommend whether Tim Cook should reduce his span

375
of control. Give reasons for your advice.
(9 marks)

376
Topic 4.2

Recruitment and selection

of employees
Nearly all businesses have employees, and they can play
a vital part in the success of a business. It is important
that businesses operate an effective recruitment and
selection process. This will enable them to recruit the best
employees.
By the end of this topic, you should know:
• why businesses need to recruit employees
• the main methods of recruitment
• the main stages in the recruitment and selection
process
• the benefits to a business from having an effective
recruitment and selection process
• the different types of employment, such as full- and part-
time employment, and the difference between them
• what a contract of employment is.

Why businesses need to

377
recruit employees
Businesses need to recruit employees in a range of
circumstances.

Starting a new business

A new business will need to recruit employees if its owners
cannot carry out all the necessary tasks and duties themselves.
An entrepreneur may not have the skills needed to carry out
specialist roles. For example, the owner of a new café may need
to recruit two types of employees:
• a chef to cook the customers’ meals if the entrepreneur is not a
skilled cook
• waiters or waitresses to serve customers because the owner
has other duties such as buying food and drinks and
completing paperwork.

Expanding a business
If a business is expanding, it may need to recruit employees for
two main reasons:
• Increasing production. The business may be increasing
production of its existing goods and services, possibly to sell
them in new markets. The business will need more employees
similar to those already employed. For example, in 2016, the
supermarket Aldi announced it was opening 80 additional
stores in the UK and would be recruiting 5,000 new
employees.
• Diversification. Some businesses decide to produce different
goods and services, sometimes selling them in new markets.
This is called diversification. As a result, they need to

378
 recruit employees with the knowledge and skills required to
produce these goods or services. Rolls-Royce plc, a
manufacturer of engines for ships and aircraft, is to design
cruise ships for a Norwegian business. The company may
have to recruit marine designers to allow it to enter this market
successfully.

Key term
Diversification occurs when a business starts selling
new products in new markets.

Business insight
Equinox Fitness clubs
Equinox operates a chain of health and fitness clubs. It
has 80 clubs in the USA, UK and Canada, and almost
doubled in size during 2015, from 7,000 to 13,000
employees. It expected to expand rapidly in 2016.
The company is using the latest technology, based on its
website, to help it to recruit new employees.

379
 Explain why Equinox might have used technology
on its website to help it to recruit employees.
(4 marks)

When employees leave

Most businesses have employees who leave their jobs at some
stage during a year. Employees may leave because:
• they have been offered another job; this could be a promotion
or perhaps have a higher rate of pay
• they are retiring or stopping working for reasons such as
caring for children.

The importance of recruiting the right

people and keeping them
Recruiting the right people is important for all businesses. The
‘right’ people will have the necessary skills to do the job
successfully and be willing to work hard. If the wrong people
are recruited, a business may lose customers who are unhappy at
receiving poor quality service or goods. The business may also
have to spend time and money recruiting other people.
Once a business has recruited the right employees, it usually
tries to keep them. High rates of retention mean that only a
small proportion of a business’s workforce leaves over a time
period, normally one year. Low rates of retention help to reduce
businesses’ expenditure on recruiting and training new
employees.

How businesses recruit and

380
select employees
Recruitment and selection are normally the responsibility of
a business’s human resource (HR) department and its human
resource managers. However, businesses may use specialist
employment agencies to help to recruit and select their
employees. This is common with small businesses and those that
are seeking highly specialist employees.
There are two major ways to recruit employees: internally from
inside the business, or externally from outside. A new business
will have to recruit externally at first as it does not have any
existing employees; established businesses can choose between
the use of internal and external recruitment.

Internal recruitment
Firms often recruit internally by promoting their existing
employees to a more senior role or by transferring employees to
a different job at a similar level in the business. A business
might recruit internally by putting notices up in the workplace
inviting suitable employees to apply for the position. A senior
employee might recommend someone for a post – this is known
as a personal recommendation. In slightly larger businesses,
posts may be advertised on the business’s internal website or in
the newsletter circulated to all employees. In very small
businesses, the owner may simply tell employees that there is a
job vacancy.
Internal recruitment offers a number of benefits to
businesses:
• Candidates will have experience of the business and will be
familiar with its methods of working.
• Candidates will know many of the people with whom they

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 will be working.
• Internal recruitment provides employees with the chance of
promotion, which may help to motivate them.
• Internal recruitment is cheaper as it avoids the need for
expensive external advertising.

Key terms
Retention is the proportion of a business’s workforce
who remain with the business over a period of time,
usually one year.
Recruitment is the process of finding and appointing new
employees.
Selection is choosing the right employees from among
those who have applied for a job.
Internal recruitment takes place when a job vacancy is
filled from within the existing workforce.

On the other hand, it is common for firms to have to pay for

training when promoting or transferring employees, as they
might not have the right skills for the new job. A business can
only choose from a limited number of employees when
recruiting internally, and the skills and experience of this group
may not be exactly what the business is looking for.

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External recruitment
External recruitment means that a business looks to hire
employees who do not already work for the business. This type
of recruitment is frequently used when a business is expanding
or moving into new markets or supplying new products.

Key term
External recruitment is filling a job vacancy from any
suitable person not already employed by the business.

This type of recruitment is normally done by using one of the

following methods:
• Advertising. This is a common technique. Businesses
advertise externally in newspapers and magazines, or on the
internet or radio, and invite interested people to apply by a
certain date.
• Jobcentre Plus. These centres are located throughout the
country. Their role is to bring together businesses looking for

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 workers and suitably skilled people. They are run by the
government’s Department for Work and Pensions.
• Employment agencies. These are privately owned businesses
that help businesses to recruit employees. Employment
agencies provide employers with details of suitable applicants
for posts they may have vacant and might help to choose the
most suitable employee. They are paid fees for these services.

Business insight
Weavers Academy job advertisement
This advertisement appeared in the Times Educational
Supplement, a weekly newspaper sold throughout the UK.
It is well known for carrying advertisements for teaching
positions in the UK.

‘Head of ICT and Business, Northamptonshire

The rapidly growing demand for places at Weavers

Academy presents us with this opportunity to
increase our staffing in a number of different
subjects. We are seeking to appoint enthusiastic and
inspirational lead teachers which would equally suit
experienced professionals or those early in their
career.

The successful candidate will join a collaborative and

committed staff team that have a vision to strive for
success through focusing on learning. Outcomes for
2016 have significantly improved and we have a
growing reputation in the local area as a caring
school with high expectations of learning, behaviour
and attendance. The academy is part of the growing
multi-academy trust “CET” and is well supported by

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 leaders in education across the country.

A job description and application form can be found

on our website:

http://www.weaversacademy.org.uk/contact-
us/vacancies

Please send your completed application form and

covering letter to our HR Manager,

Mrs S Cirelli at Weavers Academy, Brickhill Road,

Wellingborough, NN8 3JH.

Applications by email are welcomed and should be

sent to:

[email protected].’
Source: Times Educational Supplement: www.tes.com

Analyse the reasons why this school’s managers

may have decided on external recruitment to fill this
job vacancy.
(6 marks)

Recruiting employees externally offers a number of advantages

to a business:
• Managers will have a wider choice of candidates and this can
result in applications from higher-quality candidates,
especially if the job is advertised nationally.
• Businesses sometimes recruit external candidates in the hope
that they will bring fresh ideas and enthusiasm into the
business.
• External recruitment provides new employees who have the
right skills immediately. Training existing employees can take

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 time.
Although external recruitment offers the benefits of a greater
number of candidates, it is likely to be very expensive. The
business will also know less about the person or people they
appoint. This means there is a greater chance of making a
mistake.

The recruitment and selection

process
Most businesses have job vacancies at some point – that is, they
need to recruit some employees. We saw earlier that it is
important for businesses to appoint the right people. To do this,
businesses have to have effective processes to:
• recruit the best possible applicants
• select the right person or people from those who have applied.
The stages in the recruitment process are shown in Figure 4.7.

Documents used in the recruitment

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process
Before any recruitment documents can be prepared, it is
necessary for a business to conduct job analysis. Job analysis
is the collection and interpretation of information about a job.
The analysis of a job helps managers to make effective
recruitment and selection decisions.

Key term
Job analysis is the collection and interpretation of
information about a job.

To identify the best person for the job, managers must

understand what the job involves. Job analysis provides this
understanding by examining the tasks performed within a job
and the skills that are needed to carry it out efficiently. This
information is essential if the ‘right’ person or people are to be
appointed.
Once job analysis has been completed, it is possible for
managers to draw up the documents used in the recruitment
process.

Job description
A job description is a document stating information about the
duties and tasks that make up a particular job. It usually
includes:
• the title of the job
• the hours and place of work
• the main tasks that make up the job
• the employees for whom the person will be responsible.

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Person specification
A person specification is a document setting out the
qualifications and skills required by an employee to fill a post
that is advertised. A person specification might include:
• educational qualifications
• vocational or professional qualifications
• ability to work as part of a team
• experience of similar jobs.

Key terms
A job description states information about the duties and
tasks that make up a particular job.
A person specification sets out the qualifications and
skills required by an employee to fill a particular job.

A person specification may list some qualities and qualifications

as essential and others as desirable. Managers make a lot of use
of person specifications in the process of recruiting and selecting
new employees. Person specifications can be used to judge
applications. If an applicant’s qualities and qualifications match
the person specification closely, he or she may be a good person
to recruit.

Job advertisement
These can be placed in local or national newspapers, in
magazines or on the internet. A job advertisement would
normally include:
• the title of the job
• some information about the business
• the location of the job

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• working hours expected and holidays offered
• pay rates
• how to apply and the closing date for applications.
Businesses often use employment agencies to draw up their job
descriptions and person specifications and to place their job
advertisements.
The way in which the job is advertised will depend on the type
of job that is available. For junior positions in a business, an
internal advertisement on the company’s noticeboards or in its
newsletters or magazines may be used. Alternatively, the job
might be advertised in local newspapers. For more senior
positions, such as a company accountant or a production
manager, a business might advertise more widely. It may choose
to do this because it needs a large pool of potential candidates to
attract high-quality applicants. This may lead the company to
advertise in national newspapers or specialist national
magazines.

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Application form and curriculum vitae
(CV)
To apply for a job, it is necessary for applicants to give some
information about themselves. This will include personal
information such as their address, employment history and
qualifications. This information is essential so that a business
can match the candidate’s qualities and qualifications with those
set out in the person specification. In this way, the business’s
managers can choose which of the candidates are suitable.
Sometimes applicants for a job do not fill in an application
form, but provide a curriculum vitae (CV). This is a
document that sets out information about a person’s
qualifications, employment history and interests.

Key term
A curriculum vitae (CV) provides information about a
person, including qualifications, employment history and
interests.

Selection
Choosing an employee from those people who have applied for
a job is called selection. We saw earlier that it is costly to choose
the wrong person. As a result, businesses aim to have thorough
selection procedures. The stages of this process are summarised
in Figure 4.9.
All job advertisements include a closing date by which all
applications should be received. On that date, the company’s
managers will look at all the applications that have been received
and decide which ones they are interested in. They will compile

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a shortlist of applicants from which to select the successful
candidate or candidates.
An employer can use a number of techniques to select the best
candidates from the shortlist.

Interviews
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Interviews remain the most common form of selection.
Candidates may be interviewed by panels of up to ten people,
but one or two people conducting an interview is more
common. It is quite cheap for a business to stage a series of
interviews, but they are not always a reliable way of selecting the
best people for a job. Some people are very good at interviews,
but that does not always mean that they will be good at the job.

Psychometric tests
These are multiple-choice tests designed to show the personality
of the candidates who have applied for a job. The results of
these tests can help the managers of a business to judge which of
the applicants has the most suitable personality for the job.
These tests can also show which candidate is most likely to fit in
with the team of people with whom he or she will be working.

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Assessment centres
Over recent years, businesses have made increasing use of
assessment centres to avoid appointing the wrong people.
Assessment centres are more likely to be used in making senior
appointments. In an assessment centre, a candidate is likely to be
involved in a variety of activities:
• role plays simulating the job itself

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• psychometric tests
• a number of interviews
• practical tasks for candidates to complete.
Candidates can find the tasks they carry out in assessment
centres demanding and stressful. This can help a business to
select people who perform well under pressure. Thus, although
they are expensive to operate, assessment centres can help
businesses to choose the best person or people for a particular
job.

The benefits of an effective

recruitment and selection process
An effective recruitment and selection process is one that
appoints the best and most suitable employees. This gives the
business the most skilled and experienced employees and
reduces the chances of them leaving within a short space of
time. Although operating an effective process for recruiting and
selecting employees can be costly, it offers businesses significant
benefits. These may become more apparent in the longer term
and should result in increased profits for the business.

High levels of productivity

Appointing the best employees can help a business to achieve
high levels of productivity. This means that employees
produce relatively large quantities of goods or services over a
period of time, such as one year. If an employee is productive,
this means that the labour cost of producing a single unit of
output is likely to be lower. This can help a business to be more
competitive, as it helps it to sell products at lower prices. This
can increase sales. Alternatively, the business may sell at higher
prices and enjoy increased profits as its costs of production are

394
low.

Key term
Productivity is the quantity of goods or services
produced by an employee over a period of time, such as
one year.

Maths moment

Use the information in Table 4.2 to calculate which

business (A or B) has lower labour costs for each
unit of output produced.

High-quality products or customer

service
Appointing the very best people will help a business to supply
good quality products. This means that the products will meet
the needs of customers as fully as possible. Employing people
with appropriate knowledge and skills means they are able to
supply goods or services with which customers are satisfied.
• Quality. A car manufacturer, such as Nissan, will seek to
employ the most skilled engineers to enable it to supply fuel-
efficient and environmentally friendly cars to satisfy its

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 customers.
• Customer service. A restaurant which employs a
knowledgeable and skilled chef will be able to deal with very
busy periods when large numbers of customers are expecting
meals. The same person will be able to cook a meal for
someone with special dietary needs.
Improved levels of quality and customer service can be very
important for some types of businesses, such as those who
pursue objectives other than profits. For example, a charity
providing day trips for the elderly may particularly value
improvements in its customer service.

Key term
Quality is the extent to which customers’ requirements
are met.
Customer service is that part of a business’s activities
that is concerned with meeting customers’ needs as fully
as possible.

Business insight
Nissan leads the way
The Japanese car manufacturer, Nissan, produces one in
three cars that are made in the UK. It faces tough
competition from other car manufacturers such as
Volkswagen and Ford. The company’s managers say that
it is important for it to keep production costs to a
minimum.
The company’s factory in Sunderland is the largest car
factory in the UK. It has the highest rates of productivity of
any car factory in Europe or North America. It

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 manufactured 476,589 cars in 2015, building them at a
rate of one car every minute, 24 hours a day. The factory
employs more than 6,800 people, and a lot of technology
is used on the production lines.

Analyse why it is important for Nissan to operate an

effective recruitment and selection process at its
factory in Sunderland.
(6 marks)

Employee retention
Employee retention measures the proportion of employees with
a given length of service (typically one year or more) expressed
as a percentage of overall workforce numbers. This is often
measured by calculating the number of people who have
worked for the business for a certain period of time (perhaps
one year or more) as a percentage of the total workforce. For
example, if a business has 1,500 employees and 1,350 have

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worked for the business for a year or longer, its employee
retention rate will be:

An effective system of recruitment and selection should increase

a business’s level of employee retention because it is more likely
to result in the best and most suitable person being appointed.
As a result, the employee is more likely to be satisfied with the
job as they feel they are a success in this role. Equally, the
business’s managers will be content that the person works well
with other employees and has good levels of productivity. Thus,
they will want to retain the employee.
Having poor rates of retention because large numbers of
employees are leaving can pose problems for a business:
• Higher costs. Research shows that the cost of replacing an
employee who leaves is up to £30,000. Recruiting and
selecting employees is costly (for example, advertising posts

398
 and paying other staff to recruit and select employees) as well
as training costs for the new employee.
• Reductions in quality and customer service. Even
experienced and skilled employees can take time to settle into
a new job. In the meantime, the quality of their work may be
relatively low. Customers may be unhappy if they are expected
to deal with a new employee. For example, some customers
may have valued a particular hairdresser highly and be less
happy with a replacement.
• Reduced rates of productivity. A new employee will
probably be less productive until they are familiar with the
business and have possibly received training. Research shows
it takes a new employee up to six months to reach their
maximum level of productivity. In the meantime, the
business’s costs are higher.

Contracts of employment
Employees have to be given a contract of employment
within two months of starting work. A contract of employment
is a legal agreement between an employer and an employee,
setting out the employee’s conditions of employment. It is
common for a contract of employment to include:
• normal working hours
• rates of pay
• holidays
• duties at work
• place of work.
Businesses can recruit employees on different types of contracts
to meet their need for workers. There are a number of different
types of contracts of employment in use in the UK at the

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moment.

Full- and part-time employment

A business may employ a mixture of full-time and part-time
employees. Full-time employees work for the standard number
of hours in the working week. This can vary from business to
business. However, in 2015, the average number of hours
worked by a full-time employee in the UK was 39.1 hours.

Key term
A contract of employment is a legal document stating
the hours of work, rates of pay, duties and other
conditions under which a person is employed.
Full-time employment occurs when someone works a
number of hours equal to the normal working week,
normally between 35 and 40 hours.
Part-time employment takes place when an employee
works for fewer than the normal number of working hours
per week.

Many businesses also employ part-time employees who work

fewer than the standard number of hours. It is common for part-
time employees to work two or three days a week, or just
afternoons or mornings. Some part-time jobs are allowed to help
parents to look after school-age children. Thus, this group of
part-time employees may start later and finish earlier than full-
time employees each day. In 2016, there were 8.43 million part-
time employees in the UK – this is approximately 25 per cent of
those at work.

400
The benefits of full- and part-time
employment
Table 4.3 summarises the benefits to employers and employees
of full- and part-time working.

401
Job sharing and zero hours contracts
Job sharing occurs when two or more people combine to fill
a single job role. For example, some teaching posts are filled by
two people. One might work Monday to Wednesday each week,
with a second person at work on Thursdays and Fridays. For
employees who job share, it can offer many of the benefits of
part-time work set out in Table 4.3. Employers can benefit in
terms of having a broader range of skills. However, there are
disadvantages in that the people sharing the job may not
communicate well.

Study tip
You only need to know the benefits of full- and part-time
working and not the drawbacks as well.

Zero hours contracts are used widely in the UK economy. A

person with a zero hours contract is not guaranteed a set number
of hours of work each week. They may get no hours, or be

402
offered a large number. Employees on these contracts do not
have to accept any hours of work they are offered. However,
they may feel that turning down work might mean that they are
not offered any hours in the future. In 2016, just over 900,000
people in the UK had a zero hours contract – this is about 3 per
cent of the country’s total workforce.

Key terms
A job share exists when two or more employees agree to
share the responsibilities of a single job.
A zero hours contract allows employers to hire staff
without any guaranteed hours of work.

Summary

403
Businesses can recruit employees from inside the
business (internal recruitment) or from elsewhere
(external recruitment). Both approaches have advantages
and disadvantages. To recruit an employee, a business
needs to conduct a job analysis, draw up relevant
documents, advertise the position and select the best
person or people. Businesses benefit in a number of ways
from having an effective recruitment and selection
process They can use a range of different contracts of
employment.

Quick questions
1 What is meant by the term ‘recruitment’?
(2 marks)
2 State two circumstances in which a business might
need to recruit new employees.
(2 marks)
3 Which of the following is a benefit of the use of internal
methods of recruitment?
(a) It allows the business to recruit from a wider pool
of applicants.
(b) It offers the business new ideas.
(c) The business is likely to have an employee with
the right skills immediately.
(d) It offers employees opportunities for promotion.
(1 mark)
4 State two pieces of information that a business is
likely to include in a job advert.
(2 marks)
5 The use of which of the following is a method of

404
 selection?
(a) Job analysis
(b) Assessment centres
(c) Person specifications
(d) Job descriptions
(1 mark)
6 Which document used in the recruitment and selection
process lists the qualifications and skills required by
an applicant for a job?
(a) Job description
(b) Curriculum vitae (CV)
(c) Person specification
(d) Application form
(1 mark)
7 State one advantage and one disadvantage of using
interviews as a method of selection.
(2 marks)
8 Explain one reason why a business might use
psychometric tests as a method of selection.
(3 marks)
9 State two benefits a business may receive from
operating an effective recruitment and selection
process.
(2 marks)
10 What is the difference between a job share and a zero
hours contract?
(4 marks)

Case study

405
Swaledale Hotel Group Ltd
The Swaledale Hotel Group Ltd (SHG Ltd) operates 20
luxury hotels in locations across the UK. It expects very
high standards of its employees and trains them carefully
to provide hotel guests with outstanding customer service.
As a result, it has developed an excellent reputation.
SHG Ltd has grown steadily since 1996, opening
approximately one new hotel a year. The company’s sales
and profits have fallen slowly over the last three years. It
has seen a large number of its employees leave over this
period.
The company is about to open four new hotels in northern
England and is seeking to appoint managers and assistant
managers for each of these hotels. SHG Ltd’s HR
managers expect that these posts will prove popular and
should attract a large number of applicants, whether
advertised internally or externally. One HR manager is
concerned that they might have difficulty choosing the best
applicants.
1 State two methods of selection that SHG Ltd might use
over the coming months.
(2 marks)
2 Explain why the HR managers at SHG Ltd should use
person specifications as part of their recruitment and
selection process.
(4 marks)
3 Analyse why it is important for SHG Ltd to have an
effective process for recruitment and selection.
(6 marks)
4 Recommend whether SHG Ltd should use internal or
external recruitment to appoint its new managers and

406
assistant managers.
(9 marks)

407
Topic 4.3

Motivating employees
Most managers seek to motivate their employees,
although there is disagreement on the best way to do this.
Managers do agree, however, that motivation is important
because a motivated workforce can help to make a
business very competitive.
By the end of this topic, you should know:
• what is meant by the term ‘motivation’
• the benefits to businesses of having motivated staff
• the methods of motivation used by businesses.

The importance of motivation

What is motivation?
Motivation is the range of factors that influence people to
behave in certain ways. It can be described as the will to do
something. In business, motivation is the force that drives an
employee to work very hard and to carry out his or her job as
effectively as possible. There are different views on where
motivation comes from. However, most writers agree that

408
different people will be motivated by different things:
• Motivation using money. Some people believe that
motivation is achieved through the use of money. They argue
that offering employees higher play or bonuses for reaching
targets will result in increased levels of motivation.
• Motivation through non-financial factors. However, others
view motivation as the result of a non-financial factor. Thus
they believe that factors such as praise or the opportunity to
carry out a more interesting job are more likely to motivate
employees.

Key term
Motivation is the range of factors that influence people to
behave in certain ways.

Study tip
These two views on the different causes of motivation
explain the different techniques or methods used by
businesses to motivate staff. Try to remember this when
explaining why businesses use different techniques or
when thinking about what might be the best method in a
given situation.

Why do people work?

Everyone who works is motivated to do so by one or more
factors. However, people are all different and this means that
they are motivated by different factors. Abraham Maslow, a
psychologist, tried to explain this through a theory that has
become known as ‘Maslow’s hierarchy of needs’. Maslow
identified five human needs, and he said that if people could

409
meet these needs by working, then this would motivate them at
work. Maslow’s hierarchy of needs is set out below and
illustrated in Figure 4.11:
• Physiological needs. These are the most basic needs that a
person has and relate to the needs of the human body.
Physiological needs include keeping warm, having shelter and
enough food to eat – failure to meet these needs leads,
ultimately, to death. Physiological needs are mainly met by
receiving pay, which allows people to buy food and a home.
However, they can also be met at work by having a warm
office or a lunch break so that employees can eat.
• Safety needs. People need to be safe and secure in their lives
and not at risk of a threat to the quality of their lives. There
are two ways in which this need can be met at work.
Employees want security in their jobs and to know that they
will not lose their jobs and their incomes. They also need to
be safe from accidents and injury at work. This second need is
more important in dangerous working environments, such as
farms.
• Love and belonging needs. Workers want to be part of a
group and accepted as part of that group. They want to be
trusted by the people they work with and to enjoy their
company and friendship. This need can be satisfied at work
by arranging social events such as parties and outings and,
more frequently, by organising people to work in teams.
• Ego or self-esteem needs. It is normal for people to want to
feel good about themselves and to know that the people they
work with respect them for their ability to do the job.
Employees may know that they are good at their job if, for
example, they achieve high levels of sales or their customers
are complimentary. However, this need can also be met at
work by praise and by recognising an employee’s
achievements, by paying a bonus, for example.

410
• Self-actualisation. This is Maslow’s top-level need. It is the
need to be given the opportunity to stretch yourself and to
work to your full potential. This might be met by an employee
being given a demanding task to complete or by being given
the power to organise his or her working day. In both cases,
there are more demands being placed on employees, which
will help to stretch them.

Maslow argued that people would steadily move up through

these five levels of need. Once one level was satisfied they
would try to satisfy the next level. The central point of his theory
is that if employees are given the opportunity to satisfy the next
level of needs at work, they will be motivated by this. Their
level of effort and commitment to the job is likely to increase.

411
The benefits of a motivated workforce
Most managers would say that to have employees who are
motivated is a very important factor in making the business
successful. There are a number of reasons why this is the case.

Increased productivity levels

As we saw in Topic 4.2, productivity measures the quantity of
goods or services produced by an employee over a period of
time, such as one year. Motivated employees normally work
hard and try to do their jobs as efficiently as possible. The
manager of a business might find that motivated employees
always arrive at work on time, use their time at work as
effectively as possible and do not, for example, stand around
chatting. This means that the business will produce a large
quantity of goods or services with relatively few employees. In
other words, its employees will have high productivity levels.

412
 Study tip
While you may not need to know about the specific
theories of motivation by name, such as the one written by
Abraham Maslow, you may find this theory (and others)
helpful in explaining why employees can be expected to
behave in certain ways.

High levels of productivity can offer considerable benefits to

businesses. It allows them to produce goods and services
relatively cheaply because the labour cost involved in producing
each product is lower. Hence, the goods or services can be sold
at lower prices making the business more competitive. This is
very important in industries where low prices are important to
customers. For example, the airline Ryanair benefits from a
productive workforce and low labour costs. The company’s
labour costs were less than 10 per cent of the income it received
from selling flights in 2013. This is lower than many other
airlines and enabled Ryanair to sell flights very cheaply.

Improved employee retention rates

Employees who are motivated are more likely to be loyal to a
business and to remain with it even if there are tempting jobs
available with other businesses. A business has a high retention
rate if a large proportion of its workforce remains with the
business over a period of time, usually measured over one year.

413
Having a high retention rate offers two major advantages to a
business:
• It avoids the cost of recruiting and selecting new employees.
Research shows that the cost of replacing an employee who
leaves is up to £30,000.
• It removes the need to train new employees, which can be
costly. Even if new employees do have the right work-related
skills, they take time to get to know a new job and to work as
a team with their colleagues.

Higher levels of sales

A business with a motivated workforce can be expected to
achieve higher levels of sales than would be possible otherwise.
Motivated employees will work hard and seek to meet the needs
of customers as fully as possible. Customers treated in this way
are more likely to buy goods and services.

414
Levels of employee motivation can be an important factor
affecting sales in service industries such as retailing. In 2016,
research revealed that motivated employees working in shops
produce an average 2.5 times more revenue from sales than
those who are less motivated.

Improved recruitment and selection

Having a motivated workforce helps to give businesses a good
reputation as an employer. This can be a significant benefit
when recruiting new employees as the business is viewed as a
good place to work. This makes it easier for the business to
recruit the best workers, helping to improve its sales and profits.

415
Business insight
Jaguar Land Rover is Britain’s best employer
Table 4.4 shows the top five employers in Britain in 2016,
following a survey of 15,000 employees and over 400
businesses.

416
Jaguar Land Rover (JLR) enjoyed further success in
2016 as its sales figures were very impressive. Its annual
sales of vehicles rose 13 per cent to 521,571. This was
principally due to rising demand, such as the Jaguar XE.
Its revenue for the financial year was £22.2 billion, £342
million higher than in the previous year. JLR has created
over 20,000 new jobs in five years and invests heavily in
training its employees.
Analyse the possible benefits to Jaguar Land Rover
from being voted as Britain’s best employer.
(6 marks)

Methods of motivation used by

businesses
417
The methods of motivation that are commonly used by
businesses can be divided into two groups: those that use money
and those that use other methods.

Non-financial methods of motivation

Increasing authority through job
enrichment
Some employees may lack motivation because they are bored.
They find their job simple to do and so lose interest in it. Job
enrichment can help to correct this by making the jobs more
demanding and challenging. It can give employees more diverse
duties as well as more authority to take decisions at work. For
example, a receptionist for a small business might be motivated
by receiving extra tasks such as planning a marketing campaign.
This would be done alongside normal duties. Job enrichment
often involves delegating authority to junior employees. (Topic
4.1 discusses delegation and authority in more detail.)

Key term
Job enrichment is designing a job to give interesting and
challenging tasks.

Training
However, an employee may not be able to take on more
demanding duties (via job enrichment) without being trained.
The receptionist referred to above may need some training in the
basics of marketing before he or she can design a campaign
successfully. The training itself is likely to motivate because it
shows that the business owner values the employee and this

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should increase self-esteem. Training can help to motivate in
other ways, for example, by making the workplace safer
following health and safety training. Training is covered in
greater detail in Topic 4.4.

Management styles
Managers use different styles within the workplace. Although
there are many different management styles in use, it is possible
to separate these into two broad categories:
• Managers who retain authority. Some managers use a style
that is based upon their use of authority to make most, if not
all, decisions. Some of this group of managers may ‘sell’ their
decision to junior employees. However, the common factor is
that this group of managers take decisions, no matter how
they present it.
• Managers who allow junior employees freedom to make
decisions. This group of managers give much more freedom
to more junior employees to make, or at least contribute to,
decisions. Some will allow juniors a great degree of freedom
to make their own decisions, within some limits. Others grant
less freedom, but still allow junior employees to offer
suggestions and ideas.
Many employees will be more motivated from working with
managers who use the second style. This style provides
opportunities to fulfil many of the needs of employees that were
identified by Maslow. For example, giving employees freedom
to make decisions can offer the opportunity for junior
employees to meet their needs for self-esteem as well as self-
actualisation.

Business insight
Virgin Group’s ‘horrible day’

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Sir Richard Branson is a well-known supporter of a
relaxed working environment. The Virgin Group recently
held a ‘corporate day’, to highlight the ways in which the
company motivates its employees.
Virgin Group’s workforce was asked to:
• wear traditional office dress, not casual clothes
• abandon flexible working hours and arrive at 9 a.m.
• use the titles Mr and Mrs or Ms for colleagues in their
and other teams
• not look at social media or make personal phone calls.
In an interview with the BBC, Branson explained why the
company had held the day. He said that the purpose of the
exercise was to give his employees ‘a taste of what a lot
of the world is still run like. It was a horrible experience for
everybody.’ It was a shock for a workforce that normally
benefits from job enrichment and unlimited leave.

Explain one way in which the Virgin Group

motivates its employees.
(4 marks)

Fringe benefits
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Businesses may offer employees a range of additional benefits to
supplement their pay. Examples of fringe benefits include:
• health insurance
• a company car
• discounts when buying the company’s products.

Key term
Fringe benefits are the ‘extras’ that employees may
receive in addition to their pay, for example, a company
car.

The use of fringe benefits can help to make employees more

loyal and improve retention rates. However, if offered to large
numbers of employees, they can become very expensive.

Financial methods of motivation

It is very common for businesses to use money as a method of
motivation. The belief that money has the power to motivate
employees is based on the theories of a number of writers who
believe motivation is caused by external factors. Frederick
Taylor is probably the best known of these writers. He argued
that:
• employees were only motivated by money
• pay systems should be linked to the amount produced
• managers should retain authority and employees should be
supervised closely.
The work of Taylor and others has meant that businesses use a
number of methods of payment to reward their employees.
Many of these methods have been designed to motivate
employees.

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• Salaries. A salary is the income received by an employee,
stated as an annual figure. For example, an accountant’s
annual salary might be £47,500. Employees receiving salaries
are not normally required to work a set number of hours per
week. Employees paid in this way may be motivated by an
increase in salary, perhaps alongside some fringe benefits.
• Wages. Wages are usually paid each week and employees
normally work an agreed number of hours. A higher hourly
rate (called overtime) is paid for any additional hours worked.
An increase in the hourly rate may be used to motivate
employees.
• Piecework. Under the piecework system, which is also
called piece-rate, employees are paid according to the amount
they produce. They are paid an agreed figure for each unit of
output they produce, subject to them receiving the National
Living Wage as a minimum rate of hourly payment.
• Commission. This is a payment made to an employee based
on the level of sales he or she has made over a time period. It
is normally paid in addition to a wage or salary. In effect, it is
a form of piecework paid to people employed to sell goods
and services.
• Profit sharing. Under this method of payment, employees
receive a share of the business’s profits alongside their normal
wages or salaries. This can motivate as employees benefit
directly from an increase in the business’s profits. Many well-
known companies such as John Lewis and Zara operate
profit-sharing schemes.

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Key terms
Piecework is a method of payment under which
employees are paid according to the quantity of products
they produce.
The National Living Wage is an hourly rate of pay which
is set by the government. All employees above a certain
age must receive at least this rate of pay.

Maths moment
Sarah has just finished training as a veterinary nurse and
is looking for her first job. She has seen two possibilities:
• a job which pays her a salary of £17,500
• a similar post working 35 hours each week and
receiving £10 per hour.
Which one will give Sarah the higher pay?

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There is much disagreement about the extent to which money
can motivate employees. Some writers on motivation, such as
Frederick Taylor (who was mentioned earlier), think it is the
major factor motivating workers. Others give it a limited role.
Abraham Maslow, for example, believes that it can enable
employees to meet some basic needs such as those for food and
housing, as well as self-esteem needs. However, other writers
argue that it is not motivational, and that non-financial methods
should be used. This is supported by a recent survey showing
that 59 per cent of employees in the UK believe that ‘an
interesting job’ is the most important motivational factor. This
result suggests that non-financial factors, such as job
enrichment, play a vital role in motivating employees.

Study tip
Do think about how different groups of employees can be
motivated or whether the existing way is the best. What
methods of motivation could fulfil the needs that are not
currently being met? Maybe finance is not the best
method and non-financial methods could be more
effective.

Business insight
Tom’s first day
Tom was excited at the prospect of starting a new job with
a new website design company that had just opened.
However, his first day at work came as a shock. Tom was
given a small, unclean office to work in on his own, while
the two owners of the business worked in a separate,
larger and much smarter room. Tom had little contact with
them and they did not offer many comments on the work
he produced. He wasn’t sure whether he was doing well or

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not. Despite the high rate of pay, Tom left the job after the
first week.
Explain the possible actions the two owners of the
business might have taken to improve Tom’s
motivation at work.
(4 marks)

Summary
People are motivated in different ways. Some are
motivated from within and others by external factors, such
as the promise of a reward. People have different needs
that can be met by working, and meeting these needs can
help their level of motivation. There are significant benefits
to businesses from having motivated staff: they are more
loyal, more productive and usually achieve higher levels of
sales. Businesses may motivate staff by paying them
more, but also by giving them more interesting and
demanding jobs, by giving training or through the use of
fringe benefits.

Quick questions
1 What is meant by the term ‘motivation’?
(2 marks)
2 What is meant by the term ‘piecework’?
(2 marks)
3 State two types of needs that employees can meet
through work.
(2 marks)
4 State two benefits to a new business of having well-

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 motivated employees.
(2 marks)
5 What is meant by the term ‘job enrichment’?
(2 marks)
6 Which of the following is a financial method of
motivation?
(a) Commission
(b) Job enrichment
(c) Training
(d) Delegation
(1 mark)
7 Which of the following is not a fringe benefit?
(a) Health insurance
(b) A company car
(c) Discounts when buying the company’s products
(d) Piecework
(1 mark)
8 Explain one reason why training can improve the
motivation of a workforce.
(3 marks)
9 Explain the difference between salaries and wages.
(4 marks)
10 Explain how a business uses financial rewards to
motivate its employees.
(3 marks)

Case study
Amil’s workforce

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Amil Khan owns a small factory mixing and roasting seeds.
Roasted seeds are becoming increasingly popular as a
healthy snack and Amil wanted to be part of a growing
market. His business is making a small profit each month
at the moment, although its sales are rising steadily.
Amil has seven employees in his factory. He has decided
that paying them well is important. He believes that
financial rewards are the best way to motivate people and
that those who produce more should be paid more. He
thinks the business will benefit from having a well-
motivated workforce.
Each employee has a simple job to do within the factory
and little responsibility. Amil has to leave the business
regularly to talk to shopkeepers about stocking his
products. Sometimes, while he is away, production stops
because employees face problems that they do not know
how to solve.
1 State two methods of payment that Amil would be likely
to use for his workforce.
(2 marks)
2 Explain one benefit that Amil’s business may receive
from a well-motivated workforce.
(4 marks)
3 Analyse the reasons why Amil should spend more
money on training his employees.
(6 marks)
4 Do you think that Amil used the best method of
motivation with his staff? Give reasons for your answer.
(9 marks)

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Topic 4.4

Training
Training employees can bring a range of benefits to
businesses, such as increased levels of motivation and
productivity. It can help a business to be more competitive
than its rivals. However, training can be costly and highly
trained employees may leave the business.
By the end of this topic, you should know:
• what is meant by the term ‘training’
• why training can be important to a business
• the main types of training provided by businesses and
their advantages and disadvantages.

The importance of training

Training gives employees job-related skills and knowledge. It
can bring many benefits to businesses. UK businesses clearly
recognise its importance as they spent over £45 billion training
17.4 million employees during 2015.

Key term

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Training is a range of activities giving employees job-
related skills and knowledge.

Improvements in productivity
Training results in employees learning new skills and gaining
knowledge that can make them better at their jobs. For example,
training given to employees on a production line may enable
them to use new technology. This means that they can make
products more quickly and with fewer errors.
Training can help improve productivity by teaching employees
how to do their jobs as efficiently as possible. This should
reduce time wasted on unnecessary tasks and time spent
correcting mistakes and allow more time to be spent on the most
important activities. Training also makes a business more
attractive to potential employees. This makes it easier for the
business to attract the best, and most productive, workers.

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More motivated employees
We saw in Topic 4.3 that levels of motivation can be an
important part of creating an effective workforce. Training can
improve employees’ motivation:
• Training can make employees feel valued. This will help to
motivate them and make them more committed to the business
and their jobs.
• Training allows employees to carry out duties which are more
challenging and more interesting – this is known as job
enrichment. This can improve their enjoyment of the work
and their performance at work.

Improved rates of employee retention

Training can make employees feel more loyal to a business. It
also gives them additional skills, which may mean that they can

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be promoted or take on more challenging work. Both these
factors mean employees are less likely to leave.
Businesses with good employee retention rates keep experienced
staff and do not have to pay the costs of recruiting and training
new staff. Research suggests that 75 per cent of recruitment
costs relate to replacing employees who have left the business.
Thus, businesses can reduce recruitment costs significantly by
improving employee retention.
Employee retention is discussed in greater detail in Topic 4.2.

Business insight
TalkTalk fined £400,000
TalkTalk is one of the UK’s largest telecoms companies. It
has been fined £400,000 for security failings that allowed
a computer hacker to access its customers’ data ‘with
ease’. An investigation found that the cyber-attack in
October 2015 was possible because of weaknesses in
TalkTalk’s IT systems.
Criminals were able to gain access to the names,
addresses, dates of birth, phone numbers and email
addresses of nearly 157,000 customers and the bank
account details of over 15,000 customers.
Research by the UK government shows that 75 per cent
of large companies suffered IT security breaches in
2015. Half of these were caused by employees lacking
suitable skills.
Analyse why large companies in the UK might
spend more on IT training for their employees.
(6 marks)

431
Production of high-quality goods and
high levels of customer service
Training is essential if all employees, including those newly
appointed, are to provide high-quality products and high levels
of customer service. Training reduces the risk of faulty goods
being produced as employees are less likely to make errors.
Similarly, training in customer service can give employees a
clear understanding of how to meet customers’ needs and to use
the business’s systems to do this. In 2016, Vodafone, one of the
UK’s largest mobile phone service companies, received a large
number of complaints about poor customer service, such as
incorrect bills and problems transferring phone numbers.
Vodafone responded by spending £15 million on an additional
72,000 hours of customer service training for its employees. It
publicised its response to reassure its customers and its
performance has improved.

432
Types of training
Training is made up of a range of activities that give employees
job-related skills and knowledge. There are three major types of
training that a business can provide for its employees (see Figure
4.14).

433
Induction training
Induction training is the first type of training that an
employee will receive once he or she has started a new job. It is
intended to help new employees to become more familiar with
the business and the job that they are to do. Induction training
might involve meeting the other employees at the business with
whom the candidate will work closely. The new employee will
also learn key information about the business, such as how its
IT systems work, as well as more about their role in the
business. This type of training normally occurs within the
workplace. After induction training, employees may be offered
other types of training.

Key term
Induction training is the training given to an employee
when he or she first starts a job.

Induction training offers a number of benefits:

• Induction training helps new employees to integrate with

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 existing workers and to learn how to carry out their new jobs
effectively. Induction training can help new employees to
become more productive earlier.
• Some employees may leave after a very short period of time if
they do not feel that they are supported. Induction training can
help to avoid low rates of staff retention. As a result,
businesses do not face the costs and disruption that can
accompany replacing employees.

On-the-job training
Using on-the-job training means that the employees do not
leave the workplace. This type of training means that employees
may learn from more experienced workers. It is popular in the
UK with 48 per cent of businesses using it in 2015.

Key term
On-the-job training is given in the workplace.

There are a number of types of on-the-job training:

• Work shadowing. Here, experienced and skilled employees
are observed during the working day. They may offer advice
and guidance as well.
• Formal training sessions. These can be led by experienced
employees or by specialist trainers from outside the business.
These sessions can update employees on changes that have
taken place, for example, in health and safety laws.
Alternatively, they may be used to prepare employees to take
on new roles within the business.
• Computer-based training. It is becoming increasingly
common for employees to receive training in the workplace
using computer programs. In 2015, 30 per cent of businesses

435
 in the UK used computers to deliver training in the workplace.

The benefits of on-the-job training

• It can be a relatively cheap way of providing training, as
employees do not have to travel and other employees may be
able to give the training. Many businesses cannot afford to
spend heavily on training. Using this form of training means
that more employees can benefit from a limited amount of
spending. This can result in major improvements in a
workforce’s productivity.
• On-the-job training is also targeted to the exact needs of the
business, especially as it is often given by other employees.
This means that employees will receive the precise knowledge
and skills they require to carry out their roles efficiently. For
example, employees receiving IT training can receive it on the
business’s IT system, rather than a different system.
• Businesses are making increased use of computers to provide
on-the-job training. This is called e-learning. It enables

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 businesses to use computer programs to give training which
meets the business’s needs. This can be delivered at any time
and is a relatively cheap method of training, especially if used
by a large number of employees.

The drawbacks of on-the-job training

• On-the-job training is unlikely to bring new ideas into the
business unless an outside trainer is used. As a result, on-the-
job training may not lead to dramatic improvements in the
performance of a business’s employees.
• Using this type of training can result in more employees being
unavailable to work within the business for a period of time.
The business might, for example, lose the services of those
providing the training, as well as those receiving it.

Business insight
Folly Farm Adventure Park and Zoo
Folly Farm is an adventure park and zoo in
Pembrokeshire – a very quiet part of Wales. It is
committed to looking after its employees, in part through
providing training. The company relies on on-the-job
training to give employees skills in catering and customer
service, as well as on how to care for over 90 different
types of animals.
Folly Farm is a small business with a big reputation and
highly skilled and experienced employees. In 2016, it was
voted the best business in Pembrokeshire.
Explain why Folly Farm uses on-the-job training for
its employees.
(4 marks)

437
Off-the-job training
Off-the-job training takes place outside the place of work. It
might involve attending a course at a college or university,
studying at home or going on a course run by a training
company. Sometimes, off-the-job training can last for a
considerable time. For example, an accountancy firm may pay
for its employees to gain accountancy qualifications. This could
involve several years’ part-time study at a local college.

Key term
Off-the-job training is provided outside the employee’s
place of work.

The benefits of off-the-job training

• Off-the-job training can help to bring new ideas and
approaches into a business. This can be valuable in industries,
such as developing computer software, in which change is
rapid.
• Off-the-job training is expensive and can be used to motivate
employees as we saw earlier in this chapter. Receiving off-the-
job training can make employees feel valued as their employer
is spending significant sums on improving their skills. This
may result in substantial improvements in the employee’s
performance at work.

438
The drawbacks of off-the-job training
• This type of training can be expensive so, for businesses
making only small amounts of profit, it may not be affordable.
Many small businesses may not consider this as a realistic
option.
• All businesses who provide off-the-job training for their
employees take a risk. There is every possibility that the newly
trained employee will leave the business for a new job once
the training programme is complete. Off-the-job training can
prepare employees to work in a range of different businesses.
Thus, a business may spend heavily on training an employee,
but receive little or no benefit in return.

Study tip
You may find it helpful to be able to distinguish between
on-the-job and off-the-job training and what the benefits
and drawbacks are of using these types of training.

439
Factors influencing decisions on types
of training
Once an employee is settled in a job, businesses can opt to
improve their skills using off-the-job or on-the-job training.
These two types of training are used fairly equally by employers.
In 2015, around 71 per cent of UK businesses used some form
of off-the-job training, such as attending courses at a local
college. In comparison, 48 per cent used on-the-job training.
Some businesses use both methods, which is why the total is
greater than 100 per cent.
There are several factors which would influence which of these
two types of training is used.

The business’s financial position

Training, and especially off-the-job training, is expensive.
Businesses in weak financial positions will be more likely to
choose on-the-job training, if they train their employees at all.
The average business in the UK spends only about £300 a year
on training each employee. Those in poor financial positions
will spend less and would be unlikely to be able to afford the
cost of off-the-job training.

The type of training required

Some businesses require very specific training to meet their
particular needs. This might be provided best through on-the-
job training. Training provided by local colleges or other
training organisations might not suit the business’s precise needs
and could be too general. For example, on-the-job training
might be used by companies using employees to develop
computer games or other software. Similarly, relatively simple

440
training, such as that required to operate some production line
machinery, may also be provided on the job.

Off-the-job training may be more suited to training that is long

term and requires the passing of examinations. The costs of this
may be reduced if it takes place outside working hours.

The skills and experience of the

business’s workforce
It is easy to forget that the ability to train other people is a skill.
Not all employees have this skill, meaning that businesses that
make widespread use of on-the-job training may have to train
their workforces to do this. Without suitable employees to train
others, businesses may opt for off-the-job training.

441
Rapidly growing businesses, or those with low employee
retention rates, will have large numbers of new employees. This
can make it difficult to provide training on the job and may
result in training being provided by external organisations.

Business insight
Training for engineers on overhead power
lines
An overhead line engineering training centre in Penrith,
Cumbria, offers training to engineers responsible for
maintaining power lines. The off-the-job training course
has been designed to provide skills that are in short
supply.
The training is provided by Newton Rigg College, part of
Askham Bryan College. It is a three-year, part-time
course. Teaching begins with off-the-job training in the
classroom and in a purpose-built training field on the
Newton Rigg site. Off-site learning exercises also take
place at a number of UK locations managed by SPIE, a
European technical services company.

442
Analyse the possible reasons why these engineers
are receiving off-the-job training.
(6 marks)

Summary
Training can be an important way for a business to
improve the performance of its workforce. Businesses
may give induction training, as well as on-the-job and off-
the-job training. This can make the business more
successful in its markets. However, training can be
expensive, especially if off-the-job training is used.

Quick questions
1 What is meant by the term ‘training’?

443
 (2 marks)
2 Explain why training might help to improve the level of
productivity of a business’s workforce.
(3 marks)
3 Explain one reason why training might help to improve
a business’s employee retention rates.
(3 marks)
4 Using examples, explain the difference between on-
the-job and off-the-job training.
(4 marks)
5 Which of the following is an example of off-the-job
training?
(a) Work shadowing a colleague
(b) Completing a computer-based training course at
home
(c) A session led by an external training provider in
the factory
(d) A talk in the office by a senior manager
(1 mark)
6 Explain one benefit of induction training.
(3 marks)
7 Which of the following is not a benefit of on-the-job
training?
(a) It brings new ideas into the business.
(b) It is a relatively cheap way of providing training.
(c) It can be designed to meet the business’s exact
needs.
(d) It avoids the need to pay for travelling for
employees.
(1 mark)

444
 8 Explain one benefit of on-the-job training.
(3 marks)
9 Explain why providing off-the-job training might be a
risk for a business.
(3 marks)
10 Which of the following businesses is most likely to
offer its employees only on-the-job training?
(a) A business that is growing very quickly and whose
employees are overworked
(b) A business that is not in a strong financial position
(c) A business that does not have employees with the
skills to train others
(d) A business whose employees need long-term
training and have to pass national examinations
(1 mark)

Case study
John Lewis Partnership
The John Lewis Partnership (JLP) is a UK retail company
which is owned by its employees. It operates the John
Lewis department stores and the Waitrose supermarkets.
JLP employs over 91,000 people. Its staff stay twice as
long with the JLP as employees normally do with other
retailers.
JLP is heavily committed to training its employees and
spends 56 per cent more than similar organisations on
training. This is despite a 14 per cent fall in profits in 2016
and plans to reduce the size of its workforce.
The company provides induction training to all new

445
employees and promotes from within whenever possible. It
has a reputation for outstanding customer service and
spends heavily on customer service training. The
company provides on-the-job training for management
trainees, many who have just graduated from university.
1 State two benefits that JLP might receive from giving
its employee off-the-job training.
(2 marks)
2 Explain one benefit JLP may receive from providing
induction training to its employees.
(4 marks)
3 Analyse the possible drawbacks that JLP might
experience from the use of on-the-job training for its
management trainees.
(6 marks)
4 Do you think that the benefits of JLP spending heavily
on training outweigh the drawbacks? Give reasons for
your answer.
(9 marks)

Chapter review – Human resources

Read question 1, the sample answers and the comments.
Then try question 2.
1 Read Item A and answer the questions that follow.
Item A
West Norfolk Farms Ltd grows bulbs such as daffodils
and also cut flowers that are supplied to shops and
businesses throughout the UK. The company’s profits last
year fell 20 per cent to £125,000. Despite this, it is

446
expanding and plans to recruit 12 employees to work in its
greenhouses and fields. Many of the jobs are simple and
repetitive. Each new employee will receive induction
training and further on-the-job training. West Norfolk
Farms Ltd has a flat organisational structure.
The company encourages its employees to take decisions
and to organise their own work. The company’s managers
use a style of management that allows all employees to
make at least some decisions.
However, the company’s employees are not happy with
their rates of pay. One commented that other local flower
farms ‘pay at least 5 per cent more’. The managers at
West Norfolk Farms Ltd think that a pay rise might
improve the workforce’s motivation.

(a) Identify two documents that West Norfolk Farms

Ltd might use to recruit and select its new
employees.
(2 marks)
(a) Most businesses use a number of documents
to recruit and select employees and this can
help them to choose the best people. The
documents they might use are job adverts,
person specifications and job descriptions.

This answer shows knowledge, but it is too long

and gives unnecessary information. All that
was required was to write down the names of
two documents used in the recruitment and
selection process. This question could have
been answered with just a single sentence
giving more time to answer other, more

447
 demanding, questions.

(b) Explain what is meant by West Norfolk Farms Ltd

having ‘a flat organisational structure’.
(4 marks)
(b) A flat organisational structure means that the
diagram is a flat triangle. This means that
there are not many employees in the business
between top and bottom. This makes it easier
for the managers to pass messages to
employees and shop-floor workers normally
like this type of structure.

This candidate should have spent longer

thinking before starting to write the answer.
The answer does not contain the right
information – perhaps the candidate’s revision
was not thorough enough. He or she should
have said that the company would not have
many levels of hierarchy and have explained
that this may mean that spans of control are
wider. This makes it easier for the workers in
the greenhouses to communicate with the
manager.

(c) Analyse the possible reasons why West Norfolk

Farms Ltd prefers to use on-the-job training.
(6 marks)
(c) On-the-job training is teaching employees
skills and knowledge at the place of work and
is often given by other experienced workers.
The company has many jobs which are ‘simple

448
 and repetitive’ and, therefore, this makes it
easy for them to be taught by other employees.
It is not necessary for West Norfolk Farms Ltd
to send its employees on expensive off-the-job
training courses to learn this type of skill. The
use of on-the-job training is also helpful to
the company as it suffered a 20 per cent fall in
profits last year and a profit of £125,000 does
not justify paying for 12 new employees to
receive expensive training away from the
workplace.

The candidate has relevant subject knowledge

and uses this with information from the case
study to develop arguments explaining clearly
why this company, in these circumstances,
prefers to use on-the-job training. It is not a
long answer, but it is well focused and
thoughtfully constructed and is an effective use
of time. It is very likely that the candidate
planned this answer before writing it.

(d) Recommend whether West Norfolk Farms Ltd

should increase its employees’ pay to improve the
motivation of its workforce. Give reasons for your
advice.
(9 marks)
(d) Increasing employees’ pay could make them
work harder as they feel more rewarded and it
meets some of their needs, such as those for
food, shelter and clothing. West Norfolk Farms
Ltd should increase the pay of its employees
as at least one is unhappy and is complaining

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about low rates of pay. As the company is
about to recruit 12 new employees, a pay rise
might make the company a more attractive
employer and help to attract more talented and
hard-working people.
However, there are lots of reasons not to do
this. The company motivates its employees in
different ways using non-financial methods of
motivation. It allows employees to make
decisions and to organise their own work.
This can make the work much more enjoyable
and helps to make workers more productive.
I would not recommend that the company
raises its employees’ pay at the moment. The
company’s profits have fallen, and it will have
the costs of recruiting and training 12 new
workers. It also offers a range of non-financial
methods of motivation, and its wages are only
5 per cent lower than its rivals. It should
investigate what motivates its workers more
and what their needs are before committing
itself to an increase in pay which it cannot
really afford.

This is another thoughtful answer and it is

focused on the question throughout. It
analyses the reasons why the company might
give its workers a pay rise and the reasons
why it might not. Both sides of this argument
use material from the case study in support.
The final paragraph offers a clear decision and
gives reasons for this advice – exactly what

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 the question called for.
2 Read Item B and answer the questions that follow.
Item B
Jim O’Grady is the owner and manager of Volume, a chain
of bookshops in southern England. Initially, he had just one
bookshop in Chichester, but his company now operates
33 stores.
Volume’s employee retention rates (at 68 per cent) are
much lower than those of other retailers. He wants to
expand the business to have over 100 stores across the
UK.
Jim knows he needs to make some changes as he is
struggling to manage the growing business. He is
considering the following:
• decentralising the business as most decisions are
currently made in Chichester
• introducing a profit-sharing scheme for all employees as
its wages are lower than those of other bookshops
• reviewing the recruitment and selection process used by
the business to make it more effective – in particular, he
wants to appoint talented and ambitious store managers
• improving the company’s training by offering regular on-
the-job training as well as induction training.

(a) State two benefits to Volume from its use of

induction training.
(2 marks)
(b) Explain why Jim might be keen to introduce a
system of profit sharing into the business.
(4 marks)

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(c) Analyse the benefits to Jim of having an effective
recruitment and selection process for Volume.
(6 marks)
(d) Recommend whether or not Jim should
decentralise his business. Give reasons for your
advice.
(9 marks)

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5 Marketing

In this chapter, we look at the importance of a business

understanding its customers and meeting their needs and
wants. We show the benefits of understanding your
customers well and the dangers of not meeting their needs
effectively. We will look at how businesses achieve this by
identifying the particular needs and wants of a group of
people, called segmentation. We also look at the methods
of carrying out market research that businesses use to
get to know their customers and the different elements of
the marketing mix. This involves studying pricing
decisions, the way businesses communicate (promote)
their products, the nature of the product itself and the way
in which products are distributed to reach customers. We
consider the factors that influence decisions relating to the
marketing mix and the need for these decisions to be
linked to each other.

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Topic 5.1

Identifying and
understanding customers
A business can only be successful if it meets its
customers’ needs and wants effectively. This means it
must understand these needs and wants and have in
place the skills, resources and processes to satisfy these,
hopefully better than its competitors.
By the end of this topic, you should know the importance
of identifying and satisfying customer needs, in order to:
• identify a business opportunity and provide a product or
service that customers will buy
• increase sales
• select the correct marketing mix
• avoid costly mistakes
• be competitive.

An exchange process
A business is involved in an exchange process. It provides a

454
good or service in exchange for something – often money. To be
successful, this exchange must be worthwhile and beneficial for
both sides. Those investing in, running and managing the
business must feel that the rewards generated by the exchange
process are worthwhile and better than rewards that could be
gained elsewhere (the opportunity cost). The customers must
feel the benefits justify the price paid.

Key term
An exchange occurs when someone gives up something
in return for something else, e.g. a business exchanges a
product for money.

Identifying a business
opportunity
To sell its products, a business must offer something that
customers value and are willing to pay for. To do this,
businesses must identify a business opportunity. Is there
something the business can do better than others? Is there
something that customers are unhappy with at the moment? Is
there something that customers are missing and want?
A business must identify what its proposition is – what it is that
it is offering that customers will buy, what is the benefit
provided? For example:
• UPS will deliver your parcel safely and quickly. This is its
benefit.
• L’Oreal will make you feel more confident when you use their
products. This is a benefit.
• Amazon provides you with access to a wide range of products

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 and fast delivery. These are benefits.
• A Harley-Davidson motorbike makes you feel younger and
you can remember your youth. This is a benefit!

People pay for the benefits provided by a good or service. A

business has to identify these and promote them. They may not
always be obvious. Some people buy chocolate to reward
themselves – of course they eat it, but the underlying motive is
to congratulate themselves. Others buy it when they are feeling
sad about something – the chocolate makes them feel better.
Some people buy chocolate to give as a gift. Some buy it to
share. Businesses need to identify the different opportunities that
exist and develop products accordingly.

Needs and wants

People have needs. A need is something that needs to be
fulfilled for us to survive. We need to eat and we need to drink,

456
for example. Needs are what we must have to exist. We also
have wants – this is what we would like to satisfy our needs.
For example, we need to eat, but we want a sandwich from Pret
A Manger. We need to drink; we want to buy a particular brand
of water. Businesses have to understand the basic need they are
fulfilling and try to turn this into a want for their particular
product. They can do this by developing a product or brand that
people want.

Consumers and customers

The person or organisation buying the product is the
customer. The person using it is the consumer. These may
be the same person. For example, you may buy and eat your
lunch in which case you are the customer and consumer.
However, there are many occasions when the buyer and the
person consuming the product are different. Your parents may
have bought the cereal you eat in the morning or the phone you
use. This means businesses have to think about the needs and
wants of the customer as well as the consumer. For example,
when you go to upgrade your mobile phone, you may find the
questions you ask are different to what your parents ask when
deciding what phone to buy, and what you are looking for may
also be different.

Key terms
A need is something that needs to be fulfilled for us to
survive.
A want is what we would like to satisfy our needs.
A customer is someone who buys a product from a
business.

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A consumer is someone who uses goods and services
produced by businesses.

Business insight
Hotel Chocolat

Hotel Chocolat has been keen to push the idea of giving

chocolates as a present. It is particularly promoting its
online services so you can order a present and have it
delivered without even leaving your home. The business’s
sales online rose by 20 per cent last year, with overall
sales rising to £91.5 million. Evidence suggests that, in
uncertain economic times, more people buy extravagant
presents. In particular, the company has been successful
at stimulating people to buy chocolates to give to others.
The company has also been promoting the high cocoa
and relatively lower sugar content of its products to meet
the demand for healthier eating.
Analyse how Hotel Chocolat is increasing its sales.
(6 marks)

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Increasing sales
By providing more benefits and doing something better than
competitors, the sales of a business should rise. Consider the
following examples:
• In the taxi market, Uber allows us to identify on our mobile
phones the nearest taxi, to see the details of the car, to see the
rating of the driver and to pay directly from our account. This
gives us, the buyer, much more information about our options
and is more convenient than ordering a taxi the traditional way
and not knowing where it is, how long it will take or what the
driver is like. Uber, therefore provides additional benefits and
people will switch to this, increasing sales.
• The Amazon Kindle has enabled us to access and store many
books on one device – this is much easier (and lighter!) than
taking many different books on holiday. It is a benefit many
are willing to pay for, which has led to high sales.
• The iPhone is just a phone, but it also isn’t. It says something
about you as a person and your sense of style. There is
something about the way we use it, the features it has, the
style of it that add up to this being the phone of choice for
many people. This distinctiveness and its strong design boost
sales.

Selecting the correct

marketing mix
The marketing mix is the combination of factors that influence a
customer’s decision to purchase a product. You go to your

459
favourite clothes shop because, for example:
• you like the clothes there
• you think the clothes are value for money
• you like the layout and feel of the store
• it is easy to get to
• you like the staff
• you want people to know you shop there
• they have an easy refund and returns policy
• there is a sale on.

These are all aspects of the marketing mix. Our decision to buy
is influenced by these and many other factors. The more we
understand our customers, the more we, as a business, know
how to appeal to them. For example, if people are buying a
fountain pen as a present for someone else rather than for
themselves, then the business needs to make sure it is wrapped
well and looks like a gift. If people judge wine partly by the
price, then we do not want to sell it too cheaply, or this might

460
send out the wrong messages.
When buying a car, for example, are people looking for a car
that is:
• fuel-efficient?
• stylish?
• fast?
• affordable?
• environmentally friendly?
• reliable?
They may, of course, want all of these things, but which are the
elements that really matter? Which do you need to promote and
make people most aware of?
For more about the marketing mix, see Topic 5.4.

Avoid costly mistakes

If businesses don’t understand their customers, they will suffer.
If a political party does not understand its customers (its voters),
it loses the election. If a publisher does not understand its
readers, it publishes books that don’t sell. If a travel company
offers holidays to Peru when customers want to go to Malta, it
does not get the business. So understanding customers is the key
to getting sales and to avoiding costly mistakes.

Study tip
Remember that the nature of the marketing mix will vary
from product to product. For some products, you may
think for some time about the price being asked; in other
cases, you hardly notice it. The brand of clothes you buy
may be very important to you, but you may not care what

461
 brand of fruit or light bulb you buy.

If a business gets it wrong and produces the wrong products it

may have:
• to withdraw the product because sales are too low
• to amend the product in some way, which may cost money
• to lower the price, which may reduce the profits
• damaged the brand name, which may affect the company’s
future success.
Just think of the time and the cost of producing a new computer
game and finding it is not popular.

Be competitive
The competitiveness of a business refers to its ability to offer
better value for money than its competitors. It is relative, that is,
it relates to what one business offers in relation to other
competitors. To be competitive, a business must offer more
benefits in relation to the price charged than rivals do. To do
this, it must understand what it is that customers want. The
better you understand your customers, the more you can offer
them the benefits they want. Do customers want a three-hour
dining experience or fast food? Do they want to sit down to a
cooked breakfast or buy and eat their breakfast when they are
on the move?
If a business understands what exactly customers want to buy,
when they want to buy it, how much they are prepared to pay
for it and where they are likely to look for it, it will be able to
develop its marketing activities more effectively and be more
competitive. Offer the wrong thing, at the wrong time, with the
wrong message and price and you are not competitive.

462
Summary
To succeed in business it is no good just having an idea –
you need customers as well. Many businesses have failed
when there have not been enough customers buying the
product. Understanding your customer is essential to
being competitive, that is, to offering better value for
money than your competitors. You can adjust your product
better to meet their needs; you can get the price just right;
you can make the product available at just the right place
and time; and you can promote the right messages to
appeal to customers.

Quick questions
1 What is a ‘consumer’?
(2 marks)
2 What is a ‘customer’?
(2 marks)
3 What is a ‘need’?
(2 marks)
4 What is a ‘want’?
(2 marks)
5 What is meant by an ‘exchange process’?
(2 marks)
6 State two ways of measuring sales.
(2 marks)
7 Explain one possible problem that might occur if a
business does not understand a customer effectively.
(3 marks)
8 Explain one way that a business understanding its

463
 customers effectively can lead to more sales.
(3 marks)
9 Explain one way a business understanding its
customers effectively can reduce costly mistakes.
(3 marks)
10 Explain one way a business understanding its
customers effectively can lead to the correct
marketing mix.
(3 marks)

Case study
BHS
In 2016, the retail business BHS closed down after 88
years on the UK high street. The company had run out of
money and could not find a buyer to save it.
One of the problems facing BHS was that in recent years
customers did not know what BHS was or why they should
shop there. There were other stores that seemed to have
a much clearer offering in a particular range of products.
BHS had many different departments – including clothes
and home furnishings – but did not seem to specialise in
any one and had no particularly strong offering in any one
anymore. It had lost its competitiveness, and it was not
clear why customers would go there. Added to this, the
stores felt tired and lacked enough investment compared
to competitors. It had large stores, often rather quiet and
with what looked like dated stock. In areas where it once
had some strengths, such as bedding and towels, others
such as Ikea, TK Maxx and Tesco had improved their
offerings.

464
Other department stores, such as House of Fraser and
Debenhams, responded to customer demands by bringing
in some concession areas where other well-known brands
could sell their products; these were ways of getting
customers into the store. BHS did not manage to do this
successfully.
1 What is the difference between a customer and
consumer?
(2 marks)
2 Explain one way that you think customers’ shopping
habits may have changed in the last ten years.
(4 marks)
3 Analyse how understanding customer needs and wants
in retailing benefits the business.
(6 marks)
4 Evaluate the possible reasons why BHS lost its
competitiveness.
(12 marks)

465
Topic 5.2

Segmentation
In this topic, we will examine the ways in which businesses
divide up their markets and how they decide which parts
(or segments) to target.
By the end of this topic, you should know:
• what is meant by ‘the market’
• the meaning and benefits of segmentation
• the different ways of segmenting a market, including by
gender, age, location and income.

‘The market’
The marketing function of a business is interested in the nature
of the potential buyers of the products of the business. When
marketing managers talk of ‘the market’, they usually focus on
what demand there is for their product and what the sales are.
Managers will consider factors such as:
• The size of the market. How big the market is in terms of the
number of sales (this is known as the sales volume) and
how big it is in terms of the sales value. For example, the

466
 size of a market may be 200,000 units sold and a total value of
£1,000,000. It is possible for the volume of sales to increase
but the value decrease, if the price in the market is falling.
Equally, the volume may fall, but the value could increase if
prices are rising.
• The growth of a market. For example, if the sales in the
market last year were 200,000 units and this year are 220,000
units, the market has grown by 10 per cent.

Key terms
Sales volume measures the number of items sold.
Sales value measures the revenue generated.

Marketing managers will want to understand what is happening

within different parts of a market (known as segments) as well
as the market as a whole. For example, while the overall sales of
cereals might be growing, we may find that sales of cold cereals
are falling and hot cereals are rising. In the market for theme
parks, we may find the numbers of 14–24-year-olds falling,
while the number of families visiting may be rising. It is
important for marketing managers to understand the different
aspects of their market in detail.

Maths moment
To calculate the growth of a market, we use this equation:

For example, if the market was worth £50,000 and is now

worth £60,000, the change in market size is £10,000 (that
is, £60,000 – £50,000). The market growth is, therefore,
calculated as:

467
 Last year, the number of sales was 300,000 and the
average price was £12.
This year, the number of sales is 330,000 and the
average price is £15.
1 What is the growth in sales volume?
2 What is the growth in sales value?

Study tip
Make sure you get the units right. Sales volume is
measured in terms of the number of units sold, whereas
market share is measured as a percentage.

What is segmentation?
Segmentation occurs when a market is divided into different
groups of needs and wants. For example, within the car market,
there may be some buyers who are looking for a family car,
some who want a sports car, some who want a small car to drive
around the city, and others who want a larger car for rougher
terrains. Each of these groups of needs and wants are segments
within the overall car market.

Key term
Segmentation occurs when a market is divided into
different groups of needs and wants.

468
Benefits of segmentation
By identifying segments within a market, a business can:
• develop its products to fit customer needs more closely – for
example, a bigger car with more seats and more boot space for
the family car buyer
• target its customers more precisely – for example, the buyers
of family cars may watch different programmes on television,
read different magazines, and visit different websites than the
buyers of sports cars; if the manufacturer of family cars
knows this, it can promote its products in the right places at
the right time to boost sales
• set the price appropriately – for example, if the business
knows that there is a high demand for family cars and
relatively few good providers, it may be able to charge more
for its family cars.
Obviously, there may be limits to how much a business wants to
segment a market because ultimately everyone has slightly
different tastes, and in most cases a business cannot completely
tailor-make a product for each customer.

Ways of segmenting a market

Ways of segmenting a market include:
• By gender. For example, a clothes retailer may have some

469
 products specifically targeting women and other products
targeting men. A company may produce aftershaves for men
and perfumes for women.
• By age. For example, a toy company may offer some toys for
younger children (such as Duplo) and some aimed at older
consumers (such as computer games). A theme park may
offer a children’s area for younger visitors and some
particularly scary rides for older ones!
• By location. For example, a food business may change its
recipes according to where the product is being sold.
McDonald’s changes it menus in different countries around
the world.
• By income. For example, a business might target high-income
earners with some products and lower-income earners with
others. A bank may offer savings products to higher-income
earners and loans to those with less income. In relatively low-
income areas, a company such as Unilever might sell a basic
washing powder; in high-income areas, it might sell a more
expensive powder with a fragrance and conditioner.
• By the stage someone has reached in their life cycle. For
example, a housing company may produce flats for young
single people, bigger houses with gardens for families with
children and bungalows for those who are retired.
Effective segmentation allows a business to decide which
segments it wants to target. It can then focus its marketing
activities more effectively on its customers. This should make
marketing more cost-efficient and more focused and successful.

Maths moment
If a particular market segment is worth 40 per cent of total
sales and the turnover in the whole market is £2.6 million,
what is the value of the segment?

470
Targeting
Once a business has identified relevant segments in its market, it
will need to decide which ones to focus on. This is called
targeting. A business will target segments where it thinks:
• it can make a high enough return; some segments may be too
small or not profitable enough
• it can compete effectively, that is, it has the skills and
resources to win market share
• it covers the opportunity cost, that is, there are no better
alternatives.

Business insight
Sport England
Sport England exists to encourage more participation in
sports in the UK. It segments the market. One segment
Sport England identifies with is known as ‘Chloe’.

‘About Chloe

Chloe is around 23 and works in human resources

for a large firm. She shares a house with ex-
university friends. Without the pressures of family or
a mortgage, Chloe is not worried about her student
loan. She likes to spend her income on clothes,
nights out and holidays with friends.

Chloe and her housemates go to classes at their

local gym a couple of times a week, and like to swim
afterwards. At weekends, Chloe likes to go for a big
night out, including a nice meal and a few drinks with
her friends.

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Chloe is reasonably health conscious, watching what
she eats and exercising to stay trim. She is not
fanatical though, wanting to live a fun-packed life
while she is young, free and single.

What else does Chloe like to do?

In common with other adults, friends and family,

listening to music and TV all compete for Chloe’s free
time.

As a younger segment, Chloe is more likely than the

overall adult population to use the internet and email,
to go to the cinema and to visit pubs, bars and clubs.

Sport is not the top priority for Chloe’s free time.

However, 62 per cent of this segment do sport and
exercise in their spare time, compared to 52 per cent
of all adults.

How to reach Chloe

TV/RADIO: Chloe is a light TV viewer, but enjoys chat

shows and reality TV. Chloe is a heavy radio listener,
favouring national programmes over local
commercial stations, although she will struggle to
recall general advertising messages.

INTERNET: Chloe is a heavy internet user, both at

work and at home. She uses the internet for personal
email, downloading music, social messaging and
making purchases.

POSTERS/DIRECT MAIL/NEWSPAPERS: Chloe

reads broadsheet newspapers and is a heavy reader

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 of women’s lifestyle magazines.

TELEPHONE: As a heavy mobile phone user, Chloe

likes to keep in contact with friends and family,
preferring this to her landline. Chloe has a new phone
which provides internet access but is still likely to use
text as her first source of information.

Chloe’s favourite brands are Topshop, Zara, Virgin

Active, Maybelline and Wagamama.’
Source: Adapted from:
http://segments.sportengland.org/querySegments.aspx

Analyse how the above information on the Chloe

segment might influence the marketing activities of
Sport England.
(6 marks)

Summary
Segmentation involves identifying different groups of
needs in a market. Businesses will want to identify the
segments they want to target so that they can focus their
marketing mix on these groups. A good understanding of
your target market means that businesses can be more
effective in their marketing activities.

Quick questions
1 State two ways of measuring the size of a market.
(2 marks)
2 What is meant by ‘market growth’?
(2 marks)

473
 3 What is meant by ‘segmentation’?
(2 marks)
4 Explain two ways of segmenting a market.
(4 marks)
5 Explain one benefit of segmenting a market.
(3 marks)
6 Explain how the sales volume can increase but the
sales value decrease.
(3 marks)
7 A market has sales of £400,000. If it grows by 5 per
cent, how big is it?
(2 marks)
8 Give the equation to calculate market growth.
(2 marks)
9 If a market had sales of £400,000 and now has sales
of £420,000, how much has the market grown?
(2 marks)
10 What is meant by ‘targeting’?
(2 marks)

Case study
Nintendo
Nintendo became a household name in the 1980s when
its game Super Mario Bros. became popular across the
world. However, after that it struggled to keep pace with
the growth of smartphone gaming and until recently
seemed to have fallen behind its competitors. It did have a
boost to its popularity with Pokémon Go (the location-
based game where players catch virtual creatures on their
screens as they go from place to place), but much of the

474
rights to this game are actually owned by its developer
Niantic. More recently, Nintendo has announced that its
Super Mario games would be developed for the first time
for smartphones. This seems to be something of a
breakthrough for the company.
Until this development, Nintendo’s own games could only
be played on Nintendo hardware. The company’s strategy
has been to get consumers to buy its consoles as well as
the latest games. It has deliberately avoided, for a long
time, producing and selling games for mobile phones.
Nintendo’s target market has been the casual gamer, and
it has had real success in the past. Nintendo Wii was a
best seller. Its successor, the Wii U which targeted
families, was less successful because by this time the
players were already using their tablets and smartphones
and did not want or need to pay for a console. By
comparison Sony and Microsoft, which make the PS4 and
the Xbox, have targeted hard-core gamers who want much
more power and better graphics to enable them to play
their games. Between 2011 and 2013, Nintendo reported
losses.

475
Nintendo has kept away from smartphone games on the
grounds that they are too cheap and disposable compared
to their consoles that sell for less than £200 and their
games that sell for less than £60. Producing games for
mobiles relies on in-app purchases of virtual goods.
Nintendo was reluctant to get involved in this as it wanted
to be seen as family friendly and selling apps might be
seen to be taking advantage of children buying extras
online and spending parents’ money without permission.
The company was also reluctant to let anyone else use its
characters to develop games because they wanted to
keep control.
Nintendo now realises this was a mistake, and it has
missed out on a generation of potential customers. It now
seems to appreciate to some extent that selling the rights
to use its games and characters could generate huge
incomes. Even so, the company is still closely attached to
its consoles strategy and plans to launch a new one code-
named NX. This is said to be a mixture of a console and a
handheld device to be played on the go or docked at

476
home. If this does not work, the company may need to
close its hardware business.
Continued success for Nintendo will depend on creating
new, compelling characters and staying ahead in terms of
consumer hardware, which still accounts for a lot of its
revenues. The move into mobile does bring risks. One is
the power that Apple and Google have in smartphone-
gaming. Nintendo will have to pay Apple 30 per cent of the
revenues that Super Mario Run earns via its app store, for
example. Its partnerships with DeNA and Niantic mean
that it is relinquishing at least some control over game
development too, which could dilute quality. It is unclear
that casual gamers paying small amounts on their phones
will fork out the money for a pricey Nintendo device.
Nevertheless, the potential strengths of Nintendo should
not be underestimated. It has great skills on the software
side and is a brilliant maker of games. Of the world’s 25
all-time, best-selling video games, it owns 17. It also has
shown the ability to survive change in the market and
adapt to it. The firm began in 1889 with the production of
handmade hanafuda playing cards decorated with flowers,
and was one of the first to move into arcade games in the
1970s. It also likes to remind people that it invented the
whole business of hand-held games played on the go.
1 What proportion of Nintendo’s revenue was from
hardware sales in 2007 and in 2016?
(2 marks)
2 Explain the different segments that exist in the computer
games market.
(4 marks)
3 Analyse how Nintendo’s decision to target the segment
it did affected its activities.

477
 (6 marks)
4 Evaluate the view that Nintendo should continue to
develop consoles.
(12 marks)

478
Topic 5.3

The purpose and methods

of market research
Imagine entering a room that is pitch black. You are likely
to be nervous and not know what you are doing. If you
move about, you will do so slowly because you cannot see
what is around you. You will not know where you should be
going because it is so dark. Now imagine a light is turned
on and you can see. A lot of the stress you had before
has gone and you can move around much more
confidently. Which situation would you prefer? The
answer, presumably, is the second scenario, where you
can see what is going on around you and what lies ahead
of you. This topic looks at how businesses ‘turn on the
light’ to see what is going on in their markets, by using
market research.
By the end of this topic, you should know:
• the purpose of conducting market research
• some maths used in market research
• how businesses use market research to inform
decision-making
• the different primary and secondary research methods.

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The purpose of market
research
Without information on their products, their markets and their
competitors, a business is operating ‘blind’, in which case it is
taking major risks and faces a lot of unknowns. Alternatively,
businesses can try to ‘turn the light on’ by undertaking market
research so they understand the market and its conditions and
are in a better position to make decisions. Market research is the
process of gathering, analysing and presenting information
relevant to marketing.

Key term
Market research is the process of gathering, analysing
and processing data relevant to marketing decisions.

Market research will help gather information about:

• Demand. For example, the size and growth of the market and
the different segments that exist within the overall market
• Market share. That is, the sales of each producer as a
percentage of total sales in the market
• Competition. For example, the number and size of
competitors and their share of the total market sales – research
might identify which businesses are growing and help
managers understand why
• Target market. A business is unlikely to want to target
everyone in a market; it will want to focus on particular
groups. It will have its own target market that it wants to focus
on. For example, it might target older buyers, male buyers or
higher-income groups. By focusing on specific market
segments, the business can make its marketing activities

480
 more targeted. It can also give itself a different position in the
market compared to competitors. For example, an airline
might position itself as a budget airline (such as Ryanair) or a
premium airline (such as Emirates). It may clearly be a shop
for people wanting to do sports (such as Decathlon) or more
of a fashion business (such as JD Sports).

Key term
A market segment is a group of buyers with similar
needs within the overall market.

Types of data used in market

research
Market research may involve:
• Quantitative data. This involves the use of numbers such as
the size of the market, the growth of the market or the number
of customers a business has.
• Qualitative data. This involves views and opinions, but does
not provide statistically reliable information. For example, by
talking to a small group of customers you may get an insight
into how they view the brand or how the product is viewed in
relation to competitors. This data focuses on why people do
things – what motivates them to buy the products, what their
experience of the business is and how they felt having bought
and used the products.

Marketing research maths

481
Market size
Market size can be measured by the value or the volume of
sales. The volume of sales is the number of units sold. The
value of sales can be calculated using the equation:

If the number of units sold is 50 million and the average price is

£3 per unit, this means that the volume of sale is £150 million:

Maths moment
Now calculate the volume and value of sales if 30 million
units are sold at a price of £2 each.

Market growth
Market growth can be measured using this equation:

For example, if market sales were £400 million and are now
£500 million, the change in market size is £100 million (that is,
500 million − 400 million). This means that the market growth is
25%:

Maths moment
Now calculate the market growth if the market increases
in size from £500 million to £700 million.

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Market share
The market share of a product is given by this equation:

For example, if product sales are £40,000 and total market sales
are £800,000, this means that the product’s market share is 5%:

Maths moment
Now calculate the market share of a product that has
sales of £25,000 in a market which has total sales of
£800,000.

From market share to market size

If market research shows the market share of a product and its
sales, it is possible to calculate the total market size.
For example, if a product has 30% of a market and has sales of
£60,000, this means that 30% = £60,000.
1 Calculate 1%. To do this, divide both sides of the equation by
30:

483
2 Calculate the size of the whole market (100%) by multiplying
both sides by 100:

Maths moment
1 Imagine that the market share of a product is 5% and it
has sales of £80,000. Calculate the total sales in the
market.
2 The pie chart in Figure 5.2 shows the sales of four
products that make up the total market. Calculate the
market share of Product B.

484
3 Table 5.1 shows the sales of Product A and the total
market sales for 2014–17.

485
 (a) Calculate the growth in the size of the market
between 2014 and 2017.
(b) Calculate the growth in the sales of product A
between 2014 and 2017.
(c) Calculate the market share of product A in
2014 and in 2017.

Uses of market research

Market research will help managers to:
• identify opportunities in markets – for example, is there
demand for a new flavour of the company’s drink?
• weigh up different possible actions – for example, is it best to
promote the product launch online or in print?
• assess the effectiveness of actions that have been taken – for
example, how successful was the price promotion that the
business ran last week?

Methods of market research

486
There are different ways of gathering data. These can be divided
into:
• primary market research (also called ‘field research’),
which involves gathering information for the first time, for
example, using questionnaires to conduct a survey of potential
customers
• secondary market research (also called ‘desk research’),
which involves using data that already exists, for example,
using information in a newspaper or published on a website.

Key terms
Primary market research uses data gathered for the first
time.
Secondary market research uses data that has been
gathered already.

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Business insight
Innocent Drinks

In 1998, Richard Reed, Adam Balon and Jon Wright

developed their first smoothie recipes. They were
nervous about giving up their jobs so they bought £500
worth of fruit, turned it into smoothies and sold them from
a stall at a music festival. They put up a big sign saying
‘Do you think we should give up our jobs to make these
smoothies?’ and put out a bin labelled ‘Yes’ and a bin
labelled ‘No’. Customers were asked to put their empty

488
smoothie bottles in the right bin. At the end of the
weekend, the ‘Yes’ bin was full, so they resigned the next
day and set up Innocent Drinks. Within three years, their
brand was a national name.
Analyse the advantages of this form of market
research by the founders of Innocent.
(6 marks)

Maths moment
The line graph in Figure 5.5 shows the sales of Product B
and the total market sales for 2014–17.
1 Calculate the market growth from 2014 to 2017.
2 Calculate the market share of Product B in 2016.

489
Secondary market research
Advantages of secondary market
research
• It can be gathered quickly and cheaply. There is a great deal of
information available from newspapers, books, magazines,
journals and the internet. The Economist magazine and the
Financial Times newspaper regularly carry good business
surveys that are useful for exploring general trends in markets.
The government also regularly produces information on
issues such as the economy and social trends. Data gathered
by specialist market research companies, such as Mintel, are
also available for a fee.
• It can provide information on large sections of the population.
It is unrealistic to expect a business to gather detailed
information on the whole of the economy, but the government
can afford to do this.

Disadvantages of secondary market

research
• The existing data may not be exactly what the business wants.
For example, you may want information on the population of
one area of Oxford, but can only find data on the whole of the
city. You may be interested in the buying habits of 17–30-year-
olds, but can only find information on 18–25-year-olds.
• The existing data may be out of date. The latest secondary
research may be for last year or even a few years ago. Given
that some markets change rapidly, such as the market for
music, the fact that the research is not up to date may mean
the business makes the wrong decisions.
Despite the potential problems, businesses should try to use

490
secondary market research wherever possible because it is cheap
and it provides a useful starting point. This should then highlight
what other research needs to be done (if any) to get the required
information. Any ‘new’ information can be gathered using
primary research.
Table 5.2 shows the sales and forecast sales revenue of breakfast
cereals in the UK.

Maths moment

1 Use Table 5.2 to calculate the percentage change

in sales each year.
2 Analyse the possible value of this data for
someone thinking of setting up as a producer of
breakfast cereal.

Primary market research

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Primary research can be tailored to meet the business’s needs
and is up to date. This can make it more useful than secondary
research. However, it can be expensive (for example, organising
a large-scale survey) and, if not done correctly, can give
misleading results (for example, if the people surveyed do not
represent the whole group of customers).
Primary data may be gathered by:
• Observing. For example, watching how people walk around a
supermarket to see what attracts their attention. In some
shopping centres, they have shape recognition sensors – they
can recognise a person’s body shape and follow them around
to see exactly where they shop during their visit.
• Experimenting. For example, trying out a new form of
advertising and measuring the response. A business might try
out a new product in a test market to assess customers’
reaction before launching nationally. Many films have several
endings filmed and these are shown to different groups to see
how the audience reacts before releasing the final version.
• Surveying. For example, interviewing people who might buy
your products to understand their motives. This is often done
online these days, when to access some information you are
asked to answer some questions first.

Forms of survey
Surveys can include:
• Telephone surveys. Phoning customers to obtain their views
is relatively cheap. Also, it can be conducted from the office
(it does not require additional travel expenses). However, not
everyone has a telephone and some people are suspicious of
answering telephone surveys. It can also be difficult to find
the best time to contact people.
• Questionnaires. Questionnaires can be posted, but the

492
 response rate is usually quite poor. Surveys can also be
carried out in the street, but the people interviewed may not be
representative. If people are out shopping in the middle of the
afternoon, for example, they are not at work so you may not
get the views of people in work. Care must also be taken to
ensure that the people who conduct the questionnaire surveys
are properly trained. If untrained people conduct the survey,
they may lead the respondents to give them the answer they
think they want.
• Customer/supplier feedback. Some businesses ask their
customers what they think. Many products, for example,
include a helpline or customer feedback telephone number on
the packaging so the customer can contact them directly. The
only problem with this is the people who ring up may not be
typical customers. Customer feedback also relies on existing
customers, rather than potential ones or those who at the
moment would not even consider the product. Suppliers may
also give feedback on various aspects of a business, such as
the speed of its response, how it deals with stakeholders and
how it compares with other businesses.
• Focus groups. Focus groups are small groups of people
selected to give their views on a particular business issue,
such as a brand name or brand image, whether the business is
better or worse than competitors, a proposed advert, etc.
These groups may not represent the market as a whole
because they only contain a few people. However, a focus
group does give the opportunity to discuss a range of issues in
great detail. Quite often, a focus group will bring to light an
issue that can then be explored in more depth by surveying
more people (if the business can afford it).
• Internet research. Many businesses have their own website
and this provides an additional route for customer feedback. It
is also possible to track the number of visitors to a website,

493
 how they found the site, what search engine they used – and
this sort of information can provide a useful insight into
potential customers. The internet can also be used to find
secondary information, for example, from websites such as
The Times and the Guardian newspapers, The Economist
magazine, government sites such as the Office for National
Statistics and competitor websites.
• Printed press, such as newspapers and magazines. Simply
reading the newspapers and various articles in the press can
help provide insights into markets, the economy and
competitors.

Study tip
494
Do not assume that, because some market research has
been undertaken, it will automatically be useful. Always
check how it has been gathered. Asking a few of your
friends what they think, for example, could give misleading
results – they may just tell you what they think you want to
hear.

Summary
Businesses need information in order to make good
decisions. To do this, they may undertake market
research. There are many forms of market research,
such as questionnaires, focus groups and online
research. The right method of research depends on what
you are trying to find out. However, research does cost
money, use up resources and can take time.

Quick questions
1 How is the size of a market measured?
(2 marks)
2 How is market share measured?
(2 marks)

495
 3 What is meant by ‘primary market research’?
(2 marks)
4 What is meant by ‘secondary market research’?
(2 marks)
5 Explain one reason why a business conducts market
research.
(2 marks)
6 Explain one factor a business might consider when
choosing which method of market research to use.
(2 marks)
7 Explain one potential benefit of primary market
research compared to secondary.
(2 marks)
8 Explain one potential benefit of secondary market
research compared to primary.
(2 marks)
9 What is meant by ‘qualitative research’?
(2 marks)
10 What is meant by ‘quantitative research’?
(2 marks)

Case study
Anna’s Gardens
Anna Boulton loves gardening. Ever since she was small,
she had helped her mother in the garden and she had
become something of an expert on flowers and gardens.
To earn money while she was at school, she had helped
friends of the family with their gardens by mowing the
lawns, weeding and planting new flowers. She was never
short of work to do, although she did not charge very much

496
so never made a lot of money.
After school she had gone to agricultural college and
received proper training. Now, she has the offer of a job
working for a big chain of garden centres, but she really
wants to run her own business if she can. She remembers
how easy it had been to get work a few years ago and her
mother says there are still plenty of people needing help in
their gardens, so she is sure it would work. She had seen
some data for the UK while studying for her course that
showed the demand for employing gardeners was
increasing, so she feels fairly confident of starting up a
business where she had grown up. However, it would be
quite a risk turning down the secure job at the garden
centre to go it alone and she wants to make sure she can
earn enough money. She decides to undertake some
more market research.
1 What is meant by ‘market research’?
(2 marks)
2 Explain two things Anna might want to find out from
further market research.
(4 marks)
3 Analyse two factors Anna should consider when
deciding how to carry out market research.
(6 marks)
4 Do you think that, if Anna does some more research,
this will guarantee the success of her new business?
Justify your answer.
(9 marks)

497
Topic 5.4

Elements of the marketing

mix
A crucial element of a successful business is not only
understanding your customers, but also generating
demand for your products. In this topic, we examine how
firms use marketing activities to satisfy customers’ needs.
By the end of this topic, you should know:
• the meaning of the marketing mix
• the elements of the marketing mix
• factors that influence the appropriate marketing mix.

What is the marketing mix?

Think of the last item of clothing you bought. What made you
buy that particular product? The chances are that it was a
combination of factors. It may have originally come to your
attention because you were told about it by a friend or saw a
friend wearing it. Alternatively, you may have noticed it in the
store by the way it was displayed, or you may have seen an
advert. You may have liked the design, the colour or the brand

498
name. Would you have paid anything to buy it? Probably not.
Before buying it you probably looked at the price and compared
it with other items and clothes you had seen elsewhere. All the
different factors that combine to influence your decision to buy
are called the marketing mix – or the four Ps (see Figure 5.7).

Key term
The marketing mix refers to all the activities influencing
whether or not a customer buys a product. The elements
of the mix can be analysed using the four Ps: price, place,
product and promotion.

The elements of the marketing

mix

499
Product
Product refers to all the factors relating to the design, the
specifications and the features of the product. Products such as
the Dyson vacuum cleaner and the Apple iPhone have
distinctive designs that have attracted a great deal of customer
interest. Toyota cars are known for their reliability. McDonald’s
burgers are consistent wherever you are in the world. Duracell
batteries are long-lasting. Innocent Drinks do not contain any
additives. These are all aspects of products that help them to sell.
A business may alter its products to increase their appeal for
different customers (for example, Harry Potter books had one
cover to appeal to adults and one to appeal to children) but must
make sure the money they will earn will cover the costs of doing
this.

Promotion
Promoting a product means communicating something about it.
You might be letting people know your business exists, telling
them about a new product or a special offer, or highlighting the
difference between what you offer and what else is on the
market. There are many ways of communicating about a
product, for example, advertising in a local newspaper,
advertising online, sponsoring a sports event or using posters
around town. The right form of promotion depends on the
product. For example, a café might advertise in the local
newspaper, whereas a car manufacturer might advertise on
national television. Red Bull sponsors extreme sports events,
whereas Ryanair relies on a lot of online offers.

Price
There are many different aspects to pricing. For example, there

500
are the payment terms. Does the customer have to pay the full
amount now or can they pay in instalments? Can they pay with a
credit card or do they have to pay cash? Can they get a discount
if they buy in large quantities? Businesses must also consider
what amount the customer will be asked to pay for the product.
How does the price compare with that of competitors? All of
these factors will influence whether a customer thinks a product
represents value for money. Good value for money does not
necessarily mean it is a low-priced product. Customers may be
willing to pay a lot of money for something provided they think
the product and brand are worth it. The Xbox is not cheap, but
you may think it is good value for money because of all the
benefits it provides.
When setting its prices, a business will have to think about its
costs – it will want to cover its costs to make a profit. However,
it must also think about the effect that the price will have on
demand. Generally, increasing the price will lead to fewer
products being sold; you may make more profit on each one, but
if sales fall a lot you can be worse off. Sometimes, it is better to
reduce the price. Although the profit per item may be lower, if
you sell a lot more you can make more profit. Stores such as
Primark and Asda do not make a large profit on each product
they sell, but their relatively low prices mean they sell so many
items that they make a large profit overall.

Place
Place refers to the way in which products are distributed. Are
they sold direct to customers (for example, via the internet) or
via shops? Do they come direct from the factory to the shop or
are they bought by a wholesaler first? What are the stores like
where they are sold? Apple has some distinctive and elegant
stores where its latest products are displayed. Aldi is a more

501
basic store selling cheap, good value food.

Choosing the best marketing

mix
Managers must make decisions on each of the elements of the
marketing mix. However, they must also remember that the
different elements of the mix need to work together to be
effective. For example, a high-quality product might lead to the
selection of a high price, with sales in quite exclusive outlets and
promotion to relatively high-income earners.

Business insight
Call of Duty
The Call of Duty video game has been on Amazon’s best-
selling lists since 2009. Players are playing a shooting
game either individually or against other players around
the world.

502
 Analyse the elements of its marketing mix that make
it so successful.
(6 marks)

The choice of marketing mix will depend on factors such as:

• The product. Is it distinctive? Is it a product that needs a
unique design? How long does a customer expect it to last?
Something unique and long-lasting might justify a higher
price.
• Competitors’ products. What do they offer and how does it
compare with what you have?
• The target customers. Who are you trying to sell to? How
much do they earn? Why are they likely to buy your product?
How much do they need it? What do they do with their time
(so you know how to reach them with your promotion)?
Some hotels aim to be luxury and have lots of facilities such

503
 as a swimming pool, gymnasium, bar and restaurant. Others,
such as Travelodge, aim to be more basic and are clean and
relatively cheap. These hotels are serving different types of
customers and so the marketing mix is adjusted accordingly.
• Business approach. Are you trying to match what your
competitors do? If so, you might try to develop a similar but
cheaper product. Or are you trying to be different from and
better than the competition and have more distinctive
features? If so, you might be able to justify being more
expensive.

Business insight
Buying a house

Imagine you are looking for a house to buy. How would

you find out what is for sale (this depends on promotion)?
What features would you look for, such as the number of
rooms and the location (this is the product)? What would
determine how much it costs (the price)? Would you
expect to buy direct from the seller or through an estate
agent (this is the place)? The marketing mix is important

504
in influencing which house you buy. How do you think the
marketing mix would vary for someone looking to buy his
or her first house and for a 35-year-old couple, both of
whom are working, with two children aged eight and ten?
Analyse the factors that might influence your
decision to buy a particular house.
(6 marks)

Study tip
Remember that the different elements of the marketing
mix must work together. They all combine to make a
customer buy a product. If you have an exclusive brand of
handbags and shoes, you will want them sold in smart
shops at relatively high prices, and you will want to
advertise them in fashion magazines. If you sell cheap
clothing, you will target price-sensitive customers with
your promotion and distribution.

Summary
The different elements of marketing that affect a
customer’s decision to buy a product are called the
marketing mix. The marketing mix involves the four Ps: the
product, the price, the place and the promotion. The ‘right’
marketing mix will depend on many factors, such as the
nature of the product, the target customers and
competitors. ICT has helped small businesses because
they can now reach worldwide markets relatively cheaply.

Quick questions

505
 1 What is meant by ‘marketing’?
(2 marks)
2 What is meant by the ‘marketing mix’?
(2 marks)
3 If you were launching a new shop in your town selling
musical instruments, state two ways of promoting it.
(2 marks)
4 State two factors that might influence the price of a
new product.
(2 marks)
5 State two ways of distributing clothes from the
manufacturer to the customer.
(2 marks)
6 Think of your ideal mobile phone. State two aspects of
the product that you like.
(2 marks)
7 Think of a brand you like. State two things you think
the brand represents.
(2 marks)
8 Think of a shop to which you often go to buy clothes.
State two reasons why you choose this store.
(2 marks)
9 Do you prefer Pepsi or Coca-Cola (or neither)? State
two reasons for your choice.
(2 marks)
10 Think of a shop you do not go to. State two reasons
why you do not shop there.
(2 marks)

Case study

506
Fantastic Beasts and Where to Find Them

The film Fantastic Beasts and Where to Find Them was

released in cinemas across the UK in November 2016.
The film is a spin-off from the Harry Potter books and
films. It was written by J.K. Rowling and starred Eddie
Redmayne.
The film earned a total of £15.3 million in revenue on its
opening weekend in the UK. It also took an estimated £61
million in North America over the same weekend – more

507
than the rest of the US box office top ten combined.
The opening weekend earnings in the USA and Canada
were lower than for any of the Harry Potter films and not
as high as two of the Harry Potter films in the UK. The
eight Harry Potter films have taken more than $7 billion
(£5.7 billion) worldwide. The opening weekend is usually
critical in terms of determining the financial success of a
new film because the product life cycle is relatively short.
However, film companies will try to extend the sales of a
film in various ways.
This first Fantastic Beasts film is set in New York and tells
the story of a fictional author mentioned in the Harry
Potter stories. Redmayne plays the role of the animal-
loving ‘magizoologist’, Newt Scamander, who visits New
York’s secret community of witches and wizards. The film
is set about 70 years before the Harry Potter films. J.K.
Rowling has plans for a total of five films in the series.
1 State two ways you think a film company could extend
the sales of a film such as Fantastic Beasts and Where
to Find Them.
(2 marks)
2 Explain two factors that might influence the price of a
cinema ticket.
(4 marks)
3 Analyse the ways in which a film company might
promote a new film such as Fantastic Beasts and
Where to Find Them.
(6 marks)
4 To what extent do you think the product is the most
important element of the marketing mix for a film?
Justify your answer.
(9 marks)

508
509
Topic 5.5

Using the marketing mix:

product and pricing
By the end of this topic, you should know:
• the importance of product in the marketing mix
• the factors influencing the price of the product
• the significance of price in the marketing mix.

The product
The product is what customers actually buy. Not surprisingly, it
is an important element of the marketing mix. If the product is
wrong, then it is difficult to imagine that the marketing overall
will be successful. Customers will be interested in the overall
nature of the product. This includes its design, its performance,
its features and its reliability. For example, if it is a washing
machine, what size is it? What is its capacity? What is its energy
usage? What is the brand? What functions does it have? If it is a
hotel, which services does it provide? Where is it located? Is
there parking? What are the rooms like? Other factors are
considered next.

510
The service
If you are buying a product, is it easy to order in store or online?
Are the sales staff well informed? Is there any post-sales
service? Is there a delivery service? Does the product come with
a guarantee?

The performance of the product

Does the performance of the product match what was promised
in the advert? Is the holiday the same as it was described? Does
the item you bought on eBay or Amazon fit the description
online?

The price
Does the product represent better value for money than the
competition? This does not mean it is cheap – people will pay
high prices for some products (think of a Ferrari), but the
perceived benefits have to justify it.

Product development
When developing a new product, a business will consider:
• The design. What does it offer in terms of features, design,
look, ease of use or reliability compared to competitors? What
needs and wants does it fulfil?
• The price. What will customers be willing to pay for the
product? How much are the benefits worth?
• The expected sales. What is the likely demand for this
product?
• The cost of development and of production. Given the
expected sales and the price, will this product make a return

511
 that justifies the risk in producing and launching it?

Product differentiation
Many businesses will want to make their products stand out as
different from the competition – this is known as ‘product
differentiation’. For example, Pepsi and Coca-Cola are both cola
drinks, but people may regard them as very different products.
Manchester United and Manchester City are both football clubs,
but to their supporters there is a world of difference. A business
may differentiate its products by:
• building the brand image. Through its logo, its design and its
communications a business will try to differentiate itself from
its rivals. For example, JD Sports is more of a fashion
business than Sports Direct, although they both sell sports
equipment. This is shown by the clothes it stocks, the design
of its stores and the way it advertises and promotes itself.
• its Unique Selling Point (USP). A business will try to develop
some aspect of the product or the service it offers that makes
it unique. It could be a feature (‘Made in X’), a service (‘2-
hour delivery’) or even a guarantee (‘no-questions-asked
refund’).
By differentiating its products a business can hope to attract
more sales and may even be able to charge more.

512
New products
A business will want to change its products over time as
customer needs and wants evolve. For example, Lucozade was
originally a drink bought to help people who were feeling ill to
recover – you would buy it to take to people in hospital. As the
market changed, Lucozade bottles were redesigned, and the
advertising changed to focus on it as an energy drink.
Businesses may modify the product itself (for example, by
changing the recipe of a chocolate bar), its packaging (for
example, introducing a family-size pack of a box of cereal) or its
promotion (for example, to stress different benefits of the
product to target a different audience).
Businesses will also want to develop new products to add to
their existing ones or to replace them altogether. New product

513
development is an investment and involves quite high risks.
This is because many new products do not actually go on to
succeed, and the investment may have been wasted.

The stages of new product

development
The stages of new product development typically follow this
process:
1 Generate an idea. This may be a genuinely new idea or
simply improving a product that exists.
2 Check the idea. This involves testing the idea to see what it
would cost to develop and what possible returns it might
earn; this is to check it is financially worthwhile.
3 Develop the product. This will involve testing and putting
together different versions of the product to see what works.
This can take many years of research and testing to make sure
the product works and is safe.
5 Trial the product. A trial launch may be used to see if the
sales are as expected.
6 Launch it!
A business may decide not to go ahead with a product at any of
these stages because, for example, it is proving more expensive
or too difficult than imagined to develop. Even when the
product has launched this does not guarantee success – many
new products on the market fail and are withdrawn. New
product development, therefore, can bring with it a great deal of
risk. On the other hand, standing still and not innovating can
also be risky.

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Product portfolio
When a business first starts up it is likely to have only one or
two products. As it grows it will usually develop more products.
A company like Coca-Cola, for example, sells many different
types of drink. The marketing manager of a company will want
to check how the products are doing and decide whether
anything needs to be changed. This can be done using product
portfolio analysis. A ‘portfolio’ is a collection, so a product
portfolio analysis looks at a firm’s collection of products in
order to decide what to do next.

Key terms
A product portfolio is the collection of products that a
firm produces.
The Boston Matrix is a way of analysing a product’s
share and growth in their market.
A dog product has a low market share in a low-growth
market.

Product portfolio analysis

A famous way of analysing a business’s product portfolio is
called the Boston Box or the Boston Matrix (see Figure 5.8).
This model looks at products in terms of their share of the
market and the growth of that market. It consists of four
categories of products.
1 ‘Dogs’ are products that have a low share of a low-growth
market. They are not doing very well in a market that is not
growing very fast. These products are not much use to a

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 business. The business should either get rid of them because
they are not selling enough or try to improve them to make
them much more attractive. The drinks Tango and Lucozade
were dogs at one point, and then their businesses redesigned
the cans and spent millions of pounds promoting them
differently to make them successful.
2 Cash cows are products that are doing very well in that they
have a high share of the market. The market itself, however,
is not growing very fast; this could be because it has already
grown and is now as big as it is likely to get. A product like
Heinz tomato ketchup is a cash cow. The market for ketchup
is quite big but not growing very fast, and Heinz has a big
market share. Cash cow products are well known and shops
want to stock them on their shelves. Customers know these
products and buy them in large quantities.
The name cash cow refers to the fact that, although the
product was heavily promoted in the past, the business can
now gather revenue from it with comparatively little
promotional expense. Given that sales are high, this means
that profits from the product are very good. Cash cows are
great news, therefore, and tend to earn lots of money for the
business. The business should use the money earned from
cash cows to develop products for the future.
3 Question marks are products that have a small market
share of a fast-growing market, for example, a new brand in
the computer games market. These products could turn out to
be very successful, and the market is attractive because it is
growing so fast. However, the business cannot be sure
whether or not the product will succeed (that is why they are
like a problem child – they may turn out well, but they may
not). Businesses need to spend money promoting and
developing question marks to make sure they are successful.
The money for this could come from the revenue from cash

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 cows.
4 Stars are products that have a big share of a fast-growth
market, like the Sony Playstation or Apple iPhone. Star
products are doing well in an attractive market. Businesses
need to keep improving and promoting stars with the aim of
turning them into the cash cows of the future.

Key terms
A cash cow product has a high market share in a low-
growth market.
A question mark product has a low market share in a
fast-growth market.
A star product has a high market share in a fast-growth
market.

Maths moment

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 Complete Table 5.4 to identify the type of product in the
Boston Matrix.

A balanced portfolio
All businesses want a balanced portfolio of products. This
means they will want an appropriate mix of different types of
products: the cash cows provide ongoing finance that can be
used to develop new products (question marks and stars) for the
future.
Problems arise if a business has too many cash cows. If there
aren’t enough products in growing markets, the firm should
worry about the future. Equally, if a firm has a high number of
question mark products, then it is taking a risk as it is likely that
some of these may not succeed. Businesses pursuing only new
products may run out of money if they do not have cash cows to
provide valuable finance.

Business insight
Procter and Gamble has some of the best-known brands
in the world, including Ariel, Crest, Tide, Vicks, Olay,
Gillette, Braun, Bold and Head and Shoulders.

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 Analyse the benefits to Procter and Gamble of
having a portfolio of products.
(6 marks)
Analyse the elements of its marketing mix that make
it so successful.
(6 marks)

Product life cycle

Product portfolio analysis looks at all of a business’s products to
take an overview of how things are going. However, managers
will also want to track the progress of each individual product
over time, monitoring sales from the launch until a decision is
taken to stop production. The product life cycle model
describes the typical stages a product goes through during its
life. Each product is likely to go through five main stages.

Key term
The product life cycle shows how the sales of a product

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may change over time.

1 Development. In this initial stage, the idea for the product is

developed and tested to see if it will work. This may involve
building a prototype (a trial version). James Dyson built over
5,000 prototypes of his vacuum cleaner before he got it right.
New medicines are tested for many years before they are
allowed to be sold to the general public. During the
development stage, businesses spend money but have no
money coming in because there are no sales.
2 Introduction. Introduction is when the product is launched
and sales begin. It can involve a lot of expenditure on
promotion and publicity. At this stage, a business needs to
convince distributors they should stock the new product
rather than existing brands – this can be difficult as they will
not want to take a risk.
3 Growth. Growth is experienced when the product starts to
sell faster. People are beginning to buy more of it and it is
becoming successful. A business may need to find more
outlets for the product at this stage.
4 Maturity. At this stage, the sales rate begins to slow down.
Perhaps a competitor has launched something similar that is
affecting sales, or perhaps customers simply want something
new. During maturity, a business should consider introducing
some different versions of the product to keep sales up.
5 Decline. Decline occurs when sales start to fall. Businesses
need to make difficult decisions at this stage. Should sales be
boosted again by spending more on marketing, or should the
product be taken off the market?

Variation within the product life cycle

The length of time it takes for the life cycle to move from

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development to decline can vary enormously from product to
product. Some products, such as new cars or new planes, will
spend years just in the development phase. Some products, such
as a new film, can be launched and enter the decline phase
within weeks. Some brands have been around for many years
(think of Kellogg’s Corn Flakes, Coca-Cola, Ford and Cadbury
Dairy Milk); other products last for only a few years.
The marketing mix changes at different stages of the product life
cycle. For example, during the introduction stage, promotion
may focus on making people aware that the product exists. Over
time, promotion may start to concentrate on why the product is
better than the competition. A high price may be set during the
launch, particularly if the business is using price skimming (for
example, if demand is very high initially). Over time, the
product price may need to come down in order to keep sales
growing.

Study tip
Remember that the marketing mix will change at the
different stages of the product life cycle. For example, you
might launch with a high price if demand is high for a new
product; over time the price may be lowered to increase
sales. When a product is first launched, the promotion
might focus on raising customer awareness; once it is
established, the promotion may focus on the product’s
benefits compared to those of competitors.

Extension strategies
If possible, a business will want to stop sales falling and avoid
the decline phase of the product life cycle. Extension
strategies make this possible.

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Key term
Extension strategies are attempts to maintain the sales
of a product and prevent it from entering the decline stage
of the product life cycle.

Extension strategies include:

• cutting the price to make the product better value for money
• spending more on advertising to make the product more
popular
• updating the packaging of the product
• adding more or different features
• trying to get people to buy more of the product; for example,
shampoos say on the label that you should always wash your
hair twice
• trying to get people to buy the product on more occasions; for
example, we tend to buy turkey mainly at Christmas in the UK
– could you get people to eat it at other times during the year?
• trying to find new customers; for example, a business might
try to target a new market by selling its product abroad.

Business insight
McDonald’s
McDonald’s sales have recently been higher than
expected due in part to an improvement in its all-day
breakfast menu. The company has been launching a
number of initiatives to boost sales. For example, it has
introduced new items to its all-day breakfasts, including
biscuits, McMuffins and McGriddles. McDonald’s is also
keen to target younger consumer segments, many of
whom are choosing other businesses they see as more
premium such as Shake Shack.

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 Analyse the marketing actions McDonald’s might
take to boost its sales.
(6 marks)

Business insight
Mars
The MARS bar has been on sale since 1923. Over 3
million are produced every day at the UK Mars factory in
Slough.
Analyse the actions a business such as Mars might
take to prevent sales of one of its products falling.
(6 marks)

Introduction to pricing
Whenever we buy something we are usually interested in the
price. How much does it cost? Is it worth the money? Can we
afford it? We don’t always buy the cheapest product, but we do
look for the best value for money. For example, we might buy a
shirt that is more expensive than another because we like the
design and the brand. There are some brands we would not
want to buy however cheap they were. (Can you think of an
example?) We are, therefore, very interested in the price in the
context of the other elements of the mix. Get the price wrong,
for example, by making it too high given the quality of the
product, and a business’s sales will suffer.

Price and demand

In general an increase in price is going to lead to a fall in the

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quantity demanded assuming nothing else has changed.
However, the extent to which sales fall can vary significantly. If
a product has a strong brand image or a USP, it may be that the
fall in sales is relatively small compared to the price increase.
This is why businesses try to differentiate their products to make
demand less sensitive to price increases. If the fall in sales is
relatively small, a business can actually make more revenue with
a higher price.
In other cases demand may be very sensitive to price. If, for
example, a customer has many cheaper and similar products to
choose from, then if one firm puts its prices up sales may fall
significantly. In this situation a business may decide to reduce its
prices to try and gain significant numbers of customers from
rivals. Businesses such as Poundland, for example, use lower
prices to attract large numbers of customers.

Maths moment
1 The price of a product is £10 and sales are 200 units.
Imagine the price increases to £18 and sales fall to
198 units, i.e. demand is not very sensitive to price.
(a) Calculate the revenue of the business
originally and following the price increase.
(b) What does this suggest a business might
want to do if demand is not very sensitive to
price?
2 The price of a product is £10 and sales are 200 units.
Imagine the price increases to £11 and sales fall to 100
units, i.e. demand is very sensitive to price.
(a) Calculate the revenue of the business
originally and following the price increase.
(b) What does this suggest a business might

524
 want to do if demand is very sensitive to
price?

Types of pricing decision

There are many ways of pricing products. The following gives a
summary of the ways a product may be priced.

Price skimming
Price skimming is when a high price is set for a product when
it first enters a market. This strategy is used when there is high
demand. For example, when a business launches a new
computer console or a new model of laptop, it hopes that there
will be people who are desperate to buy this product. It,
therefore, sets a high price knowing that this group of people
will be willing to pay it (ideally they are queuing up outside the
shop waiting for the new product to be released). We can say
that such buyers are not sensitive to price.
Price skimming helps businesses to obtain the money needed to
repay development costs. Once the first group of customers has
paid the high price, the price is then reduced in order to attract
new customers who need a lower price to get them interested.
With a price skimming approach, the price starts high and is
gradually reduced over time. The strategy works best if the
product is unique in some way and, therefore, people are willing
to pay more.

Price penetration
This approach is used to launch a product with a low price in
order to get sales quickly. Penetration pricing is a way of
trying to get market share very quickly and of trying to establish

525
a product as the market leader. The strategy works best if
customers are very sensitive to price. By producing on a larger
scale, a business may get its name known quickly and may also
benefit from lower costs by buying supplies in bulk and from
other economies of scale.

Key terms
Price skimming is setting a high price for a product when
it first enters the market.
Penetration pricing is launching a new product at a low
price to achieve fast sales.

Competitive pricing
Businesses using competitive pricing try to match the price
that others are charging. This approach is used a lot by
supermarkets and insurance companies, which openly compare
their prices with those of other businesses to show customers
that they offer good value. Competitive pricing is common in
markets where there are a few big firms competing directly
against each other and where customers can compare their
products easily. If the products are similar, then the price
becomes an important factor that will influence a customer’s
decision to buy the product.

Loss leader
A business sometimes sells a product at a loss, called a loss
leader, so that the customer will buy more of something else
where the firm makes a profit. For example, a company might
sell computer printers cheaply and then charge a lot for the ink
cartridges. Similarly, a company might sell razors cheaply and

526
charge a lot for replacement blades. Supermarkets also use this
approach by selling some products at a loss and advertising
these in the shop windows. This gets customers into the shop,
and the supermarkets then hope they will buy some of the
higher-priced items.

Cost plus pricing

Cost plus pricing is an approach that aims to ensure the
business covers its costs and makes a profit. It works by
calculating the costs of providing the product and adding a
percentage on to this to decide on the price. This is known as
mark-up. Mark-up is the amount added on to costs to determine
the price. For example, if an item costs £10 and you add on 20
per cent you will sell it at £12. Cost plus pricing is quite
common for retailers. They buy at a certain price, add on a
percentage and then sell it on. This approach is simple to apply
but does not take account of demand in the market – it does not
directly consider what people are willing to pay.

Key terms
Competitive pricing is matching the prices that
competitors charge.
A loss leader is a product sold at a loss in the hope that
the customer will buy other items from the business where
they make a profit.
Cost plus pricing is where products are priced by
covering the cost of it to the retailer and adding a
percentage on top.

Business insight

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Apple
The Apple iPhone 7 was launched in 2016 and sold for
around £600 for the cheapest option.
Analyse the factor that might have affected the
price originally set for the Apple iPhone 7.
(6 marks)
Analyse the reasons why the price of the iPhone 7
might have changed since it was launched.
(6 marks)

Maths moment
Imagine you buy an item at £20 and add on 25 per cent.
To calculate 25 per cent of £20 we use:

The new price will be £20 + £5 = £25.

What if the mark up is 30 per cent? What would the
price be?

Factors influencing the price

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The price of a product depends on many factors.

Costs
To make a profit, the price must cover the costs. There are fixed
costs (such as rent) and variable costs (such as materials and
components).

Demand
Demand determines what people are willing and able to pay for
a product. If demand is high, then a business can increase the
prices it charges. If demand is low, the business will probably
have to lower the prices of the product. In 2008, the UK
economy was not doing well and many people lost their jobs or

529
had lower incomes. Many businesses had to cut their prices to
sell their products.

The nature of the market

If a market contains many firms selling similar products then
prices have to be competitive. In such markets, customers can
directly compare the prices being offered by rival firms and will
choose to buy from the cheapest. Offering a product that is very
different from the competition gives the ability to charge more.

A business’s objective and approach

to pricing
If a business aims to gain a large share of the market and to
make its product well known, then it may use penetration
pricing and have a relatively low price. If it aims to promote its
product as very high quality and top of the range, it will
probably charge a high price.

Position in the product life cycle

The price that can be charged will probably change at different
stages in the product life cycle. For example, when demand is
rising fast in the growth phase, it is probably feasible to keep the
price high. When demand falls in the decline phase, the price
may need to be reduced.

Rest of the marketing mix

Price is just one element of the marketing mix and must fit with
the other elements. Clothes with a well-known fashion design
label, which are sold in exclusive shops in London and are

530
promoted in expensive fashion magazines, should have a high
price to fit with the rest of the mix. If the product is mass-
produced, basic and sold in many outlets next to other similar
brands, then the price is likely to be more competitive.

Study tip
Many different factors influence the price of a product.
You will need to think about the precise context of the
business. Does it have an innovative product? If so, the
price might be high. Is it a basic product? If so, the price
may be lower. Is the owner keen to get a lot of sales
quickly or not? The right price will depend on the position
of the business.

Business insight
Aldi
Aldi is a discount store. It sells fewer types and brands of
products than some other supermarkets, such as
Sainsbury’s and Tesco, but buys these in bulk so it can
get them for lower prices. It has sites in cheaper locations
outside city centres to keep rents down. It does not have
that many refrigerated items because these are
expensive to store and its displays are basic. Aldi aims to
offer a limited range of products at low prices.
Analyse the reasons why other supermarkets do not
charge prices as low as Aldi.
(6 marks)

Summary
As a business grows, it will have many new products and

531
managers need to think about what price they will charge
for these. There are many options, such as price
skimming and penetration pricing. The right price depends
on factors such as the costs, demand and competitors.

Quick questions
1 What is meant by a ‘product portfolio’?
(2 marks)
2 What is a ‘cash cow’?
(2 marks)
3 What is a ‘dog product’?
(2 marks)
4 Explain the stages of the product life cycle.
(4 marks)
5 What is an ‘extension strategy’?
(2 marks)
6 What is meant by ‘price skimming’?
(2 marks)
7 What is meant by ‘penetration pricing’?
(2 marks)
8 Explain one factor that might influence the price of a
product.
(2 marks)
9 The costs of producing a product are £30. The mark-
up is 20 per cent. What is the selling price?
(2 marks)
10 The cost of a product is £12. The sales price is £15.
What is the percentage mark up?
(2 marks)

532
Case study
Ryanair
The budget airline Ryanair expects its average fares to
fall by 7 per cent this year as it cuts prices to increase its
market share when faced with increasing competition.
Analysts said rival airlines were likely to follow Ryanair’s
lead. The price cuts were made as Ryanair announced 43
per cent rise in its profit to €1.2 billion for the year.
The CEO of Ryanair said that if others now cut their price,
Ryanair would cut its prices even further. Rival airlines
include British Airways’ owner IAG, Lufthansa and Air
France-KLM. Ryanair uses a ‘load factor active/yield
passive’ model; this means that it will cut fares as much as
is needed to keep its aircraft full and capacity utilisation
high.
Despite the fare cuts, Ryanair said it expected profits for
2017 to rise 13 per cent, with falling fares balanced by an
increase in passenger numbers. But falling fares could hit
profitability in 2018.
1 What is meant by ‘market share’?
(2 marks)
2 Explain one factor other than price that might affect
whether customers choose a particular airline.
(4 marks)
3 Analyse the factors that might influence demand for
travel.
(8 marks)
4 To what extent do you think Ryanair is right to lower its
prices?
(12 marks)

533
534
Topic 5.6

Promotion and distribution

In this section we look at promotional and distribution
activities in more detail and consider their importance to a
growing business.
By the end of this topic, you should know:
• how promotional activities enable growth
• how to select the right promotional mix
• influences on distribution
• the importance of distribution.

Introduction to promotion
The marketing mix is made up of the four Ps: the price, the
product, the place (distribution) and promotion. Promotional
activities are ways of communicating about the business and
its products.

Key term
Promotional activities are the different ways in which a
firm tries to communicate with its customers.

535
A business may communicate about its products in order to:
• inform customers about the business
• try to persuade customers to buy a product
• remind customers of the advantages of a product.

Types of promotional activity

There are many ways of communicating with customers, such
as:
• Advertising. Advertisements can appear on television, in
magazines, in newspapers and on posters. These forms of
communication have to be paid for. Advertisements can occur
in many forms. For example:
• in print such as newspapers, magazines and billboards
• online
• on the radio
• on television and in cinemas
• on vehicles such as buses.
• Sales promotions. These are short-term incentives to
encourage customers to buy the product. They include:
• discounts – reducing the price to give more incentive to buy
• buy one get one free offers
• competitions and coupons
• point of sales displays, i.e. in-store displays to attract buyers
• free gifts
• free samples.
• Public relations activities. These are the actions used by a
business to arrange free media coverage of its activities and/or
products. The boss of Virgin, Richard Branson, is very good

536
 at getting coverage of his business for free. When he opens a
new store, for example, he often puts on a big show that gets
media coverage; this is cheaper than advertising. Similarly
the boss of Ryanair often says controversial things to get
coverage of his brand. The problem with public relations is
that you cannot control what will be said by the media.
• Personal selling. Many businesses will have a sales force to
help promote their products. Members of the sales team might
visit different stores to get them to stock their products. They
will let the businesses know about new offers, new products
and the benefits of their products compared to those of
competitors.

Key terms
Sales promotions are short-term incentives to
encourage customers to buy.
Advertising involves paid for communications.

Business insight
Red Bull
The Red Bull energy drink is sold all over the world. Over
4 billion cans are bought each year. Rather than spend
millions of pounds on traditional poster or television
advertising, Red Bull uses a range of different
promotional activities. For example, it sponsors extreme
sports events such as snowboarding, cliff diving and
surfing. It also gives cars featuring large Red Bull cans to
students to drive around universities and get others
interested. Its slogan is Red Bull ‘gives you wings’.
Analyse the possible reasons why Red Bull uses
these different forms of promotion rather than the

537
 more usual advertising.
(6 marks)

Maths moment
A business sets a promotional budget of 5 per cent of
expected turnover. Its expected turnover is £2 million.
What is its promotional budget?

What is promotion used for?

Promotional activities are about communication. Businesses may
want to communicate to:
• inform customers or remind them about some aspect of the
product; for example, a business may want to announce that it
has a new product on the market, or it may want to remind
you about an event
• create or increase sales; a business may want to try and
promote more sales by telling potential customers about a
special offer or sale
• create or change the image of the product; to extend sales a
business may want to change customers’ perceptions of a
product; for example, it may want customers to think of it as a
more premium product and worth paying extra for
• show the benefits of a product; a business may want to explain
why its product is so good; this can involve highlighting what
its particular strengths are; for example, how it is more
effective than it used to be or better than the competition.

Factors influencing the promotional

538
activities of a growing business

The following are factors that influence how the promotional

mix is used.

Key term
The promotional mix is the combination of promotional
methods used by a business to communicate with its
customers.

Costs and finance

Some forms of promotion are much more expensive than
others. Advertising on television is more expensive than

539
advertising in a local newspaper. The amount of finance a
business has available can affect the different forms of
promotion it can afford.

Target market
If a business is trying to communicate with people all over the
world, then the internet might be a good form of
communication. A local newspaper, by contrast, is not
appropriate because it will not reach enough people. For a
business simply trying to reach a local audience, national
television is too expensive and not targeted enough; local radio
might make more sense. Businesses also need to think about
what their target audience does. What do they read? What do
they watch? What do they listen to? Only when you understand
their habits will you know the best way of reaching them.

Competitors’ actions
If competitors are very visible in terms of advertising, there may
be pressure on a business to respond to this. If competitors run a
particular promotional campaign very successfully, a business
may want to adopt similar promotional methods.

Nature of the market

Factors such as the size of the market, the total amount spent in
the market and where customers are based will all affect the best
way to promote the product. For example, if the market is a
mass market with many sellers, forms of promotion such as
television advertising may be cost effective. If the market is
relatively small, then this would not justify the costs of such a
campaign. In this situation a business may rely more on other
incentives. If customers are located in a relatively clear area,
then a poster campaign might work, but if they are located in

540
very different areas, this might not be a particularly good way to
reach them. If they are price sensitive, discounts might work. If
price is not a key issue, a gift might be better.

Nature of the product

The brand image and type of product may influence what
promotion is suitable. For example, if a product is a premium
brand, then discounting the price, having competitions or two
for the price of one would not fit with the brand and customers’
perceptions. A two for the price of one offer may work well for
fast food restaurants.

Reasons for promotion

Choosing the right method of promotion is very important for

any business. If you want to communicate with words, sound
and pictures, then television is a good form of communication.

541
If you only need words and images, then a poster campaign can
work. Every form of communication has advantages and
disadvantages. For example, a printed advert can be read several
times, whereas a radio advert may only be heard once. On the
other hand, someone may remember sounds more than they
would notice a printed advert. A growing business may be able
to afford promotional activities that have a variety of
communication methods.

Study tip
The right mix of promotional activities depends on a
number of factors and you will need to think about the
context of the business. Is it trying to reach high-income
earners? Young people or old people? How much money
does it have to spend?

Overall, when selecting which promotional activities to

undertake, businesses need to think about:
• the coverage of a promotion – how many people will see it?
• the quality of the promotion – how effective is it likely to be?
• the cost
• the different media options – for example, print, film or
sound.

Business insight
Eggxactly

542
The Eggxactly was designed by James Seddon. James
often overcooked his daughter’s boiled eggs and decided
that cooking eggs should be as easy as making toast. He
experimented a lot and then came up with the idea of
using soft stretchy heating elements instead of boiling
water. By stretching the elements over the egg and
controlling them with a microprocessor, he was able to
cook eggs accurately and just the way his daughter likes
them.
Although the idea seems relatively simple, the technology
has proved difficult to develop in a way that can make a
high enough financial return. It has taken over ten years
since the idea was launched on the BBC TV show
Dragons’ Den in 2006 to bring the product to the market.
The product is now ready to launch with a retail price of
around £30.
Eggxactly claims to use just 1 per cent of the energy
required to cook an egg in a pan with water. The inventor
claims that most people use a pint of water to boil an egg;
if you have an egg a day, the Eggxactly pays for itself
within a year!

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 Source: www.eggxactly.com

Analyse the ways in which Eggxactly might be

promoted.
(6 marks)

The distribution channel

The marketing mix is made up of the four Ps: price, product,
promotion and place. By ‘place’ we mean the way in which the
product is distributed. The distribution channel (or chain of
distribution) describes how the ownership of the product passes
from the producer to the final customer. The distribution
channel may include the following:
• Producers. A producer supplies goods or services. For
example, Cadbury produces chocolate and Direct Line
provides insurance.
• Wholesalers. Wholesalers buy products from producers in
bulk and supply in smaller quantities to retailers (this is
known as ‘breaking bulk’). Some wholesalers sell through
cash and carry stores. These are warehouses where goods are
displayed for retailers to choose the products they want.
Wholesalers can offer advice and transport services to
retailers. Selling to a few big wholesalers reduces the transport
costs for manufacturers (because it is a lot cheaper than
transporting to lots of retailers). It also means the
manufacturer has fewer deals to negotiate.
• Retailers. Retailers are the shops that sell goods and
services to the final customers. Supermarkets such as Asda,
chain stores such as Waterstones, franchises such as
McDonald’s and small independently owned shops are all
examples of retailers who are at the end of the chain of

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 distribution. Some services (insurance, for example) are sold
through other outlets and online such as branches of banks
and building societies.

Key terms
The distribution channel describes how the ownership
of a product passes from the producer to the final
customer.
Wholesalers break bulk; they buy in large quantities from
a producer and sell to retailers.

Connecting the distribution channel

The following are ways that the distribution channel connects to
the customer.
• Mail-order businesses. Mail-order businesses produce
catalogues and customers order from these. The businesses do
not have physical retail outlets.
• Telesales. This is where businesses sell their products over the
telephone. They may telephone people hoping to convince
them to buy their product (for example, double glazing) or
simply take orders over the telephone rather than having a
shop.
• Online selling via e-commerce and m-commerce. Many
businesses now sell a range of producers’ products online.
This is called e-commerce. Think of Amazon, Zappos,
ASOS and eBay. They do not necessarily have a physical shop
where people can go – they simply have a website where
orders can be placed in the same way that customers place
orders from a mail-order catalogue. The rapid growth in the
use of smartphones means that more online selling is via

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 mobile phones; this is called m-commerce. Many retailers
now have physical stores and an online operation as well.
This gives customers different ways of accessing products. In
some cases businesses offer click and collect services so
customers can order items online and pick them up in store.
Providing physical and online options is known as a ‘multi-
channel’ operation.
Mail order, telesales and online selling are all examples of
direct marketing. The business sells direct to the customer.

Key terms
Retailers are shops that sell direct to the customer.
E-commerce involves online trading.
M-commerce involves online trading via a mobile phone.
Direct marketing occurs when there is a direct link from
the producer to the customer with no intermediaries.

Levels of distribution
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Wholesalers and retailers are parts (or intermediaries) of the
distribution channel. They are organisations that provide a
service and help get the products from the producer to the
customer.

Key term
An intermediary is a link in the distribution chain between
the producer and the customer.

There are various types of distribution channel:

• Zero level. This means there is no intermediary between the
producer and the customer. The maker of the product sells
direct to the final buyer. Dell computers used to sell only
online so they dealt with the customers directly.
• One level. This occurs when there is one intermediary
between the producer and customer. For example, a business
may sell to a retailer who then sells to the customer.
• Two level. This occurs when there are two intermediaries
between the producer and the customer. For example, a
producer sells to a wholesaler who sells to a retailer who sells
to the customer. A wholesaler buys from a number of
businesses in bulk. A retailer then buys a combination of
products from the wholesaler to stock for the customer. It is
easier for the retailer to go to the wholesaler than to contact
many different producers directly.

Advantages of using intermediaries in

the distribution channel
A producer can access many thousands of customers by selling
to retailers that then distribute to their own stores, or by selling
to wholesalers that then sell them on. The intermediaries help to

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distribute the products widely and can save the manufacturer the
costs of trying to distribute direct to many different customers in
many different places.
By selling its products in other businesses’ stores, the producer
enables the customers to compare what is on offer. If you only
produced one brand of washing machine, for example, it is
unlikely you could operate your own retail stores for these
profitably. Customers want to go somewhere to compare a range
of different brands.

Disadvantages of using intermediaries

in the distribution channel
Intermediaries will want to make a profit so the price is
increased at each stage. This makes the final product more
expensive than if the producer sells directly to customers.
By selling the product on to someone else, the producer loses
control. An intermediary can promote the product as they
choose – the producer may not approve of their displays,
descriptions, or even their store layout.

Selecting the right channel of

distribution
In order to select the right channel of distribution, businesses
need to think about the following:
• Costs. What are the costs of distributing via other
intermediaries compared to selling directly?
• Lack of control. To what extent does this matter? In the case
of some products, the way the shop looks, the way the
products are displayed and the way the brand is described are
very important, for example, exclusive fashion labels. The

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 producers of such goods might want to sell through their own
stores rather than handing over to someone else. In the case of
newspapers or mint sweets, the nature of the store may not
matter as much, so using intermediaries does not create
problems.
• The product. Some products, such as milk and chewing gum,
are called convenience products. Customers will not travel
very far to buy them; they will go to the nearest store. In order
to sell, convenience goods need to be distributed widely in
lots of shops. You could not rely on your own shops for these
as there would not be enough different products on offer.
Other products are more ‘speciality items’. These are products
that customers do not buy very often and which are often
expensive and not widely available. Customers will travel
some distance to find these and when they get there, the
nature of the store and the training of the staff will be very
important. Examples include expensive music systems,
fashion brands or sports cars. These products will probably be
distributed in a few specialist stores, possibly owned by the
producer.

Business insight
Betterware
Betterware is one of the UK’s most successful home
shopping companies. It is best known for its extensive
homeware and housecare cleaning products, although its
range has grown over the years to include gifts, personal
care and beauty, as well as outdoor products. It has over
5,000 distributors who visit houses door to door and has
a purpose-built office and warehousing complex in the
Midlands that handles around 5 million customer orders
every year. Customers can order products through the
network of distributors, by post, or over the phone and

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 online.
Analyse the advantages and disadvantages for
Betterware of having a door-to-door sales force.
(6 marks)

Many businesses use a range of distribution channels. Can you

think of products that you can buy through more than one
distribution channel, for example, direct from the producer and
via their own retail outlets? Using more than one distribution
channel may increase sales and reduce the risks if there was ever
a problem with one of the channels.

Importance of getting distribution right

Getting the right distribution can influence the success of the
business because it can affect:
• Sales. If a product is not available when and where customers
want it, they may buy something else instead.
• Image. If a product is sold in the wrong place then it may
damage the brand and affect its sales over time. Perfume
companies such as Chanel will not allow their products to be
sold in some stores (such as Superdrug) because they think it
cheapens the value of the brand.
• Costs. How a product is distributed will affect costs and the
final price. The more intermediaries there are, the higher the
final price because all the firms involved want to make a
profit.

The internet and distribution

The growth of the internet has made it much easier for
businesses to reach their customers directly. By using company
websites, customers may be able to order from anywhere in the

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world, 24 hours a day. This makes direct distribution much more
possible than it was in the past. Why go to a retailer if you can
buy direct from the manufacturer? There are advantages to the
customer of using a retailer, such as the advice received and the
range of different brands on offer, but the disadvantage is that
retailers are likely to be more expensive. The future is likely to
see a further increase in direct zero-level distribution channels.

Study tip
The ‘place’ is often forgotten when students write about
the marketing mix – they nearly always focus on
promotion and the importance of advertising. But place
can be crucial. When you are hungry and want a snack,
you go to the nearest shop to buy something. You
immediately see a brand of crisps you like and buy a
packet. Just think how important it is to get these crisps
into thousands of shops all over the UK and displayed in a
good place. If that brand was not there, you would simply
have bought something else. Good distribution is
essential for you to buy it.

Summary
As a business grows, it will have more customers and will
look for different ways of delivering its products and
services to them. This may be via intermediaries such as
wholesalers or retailers or via online sales. Choosing the
right distribution channel depends on many factors, such
as the nature of the product itself, the costs, the actions of
competitors and where the customers are based.

551
Quick questions
1 Describe two types of promotional activity.
(2 marks)
2 Give two examples of messages that a business
might want to communicate to its customers.
(2 marks)
3 State two advantages of advertising in a newspaper
compared to radio advertising.
(2 marks)
4 Explain one factor that might affect the type of
promotion that might be chosen by a business.
(2 marks)
5 Explain one way the internet changed the way in which
businesses can promote their products.
(2 marks)
6 What is meant by a ‘distribution channel’?
(2 marks)
7 What is the difference between a wholesaler and a
retailer?
(2 marks)
8 What is meant by ‘m-commerce’?
(2 marks)
9 Explain one benefit of distribution directly to
customers.
(2 marks)
10 State two reasons firms sell through intermediaries.
(2 marks)

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Case study
Zalando
In Westphalia in Germany there is a warehousing facility
the size of 13 football pitches. This is the logistics centre
of Zalando, Europe’s biggest online vendor of clothing and
footwear. Inside the warehouse, staff are packing boxes
with shoes, clothes and accessories on a 14-kilometre
conveyor belt where they are weighed, sorted and labelled.
They are then distributed to 15 countries. Zalando ships
over 55 million orders (that is over 100 per minute) from
three of these warehouses each year.
The company was set up by David Schneider and Robert
Gentz in their Berlin flat in 2008 where they sold flip-flops
online. While sales of clothing in physical stores are fairly
flat, online sales are increasing by around 15 per cent a
year in the countries where it is operating.
Selling fashion clothing and accessories is not easy.
Around half of what Zalando sells (in terms of the value of
sales) is returned because it is the wrong style or does not
fit. Customers can order as much as they like and have
100 days to return items at no cost. The company is even
trialling collecting returns from customer’s homes and
offices.
Zalando has relationships with 1,500 brands that supply
150,000 articles. It sells mostly well-known labels. Another
online fashion retailer, ASOS, sells only 850 brands of
clothing and shoes and relies heavily on its own label. One
appeal for retailers and brands is that Zalando saves them
from having to invest in e-commerce themselves.
Zalando argues that Amazon is targeting a more price-

553
conscious shopper, whereas it is targeting a higher-value,
more brand-conscious segment. The company believes
that for such customers, shopping for clothes, shoes and
accessories is an emotional activity; shopping on Amazon
is just a transaction. ‘Amazon lists prices, we give advice,’
says Zalando.
1 What is meant by ‘e-commerce’?
(2 marks)
2 Explain what is meant by targeting a ‘higher-value, more
brand-conscious segment’?
(4 marks)
3 Analyse how Zalando might promote its services.
(6 marks)
4 To what extent do you think e-commerce is a good
distribution channel for all businesses?
(12 marks)

Chapter review – Marketing

Read question 1, the sample answers and the examiner’s
comments. Then try question 2.
1 Read Item A and answer the questions that follow.
Item A
Whitbread plc is the UK’s largest hotel, restaurant and
coffee shop operator. It has 50,000 employees and
serves millions of customers both in the UK and overseas.
Whitbread plc’s product portfolio includes Costa coffee
shops, Premier Inn hotels and restaurants such as
Brewers Fayre, Beefeater Grill and Table Table.
In 2016, Whitbread plc announced an increase in profits.

554
This increase was helped by growing sales at Costa
coffee shops and its Premier Inn hotels. Costa has seen
amazing growth in recent years. The company says that
the success of its brand has been due to its ability to
consistently deliver great value for money. It claims this is
due to a combination of service, price and quality of the
product. Whitbread plc plans to open between 230 and
250 new Costa coffee shops worldwide, as well as 3,700
new Premier Inn rooms in the UK. It is also developing
new premium coffee products to sell in Costa, introducing
a new fresher food range and making good progress
rolling out Costa Drive Thru formats.

Both Costa and Premier Inn have had to cope with higher
wage costs due to government legislation that increased
the National Minimum Wage in 2015. Costa has also had
to cope with higher costs to buy in the coffee. Costa is,
therefore, considering an increase in the price of its
coffee. This means customers are going to have to pay
much more for their coffee or Costa is going to have to
absorb some of the costs.

(a) What is meant by ‘profit’?

(2 marks)
(a) Profit is calculated using the equation total
revenue − total costs.

This is a precise, focused answer to the

question.

(b) Explain why Costa is developing new products such

as Drive Thrus and more premium coffee and food
products.

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 (4 marks)
(b) Costa wants more sales. The Drive Thrus and
premium coffee will attract customers. This
means they will sell more. If they sell more,
they can make more profit. New products bring
customers. Customers bring sales. Sales
bring profits.

This answer has some value in that it identifies

that new products are launched to boost sales.
However, the point is not explained. Why has
the business developed these products? For
example, customers tastes are changing and
people want more convenience; this is why
Drive Thrus are proving more popular. Or with
growing competition in the coffee market,
Costa needs to differentiate its product and
producing premium coffee helps do this.

(c) Analyse the benefits to Whitbread plc of having a

portfolio of products.
(8 marks)
(c) A portfolio of products is a collection.
Whitbread has hotels, coffee shops and
restaurants. This means it operates in
different markets which can help to spread
risks. If there are falls in demand for hotels, for
example, the demand for coffee shops may still
increase, reducing risks for the business.
These businesses are all to do with serving
food and drink and serving customers so they
have something in common and can share
some experiences and resources. However,

556
 the fact they have different customers means
the business can spread risks.

This answer shows a clear understanding of

the product portfolio.

(d) Analyse the case for and against Costa increasing

the price of its coffee. Based on your analysis,
recommend whether increasing its price is a good
idea.
(12 marks)
(d) Costa may want to increase the price of its
coffee because its costs have increased. It is
paying more for coffee and for wages and so
to cover its costs and still make the same
profit per item it will need to put the price up.
However, if it puts the price up, sales may fall
because customers may switch away from
coffee completely or switch to another coffee
shop. There are now many other businesses
selling coffee and so customers can easily
find somewhere else to buy their drinks. This
means Costa may not want to put up prices for
fear of sales falling quite a lot.
Overall, Costa should put up the price
because of the higher costs. To make profit
with higher costs, you need more revenue. To
make more revenue, you need higher prices.

This answer raises relevant points. Yes, Costa

will need to consider costs and yes, it will also

557
 worry about the loss of sales. The conclusion
does not build on all the arguments made
earlier. It ignores the argument about falling
sales. It assumes the first argument is right
without referring back to the counter-argument.
The conclusion (recommendation) needs to
come back to the earlier arguments. In this
case, it might argue that the danger of losing
sales is less likely, given the strength of the
Costa brand or the quality of its coffee and,
therefore, it would be able to push up prices.
2 Read Item B and answer the questions that follow.
Item B
According to a recent market research report, the number
of smartwatches sold fell by over 50 per cent in 2016.
Apple Watch still had the largest market share within the
smartwatch market, but the number sold was just over 1
million between July and September 2016, down from 39
million the year before.
Of the five leading brands (Apple, Garmin, Samsung,
Motorola and Pebble), only Garmin showed growth, but its
figures remained low. One factor may be that new
versions of these smartwatches are expected soon, but
nevertheless sales seem slow. Some customers seem
unsure why to buy a smartwatch. To address this issue,
manufacturers are looking at what segments they are
targeting and refining their promotional messages. Most
are focusing on measuring fitness as the key benefit the
watch can provide. Apple’s most recent promotional
activity concentrates on the Apple Watch and its ability to
address health issues, rather than it being a fashion
accessory. It has discontinued the gold edition of its

558
original ‘wearable’, which retailed at $10,000 (£8,000).
The latest Apple Watch version can track swimming
activity, and the company is working on a special edition, in
partnership with fitness giant Nike.
Smartwatches face growing competition from traditional
watchmakers, such as Fossil. These traditional makers
are producing new models sold through watch retail
channels rather than technology stores.

(a) What is meant by ‘market share’?

(2 marks)
(b) Explain one benefit to smartwatch producers of
segmenting the market.
(4 marks)
(c) Analyse the factors a traditional watch
manufacturer might consider when deciding
whether to use retailers to sell its products.
(8 marks)
(d) Sales of smartwatches are falling. To what extent
do you think it is inevitable that sales of
smartwatches will continue to fall?
(9 marks)

559
6 Finance

Finance is an important influence on the activities of a

business. This chapter looks at the role of finance within a
business starting with the sources of finance that a
business can use. We will consider the benefits and
drawbacks of the main sources of finance that are
available to businesses in the UK. Many businesses fail
because they do not manage their cash flows effectively.
This chapter will consider why cash is important to
businesses, how flows of cash can be forecasted and how
cash differs from profit. We will also introduce many of the
key financial terms used by businesses and conduct a
range of financial calculations which help managers to
make decisions. Finally, we shall look at two vital financial
documents produced by businesses and analyse what
they can tell us about the financial performance of a
business.

560
Topic 6.1

Sources of finance
Both new and established businesses need to raise
finance. A new business needs to raise money to buy raw
materials and to pay rent or buy buildings. An established
business may plan to expand or to install new equipment to
improve the efficiency of its production methods. It will
need money to do this. This topic considers why
businesses need to raise money and the sources that can
be used to do this.
By the end of this topic, you should know:
• why businesses need to raise finance
• the sources of finance used by new and established
businesses
• the advantages and disadvantages of using these
sources of finance
• which sources are most appropriate for given
circumstances.

Why do businesses need to

raise finance?
561
Understanding why a business needs to raise finance (money)
makes it much easier to select the most appropriate source of
finance. Businesses need finance for a number of reasons.

New businesses
A new business will need finance to purchase a range of items
that are essential if it is to be able to start trading. An
entrepreneur will need to spend money on at least some of
the following in order to start a business:
• Renting or buying a building. This might be a shop, an
office or a factory and is likely to be relatively expensive.
• Vehicles. Many businesses will require cars to visit customers
and suppliers, as well as vans or lorries to deliver products.
• Advertising the business. Potential customers will not know
about a new business unless it promotes itself. Many new
businesses spend quite large amounts of money on
advertising, even before they start trading.
• Equipment and machinery for the business. Most
businesses require some equipment or machinery, especially if
they are planning to manufacture products. For example, a
new furniture-making business will need equipment to cut,
sand and polish wood.
• Inventories of raw materials. A shop will need inventories
if it is to have anything to sell. So, for example, a greengrocer
will need to buy inventories of fruit and vegetables to sell.
The furniture maker referred to above will need to have
inventories of wood, nails, screws and wood stains to
construct the furniture.

Key term
An entrepreneur is someone who is willing to take the

562
risks involved in starting a new business.

Key term
Inventories are raw materials that have not yet been
used or products that have been made, but not sold.
These are also called stocks.

Established businesses
Established businesses that have been running for some time
often need to raise finance for a number of reasons:
• To expand. It is common for businesses to decide to increase
the scale of their enterprise, possibly by entering new markets
or selling more in existing markets. To do this, businesses may
need to raise finance to pay for additional shops, factories or
offices as well as to recruit new employees. For example,
Spotify, a company that supplies music, podcasts and video
streaming services, attempted to raise $500 million in 2016 to
fund further global expansion.
• To improve efficiency. Businesses can raise money to spend
on training employees or to purchase technology to use in
production. Better trained employees or production-line
technology can help businesses to produce goods and services
more quickly and with fewer resources. However, this can be
expensive and require large sums of money.
• To develop new products. Developing new products is an
important way for many firms to compete, but it can be costly.
To develop new products, businesses may have to pay for
scientific research or for new production facilities, as well as
for advertising to inform customers. In 2015, Nissan, the
Japanese car manufacturer, spent £100 million at its factory in

563
Sunderland to enable it to make its new Juke car there.

564
Sources of finance

Internal sources of finance

An internal source of finance is money that is available
from within the business. Using internal sources of finance
means that a business does not face possibly high interest
charges. It also means that other organisations, such as banks,
do not have a say in how the business is run. However, many
businesses only have limited internal sources of finance.

Owners’ funds
Owners’ funds is the name given to money put into the
business by its owners. There might be one or more owners of a
business, depending on whether the business is set up as a sole
trader, a partnership or a private limited company. The greater
the number of owners in a business, the more potential the
business has to use this as a source of finance. The owners of a

565
new business may use their savings to invest in their business –
if they have any.
Owners’ funds are normally used as a source of finance when
the business is first set up, but they can also provide money for
well-established businesses. Owners’ funds are a major source
of finance for sole traders and partnerships, which are not
allowed to sell shares to raise money. A major benefit of using
this source of finance is that the business does not have to pay
any interest on it.

Key terms
An internal source of finance is money that is available
from within the business, for example, retained profits
from previous years.
Owners’ funds is money put into a business by its owner
or owners.
Interest is a payment made in order to borrow money. It
means a business pays back more than it borrows.

Retained profits
This is profit made by the business in earlier years (see Figure
6.2). A profitable business may build up a large sum by saving
its profits from previous years. One major advantage of using
retained profit is that the business will not have to pay interest as
it is not borrowing money. This source of finance may be
available immediately to a successful business. Retained profits
form the most important source of finance for large businesses.
It is estimated that between 80 per cent and 90 per cent of funds
raised by large firms in the UK for investment come from
retained profits.

566
However, this source of revenue is only available to successful
firms that have made a profit. In addition, there is a downside to
using retained profits – a company’s shareholders may be
disappointed if profit is kept within the business and is not paid
to them as dividends.

Key term
A shareholder is a person or organisation that owns part
of a company. Each shareholder owns a ‘share’ of the
business.

Maths moment
Use the information in Figure 6.2 to calculate the retained
profits available to the company in the following
circumstances:
• Costs of production = £19.5 million
• Dividends = £1.5 million
• Sales revenue = £23.4 million.

Study tip
There is often evidence in examination questions as to
whether retained profits are a suitable source of finance

567
 for a large business. If the business on which the question
is based is described as successful or profitable, then
retained profits may be a good source of finance. An
examination question may also give information about a
business’s profits in the form of figures.

Selling assets
Selling assets can provide a business with large sums of
money, depending on what is sold. Assets can be sold in two
ways:
• selling assets such as buildings for cash
• selling an asset and leasing it back, so that it is still available
for use. In 2015, the supermarket Morrisons raised £175
million by selling property and has leased it back from the
new owner.

Key term
An asset is something that is owned by a business.
Examples include land, buildings, vehicles and machinery.

Selling assets can provide a business with money without having

to pay interest charges. However, there are disadvantages to
using this source of finance. A business may sell an asset that it
will need later. If it sells the asset and leases it back, the business
will have to pay a sum of money regularly to the new owner.
This may reduce the business’s long-term profits.

568
Trade credit
Trade credit is a period of time which suppliers allow
customers before payment for supplies must be made. Many
businesses are able to negotiate trade credit to allow a period of
30, 60 or even 90 days before payment has to be made for
supplies. In effect, this is a short-term loan.

Key term
Trade credit is a period of time which suppliers allow
customers before payment for supplies must be made.

This is a source of finance for which no interest is charged.

However, it is very short term and only relatively small sums of
money can be raised in this way.

Business insight

569
Liverpool Football Club’s record profits
In 2016, Liverpool Football Club announced that its
financial performance over the previous year had been
very strong. The club revealed that its annual financial
results showed a record yearly revenue of nearly £300
million and profits of £60 million. Liverpool Football Club is
owned by the Fenway Sports Group. The Fenway Sports
Group paid £300 million to buy the club and wants to make
profits from its ownership.
The club has said that the manager, Jürgen Klopp, will be
able to spend heavily on new players using these profits.
However, a single top class footballer can cost up to £50
million.

Analyse the advantages and disadvantages to

Liverpool Football Club of using its profits as a
source of finance to buy new players.
(6 marks)

570
External sources of finance
An external source of finance refers to money that comes
from outside the business. Using external sources of finance
offers firms the opportunity to raise large sums of finance, but
can bring disadvantages such as heavy interest charges.

Key term
An external source of finance refers to money that
comes from outside the business, for example, a loan
from a bank.

Bank loans
If a bank believes that an entrepreneur has a good business idea
and will be able to repay any money it lends, it may agree to
create a loan to help start the business. A bank loan involves a
bank giving a business a large sum of money in return for the
business agreeing to repay the amount in instalments over the
next few years. The business will also be charged interest on
the loan. This is an extra payment that the borrower has to make
to the bank and allows the bank to make a profit on its lending
activities.

571
However, there are disadvantages with bank loans. The bank
may ask for collateral – an asset belonging to the business that
is borrowing the money. Banks are more likely to ask new
businesses for collateral as they often represent a greater risk.
The bank has control of the collateral asset and the right to sell it
if the business fails to repay the loan. In addition, if the bank
charges a high interest rate for the loan, this may make it an
expensive source of finance.

Mortgages
A mortgage is a special type of loan. It is used by businesses to
buy property such as offices, shops and factories. A mortgage
may be for a large sum of money and is normally paid back over
a long period of up to 30 years. The business is given the sum of
money by a bank or building society and has to make regular
payments until the money and any interest has been repaid.
The amount of money borrowed is often large because land and
buildings are usually very costly. The building or land purchased
with the mortgage is normally used as collateral (or security) for

572
the loan. If the business fails to make repayments on the
mortgage, the bank or building society will sell the building
or land to regain its money.

Overdrafts
Overdrafts give entrepreneurs and businesses the right to
borrow variable amounts of money up to an agreed limit.
Overdrafts are very flexible loans as businesses only use them
when required.

Key terms
Collateral is an asset that a bank holds as security for
the repayment of a loan.
Mortgages are loans from banks and building societies
that are used to buy land and buildings, such as offices
and shops.
Building societies are organisations that offer a range
of financial services. However, their major business is
providing savings accounts and lending money for the
purpose of buying property.
An overdraft is a flexible loan which businesses can use,
whenever necessary, up to an agreed limit.

573
Figure 6.3 shows how a new business might be able to benefit
from the use of an overdraft. The business has agreed an
overdraft of £2,000 with its bank. This means that the business
can borrow any amount up to £2,000 from the bank for any
period it chooses. An overdraft is a flexible loan in that a
business uses it only when it needs to do so, in this case between
months 4 and 8, and 11 and 16. At other times, the business does
not need to borrow any money. In this way, the business only
pays interest for the few months that it needs to do so.
Overdrafts do have disadvantages for businesses, however.
First, a bank may not agree to grant some businesses an
overdraft or may charge very high rates of interest. This can
make it a very expensive source of finance. Also, a bank may
withdraw a business’s overdraft with little notice, leaving it with
serious financial problems.

New share issues

Only companies can sell shares. Shares can be sold in return for
a payment, which can be used in a variety of ways. The people

574
who buy the shares are called shareholders and each owns a part
of the company. It is much easier for public limited companies
to sell shares as they can use the Stock Exchange – a market
through which companies can sell shares. Selling shares means
that the company is not committed to pay interest as it would be
if it arranged a loan.
However, there are disadvantages for companies of using the
sale of shares as a source of finance. First, if the business sells a
large quantity of shares, it may mean that the new owners
(shareholders) have enough shares to take control of the
business from the current owners. Second, the new shareholders
will expect to have a share of the company’s profits (as
dividends).

Business insight
Centrica
Centrica plc is a large public company that supplies gas
and electricity in the UK and North America. It owns
several companies, including British Gas and Scottish
Gas.
In 2016, Centrica raised money by selling new shares
worth more than £700 million. The money raised is to be
used to repay some of the company’s loans as well as to
buy another company. Centrica’s share price fell 12 per
cent following the announcement.
Analyse the advantages and disadvantages to
Centrica of using the sale of new shares as a
source of finance.
(6 marks)

Loans from friends and family

575
Borrowing money from friends and family is a popular source
of finance for many entrepreneurs who are setting up a small
business. This source of finance has the advantage of being easy
to arrange and often the money will be lent free of interest
payments. It may also be a source of finance for a small
business seeking to grow.
There are disadvantages, however. Friends and family may not
be able to lend enough money or may need to have it returned
suddenly, leaving the business short of finance. Also, and
importantly, friends and family will be less likely to look closely
at the entrepreneur’s business plan and to make the entrepreneur
think carefully about the proposed business.

Hire purchase
Hire purchase is a method of purchasing assets and paying in
instalments. It is really a special form of a loan. Hire purchase

576
can be an expensive way of buying something, and the business
will not own the item until it is completely paid for. Businesses
will not be able to raise large sums of money from this source.

Government grants
A grant is a sum of money given to an entrepreneur or a
business for a specific reason. The government encourages
people to start or to expand businesses because this creates jobs.
In addition, businesses pay taxes and this helps the government
to pay for its own spending plans.
Grants from the UK government are usually given if a business
will create jobs, especially in areas where many people do not
have jobs. Government grants will only cover part of the money
needed – the business concerned usually has to put in a sum of
money equal to the government grant. The UK government
offers a range of grants for new and existing businesses.
Grants can be difficult to obtain. Businesses may have to meet a
number of conditions, such as creating a certain number of jobs,
in order to qualify. The application for grants can also involve
completing a lot of forms and an interview. However, most
grants do not have to be repaid and also do not lead to any
interest payments.

Business insight
Travelodge’s expansion
Travelodge, the budget hotel chain, announced that it was
to open 19 new hotels in the UK in 2016, bringing its total
to 542. This expansion required an investment of £140
million. The company’s profits rose by £40 million in 2015
to £261 million.
The company has also just completed a modernisation

577
 programme of its existing hotels, which cost £100 million.
It also plans to open a further 250 hotels over the next few
years.
Explain one advantage to Travelodge if it was to use
a mortgage as a source of finance to buy its 19 new
hotels.
(4 marks)

Choosing an appropriate
source of finance
There is no single ‘best’ source of finance for a business. The
most appropriate source of finance will depend on the
circumstances. The factors that influence decisions on which
source or sources of finance to use can vary between new and
established businesses. These are summarised in Figure 6.4.

578
Influences on the choice of sources of
finance for new businesses
An entrepreneur starting a new business will take a number of
factors into account when choosing how to finance a business,
but is likely to have less choice than an established business. For
example, the entrepreneur cannot use retained profits from the
business. Bank loans may be more difficult to negotiate because
the business is unknown and may be judged to be risky.

The amount of personal finance

579
available to the entrepreneur
It is common for entrepreneurs to use their own money to
finance the new businesses, at least in part. The more personal
finance an entrepreneur has, the less he or she needs to raise
from other sources.
Some entrepreneurs set up businesses when they become
unemployed. If someone loses a job, they may receive
compensation known as redundancy pay, which can be used to
start a business. In other circumstances, entrepreneurs sell their
homes to raise funds.

The legal structure of the business

Only companies can sell shares as a source of finance. A new
business may be a private limited company (ltd). This means
that raising funds by selling shares is possible. However, private
limited companies may only be able to make limited use of
shares to raise money as all shareholders have to agree for this
source to be used.

How risky the new business is judged

to be
If a new business is thought to be very risky, this will reduce the
sources of finance available. Banks and building societies may
not be willing to offer mortgages, loans or overdrafts for fear of
not being repaid. In these circumstances, an entrepreneur may
be forced to rely on his or her own finance as well as that
provided by friends and family. Alternatively, the entrepreneur
may form a company and sell shares in it.

Influences on the choice of sources of

580
finance for established businesses
Established companies generally have a larger range of sources
of finance. For example, they may be able to use retained profits
or to sell shares on the Stock Exchange. However, a range of
factors will influence which sources of finance are most
appropriate in any given circumstances.

Profitability of the business

A profitable business will be more able to use retained profits as
a source of finance because it has the money available.
However, a profitable business will also be more likely to
persuade a bank to agree to a loan as it should be able to make
the repayments.

Assets owned by the business

A business that owns assets such as buildings and property may
choose to raise finance by selling the assets and perhaps leasing
them back if necessary. A business that owns valuable assets
may also find it easier to persuade a bank to lend it money, as it
has suitable collateral as security for the loan.

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Past history and future prospects
A business that is expected to make a profit in the future may be
in a strong position to take out a bank loan, as it is more likely to
be able to pay back the loan on time. Equally, a business with a
good record for paying loans on time may be in a better position
to agree a bank loan or a mortgage.

Legal structure of the business

Only companies can sell shares as a source of finance. Many
established businesses are companies – either private or public.
It is easier for public limited companies (plc) to use shares as a
source of finance, as they do not have to gain the agreement of
the existing shareholders, and they can use the Stock Exchange
as a market to sell the shares. This can make this a very
attractive option for a profitable public company.

582
Amount of finance that has to be raised
It is likely that, if a business needs a large sum of money, it will
use more than a single source of finance. This may be because a
bank would not be prepared to lend such a large sum, or
because selling the required number of shares would mean that
the owners lose control of the business. Using several sources in
this situation helps to avoid the worst disadvantages of any one
source of finance.

Summary
Businesses can raise finance from a number of sources.
The most important are retained profits, the sale of
assets, bank loans, mortgages, and the sale of shares.
However, new businesses can rely upon loans from
friends and family, as well as the entrepreneur’s own
money. Each of these sources of finance has advantages
and disadvantages. The best source of finance depends
on the circumstances. Entrepreneurs and managers might
take into account the past and expected profitability of the
business, the assets available to the business, its legal
structure and the amount of money that the business
needs to raise.

Quick questions
1 State two reasons why a new business might need to
raise money.
(2 marks)
2 Explain, with the aid of an example, the difference
between internal and external sources of finance.
(4 marks)

583
3 Which of the following sources of finance will not need
to be repaid at some stage?
(a) A bank loan
(b) A mortgage
(c) An overdraft
(d) Retained profits
(1 mark)
4 Which of the following is a possible disadvantage of
using a bank loan as a source of finance?
(a) The need to provide collateral
(b) Making repayments in instalments
(c) Only companies can use this as a source of
finance
(d) This source of finance is only suitable for short
periods of time
(1 mark)
5 Which source of finance allows businesses to borrow
variable amounts of money up to an agreed limit?
(a) Mortgages
(b) Overdrafts
(c) Hire purchase
(d) Government grants
(1 mark)
6 Explain one disadvantage to a business of using
government grants as a source of finance.
(3 marks)
7 ‘It is really a special form of a loan. It can be an
expensive way of buying something and the business
will not own the item until it is completely paid for.’ Of
which of the following sources of finance is this a

584
 description?
(a) A loan from friends and family
(b) A mortgage
(c) Hire purchase
(d) An overdraft
(1 mark)
8 Which of the following sources of finance can only be
used by companies?
(a) Trade credit
(b) An overdraft
(c) A new share issue
(d) Hire purchase
(1 mark)
9 State two factors that might influence a decision on
the most appropriate source of finance by a new
business.
(2 marks)
10 State two appropriate sources of finance for a
profitable public limited company.
(2 marks)

Case study
Mantra Ltd
Mantra Ltd is a private limited company that manufactures
sheds, bird tables and other garden furniture. It has a
factory in Buckinghamshire and two shops in towns
nearby, where it sells its products. The company regularly
uses its overdraft as a source of short-term finance, even
though interest rates have risen recently.

585
The company has two shareholders, who are brothers and
who run the business. Mantra Ltd has enjoyed rising sales
over recent months, and its profits have risen steadily.
Last year, the company’s profits were £20,000.
Mantra Ltd needs to build an extension to its factory and
to buy new equipment for the enlarged factory. The cost of
the factory extension and the new equipment is estimated
to be £190,000. The shareholders plan to use a bank loan
to raise the entire £190,000, although collateral will be
required. However, the company’s accountant has
suggested that the company sells one of its shops rather
than taking out a loan.
1 Identify two assets that Mantra Ltd might use as
collateral for the bank loan.
(2 marks)
2 Explain why Mantra Ltd should not rely on its overdraft
as a source of finance.
(4 marks)
3 Analyse the disadvantages to Mantra Ltd of borrowing
£190,000 from a bank.
(6 marks)
4 Mantra Ltd’s accountant has advised the company to
raise its funds by selling one of its shops rather than
taking out a loan. Recommend which source the
company should use. Give reasons for your answer.
(9 marks)

586
Topic 6.2

Cash flow
Managing cash flow effectively is an important part of the
successful management of new and existing businesses.
This topic introduces you to cash flow and cash flow
forecasts and explains their importance.
By the end of this topic, you should know:
• what cash flow is
• why cash flow is important to all businesses
• how and why cash flow forecasts are constructed
• how to interpret cash flow forecasts and to overcome
cash flow problems
• the difference between cash and profit.

What is cash flow?

Cash flow is the money that flows into and out of a business
on a day-to-day basis. There are a number of reasons why a
business would receive cash inflows as well as many likely
causes of outflows of cash from the business.

587
Key term
Cash flow is the money that flows into and out of a
business on a day-to-day basis.

Cash inflows
Cash inflows mean that money flows into a business and
becomes available to it. There are several reasons why a
business might receive cash inflows:
• Income from sales. The money businesses earn from selling
goods and services creates an inflow of cash to the business.
This is called sales revenue or income (see Topic 6.3).
• Loans from banks. It is common for a business to borrow
money in order to buy new items such as vehicles, machinery
or property. When the loan is given to the business, this
becomes a cash inflow for the business.
• Money invested by the business’s owners. When a business
is first started, its owners may invest money into the business
resulting in a cash inflow. Later, an established company
might sell new shares causing a cash inflow.

Cash outflows
When a business makes a payment, it causes an outflow of cash.
A number of actions can lead to a cash outflow:
• Buying raw materials. Most businesses need to buy some
raw materials to allow them to trade normally. For example, a
restaurant will need to buy ingredients to make into meals, as
well as buying a stock of alcoholic and non-alcoholic drinks
to sell to its customers.
• Wages. All businesses, particularly those selling services

588
 (where wages are usually a higher percentage of costs), suffer
an outflow of cash due to the payment of wages to employees.
• Rent or mortgage. Many businesses rent the buildings in
which they are located. These may be shops, offices or
factories. This means they have a regular outflow of cash to
pay their rent (or mortgage if they have a loan to buy the
property).
• Interest on loans. We saw earlier that a bank loan leads to an
inflow of cash. Paying interest on the loan, however, leads to
regular (possibly monthly) cash outflows.
• Taxes. Businesses have to pay sales taxes and taxes on profits.
Both of these cause cash outflows. Why might house builders
experience a large time gap between cash outflows and cash
inflows?

Study tip
Do not write about profits if the question is on cash flow.

589
 These are two very different concepts as we shall see
later in this topic.

Why is cash flow important?

Managing a business’s cash flow effectively is a very important
task for managers. If a business does not have enough cash
available to pay its bills, it could fail. A business that is unable to
pay its suppliers will probably not receive any further supplies.
It may be unable to pay its workers. The business will probably
be forced to stop trading in these circumstances.
Poor management of cash flow is the main cause of the failure
of small businesses. It is estimated that 70 per cent of businesses
that fail in their first year of trading do so because of cash flow
difficulties. More than 20 per cent of business failures in the UK
in 2015 were caused by late payments or non-payment by
customers.
Time is a very important issue in relation to cash flow. Managers
need to be aware that if outflows of cash occur before inflows
take place, the business is likely to be short of cash. When
managing cash flow, it is vital to ensure that cash inflows take
place in time so that the funds are available for cash outflows.

590
Business insight
Small firms do not chase up bad debts
Small businesses in the UK face a tough fight to survive
given that 60 per cent fail within five years of starting
trading. Recent research by the insurer Direct Line has
shown that the UK’s small businesses are losing £5.8
billion a year by not chasing up customers who do not pay
their bills. The money owed by these customers is often
written off, meaning that they are never paid. These are
called ‘bad debts’. Explain why bad debts can cause a
small business to have cash flow problems.

591
 (4 marks)

The benefits of having a positive cash

flow position
If a business has a positive cash flow position, it means that it
avoids periods in which it has a negative cash balance. This
offers a business a number of benefits:
• The business does not need to borrow and can avoid paying
interest charges. Many businesses borrow using overdrafts to
cover periods of cash flow difficulties. Overdrafts can be an
expensive way of borrowing.
• A business will be more able to arrange long-term loans if it
has a positive cash flow position. Banks and other potential
lenders will have greater confidence that the business has the
ability to make repayments of the loan on time.
• Cash flow problems are a major cause of business failure. A
positive cash flow position helps to reduce the risk of a
business failing.

Interpreting cash flow

forecasts and statements
It is possible to construct a table of the inflows and outflows of
cash that are expected by a business’s managers. When such
tables are drawn up as part of the process of planning a
business’s activities, they are called cash flow forecasts.
However, when completed as a record of trading, they are called
cash flow statements. A business may use a cash flow

592
statement to look at what happened to cash flows over a
previous trading period and use this to help it plan its future
management of cash. For example, it might see that last year it
was very short of cash during the Christmas period. Knowing
this, managers can take actions to avoid the same problem
occurring again this Christmas.

Key terms
A cash flow forecast is a plan of the expected inflows
and outflows to and from a business over a period of time.
A cash flow statement is a record of the cash inflows
and outflows that took place over an earlier period of time.

The cash flow forecast in Table 6.2 was drawn up by Peter and
Sue, who are planning to open a restaurant.

593
Cash flow forecasts are normally organised into three sections:
• Cash inflows are normally at the top. When added together,
the cash inflows equal the ‘Total cash inflow’ (A).
• The second section is cash outflows. These are added together
to give the ‘Total cash outflow’ (B).
• The third section includes the net cash flow, the opening
balance and the closing balance:
• The row called ‘Net cash flow’ (C) shows the net flow of
cash into and out of the business. It is calculated by taking
the ‘Total cash outflow’ (B) from the ‘Total cash inflow’
(A).
• The amount of cash held by the business at the start of the

594
 month is shown by the ‘Opening balance’ figure (D). This
is the figure the business had as cash on the last trading day
on the previous month. In the example above, this date was
30 November. So the closing balance for one month
becomes the opening balance for the next month.
• Finally, the amount of cash the business has at the end of
the month is shown by the ‘Closing balance’ figure (E).
The closing balance is calculated by adding together the
opening balance (D) and the net cash flow (C).

All negative figures are shown in brackets. For example, in Peter

and Sue’s forecast the net cash flow for January and the closing
balance for February are negative.

Maths moment
Assume that Peter and Sue revise their cash flow
forecast for February. The restaurant’s forecast sales
revenue is increased to £10,000. The amount of outflows
for the purchase of inventories of food and drink is

595
£4,750.
Recalculate the cash flow forecast for February
after these changes.

Business insight
The Cathedral Bookshop
Leverett Books Ltd has drawn up a cash flow forecast for
its new bookshop which opens at the University of
Warwick in January. This is for the first four months of
trading and is shown in Table 6.3. However, the forecast
is not complete.
Complete the cash flow forecast for the Cathedral
Bookshop by filling in the blank spaces A, B, C and
D.
(4 marks)

596
Interpreting Peter and Sue’s cash flow
forecast
What can Peter and Sue learn from their cash flow forecast? The
major piece of information it contains is that their business will
be short of cash in January and February. The forecast shows
that by the end of January they will have spent £1,670 more than
the business has available. This poses a real problem for the
business, as it will not have enough cash to pay its suppliers of
food and drinks or possibly the wages of staff. In February, the

597
cash position is little better – they will again not have enough
cash, although this time the negative figure is smaller at £930.
The cash flow forecast also gives Peter and Sue detailed
information about what is causing the cash inflows and
outflows. This information will help them to make decisions on
how to improve the cash position of their business. We will
consider this later in this topic.

The importance of cash flow forecasts

It is common for a business to experience cash flow problems.
These can be managed if the managers and entrepreneurs are
aware of the possibility and are prepared to take the necessary
actions to overcome them.
Constructing cash flow forecasts helps to do this in two main
ways:
• Managers can identify times when the business might be short
of cash.
• Managers can take suitable actions to avoid cash shortages
becoming a major problem.

Study tip
Try not to always think that cash flow problems will lead to
a business having to stop trading. In many cases,
entrepreneurs and managers can take actions to
overcome the problems.

The causes of cash flow problems

A cash flow problem arises when a business struggles to pay its
debts as they become due. If a business experiences negative net
cash flow over a period of time, its cash position can become

598
very weak.
Businesses encounter cash flow problems for a variety of
reasons:
• Poor management. This is a surprisingly common cause of
cash flow problems. Managers may not be aware of the
importance of managing cash flow and may not plan carefully.
This is more likely with small businesses, which may not
employ specialist managers of finance. Even experienced
managers may take decisions that weaken a business’s cash
flow position. For instance, a manager may spend too much
on inventories of raw materials causing an outflow of cash
long before inflows result from sales.
• The business is making a loss. A business makes a loss when
over a period of time its costs of production are greater than
the revenue it receives from sales. A business making a loss
will be at risk of running out of cash at some point. This will
occur because more cash is flowing out of the business than it
is receiving.
• Offering customers too long to pay. When a business allows
a customer time to pay for goods or services, it is known as
giving trade credit (see Topic 6.1). Managers may be too
generous in offering customers trade credit, especially if they
are keen to increase the business’s sales. Offering, say, 60
days’ trade credit to a major customer means that the business
has to wait two months for the agreed cash inflow. In the
meantime, it may be unable to pay its own bills on time.

599
Solutions to cash flow problems
When faced with cash flow problems, managers may use a range
of solutions to cash flow problems, including the following.

Reschedule payments
It may be possible for a business to agree with its suppliers, or
others to whom it owes money, to delay its payments (outflows).
If this gives sufficient time for the business to receive inflows of
cash, the problem may be solved. Alternatively, a business may
be able to persuade customers to pay more quickly, thereby
speeding up cash inflows. Businesses often offer customers a
discount for early payment. Similarly, customers who owe the
business money could be chased up and persuaded to pay
promptly.

Cut costs

600
If a business can lower its costs, the result should be reduced
cash outflows. This could mean employing fewer staff or
holding smaller stocks of raw materials. Alternatively, the
business could seek to use cheaper sources of fuel or raw
materials. This may, however, result in the business supplying
goods and services of lower quality. In the long term, it may lose
customers as a consequence.

Use overdrafts
An overdraft is a short-term, flexible loan that can provide the
business with the cash that it needs. In effect, arranging an
overdraft provides an immediate inflow of cash. Overdrafts can,
however, be a relatively expensive form of borrowing. If a
business uses them extensively, it may damage their profits.
Banks can also ask for an overdraft to be repaid immediately.

Find new sources of cash inflows

It may be possible for a business to generate extra cash inflows.
Many public houses offer meals and some provide
accommodation, especially if they are in locations popular with
tourists. This can generate significant cash inflows. However,
this solution can take time to implement and may involve further
cash outflows as the new enterprise is developed.

Study tip
Solutions to cash flow problems often bring their own
problems and you may need to discuss these.

Business insight
Fastjet is expected to run out of cash
Fastjet is an airline that operates in the African country of

601
 Tanzania. It is noted for its low fares. However, the
company is not profitable: it made a loss of $25 million in
2015. This was mainly due to revenues from fares ($65
million) being lower than forecast.
One of the company’s shareholders has been very critical
of the company’s managers. Sir Stelios Haji-Ioannou has
said that it does not make sense for the company to have
an expensive head office at Gatwick in Sussex, when it
operates in Tanzania. He has said he expects the
company to run out of cash.

Explain one possible reason why Fastjet might

suffer from cash flow problems.
(4 marks)

Selecting the ‘best’ solution

All of the proposed solutions above have disadvantages.

602
Managers have to take these into account when deciding how to
tackle a cash flow problem. Two key factors may influence
managers’ decisions on how to overcome cash flow problems:
• The cause of the cash flow problem. Managers need to
consider carefully why the business is facing cash flow
problems. For example, if the cause is giving customers too
long to pay, then the best solution would be to reduce the
amount of trade credit that is offered. An overdraft could
overcome this problem, but this means the business will incur
extra interest payments and thus may not be the best solution.
• The business’s circumstances. The business’s circumstances
also play an important part. In the above example, the
business may be new to a market and need to offer very
generous terms for trade credit to attract customers. In these
circumstances, using an overdraft might be the best way to
overcome the cash flow problems.

The difference between cash

flow and profit
Cash flow is entirely different from profit. Profit is the extent to
which a business’s revenue exceeds its total costs over some
period of time. Profits can be paid to the owners of a business as
a reward for taking the risk of investing into the business.
Alternatively, profits might be reinvested into the business.

Key term
Profit measures the difference between the values of a
business’s revenue (sales) and its total costs.

In contrast, cash flow is the way in which money moves through

603
the business. Cash flow shows the balance between cash moving
into and out of the business. Cash is essential for all businesses
to ensure that they can pay debts on time.

Businesses can survive for some time without making a profit.

For example, Amazon, the world’s largest online retailer, hardly
made a profit from 2004 to 2014, preferring to offer very
competitive prices. Cash flow is vital in the short term. If a
business does not have enough cash to pay its bills, it is likely to
be forced to stop trading. A business can survive for some time
without profits; it will not do so without cash.

Summary
Cash flow is the money flowing into and out of a business
over a period of time. Businesses forecast their cash
flows to reduce the chance of facing cash flow problems.
Businesses with poor management and those making
losses commonly suffer from cash flow problems.
Businesses can take a number of actions to improve their
cash flow position, including rescheduling payments and

604
arranging overdrafts. Finally, cash flow is entirely different
from profit.

Quick questions
1 What is the difference between a cash inflow and a
cash outflow?
(3 marks)
2 Which of the following would be likely to lead to a cash
inflow for a restaurant?
(a) Payment for supplies of food
(b) Payment for a meal by diners
(c) Payment of the hotel’s electricity bill
(d) Payment of the chefs’ wages
(1 mark)
3 State two possible sources of cash outflow for a
bakery.
(2 marks)
4 A business has the following data for February:
• Opening balance: (£250,000)
• Cash inflows: £3,250,000
• Cash outflows: £3,150,000
What is the business’s net cash flow for February?
(a) £3,500,000
(b) £3,000,000
(c) (£150,000)
(d) £100,000
(1 mark)
5 Using the data provided in question 4, what is the

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 business’s closing balance for February?
(a) (£150,000)
(b) £150,000
(c) (£350,000)
(d) £100,000
(1 mark)
6 State two reasons why cash flow forecasts are
important to businesses.
(2 marks)
7 Explain why offering very generous trade credit terms
to customers might cause cash flow problems.
(3 marks)
8 State two possible disadvantages to a business of the
use of an overdraft as a solution to a cash flow
problem.
(2 marks)
9 State two factors that managers should take into
account when deciding on the best solution to a cash
flow problem.
(2 marks)
10 What is the difference between cash flow and profits?
(3 marks)

Case study
Kimmi’s Garage
Kimmi owns and manages a garage repairing and
servicing cars. Kimmi has just agreed to buy her supplies
from a different company. Its prices are low, but payment
has to be made when placing an order. Her previous

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supplier allowed her two months to pay. Kimmi allows her
customers one month to pay their bills.
Although the business had been successful in the past,
she is worried about the business’s future, especially its
cash flow. The figures in her latest cash flow forecast are
worrying. Kimmi is an experienced car mechanic, but
knows relatively little about finance. She is not sure what to
do.
1 Complete the following figures on Kimmi’s cash flow
forecast:
(a) the net cash flow for February
(b) the closing balance for April.
(2 marks)
2 Explain why Kimmi might have been worried by the
figures in her cash flow forecast.
(4 marks)
3 Analyse factors that might have caused the cash flow
problems for Kimmi’s business.
(6 marks)
4 Kimmi’s business is forecast to suffer cash flow
problems during the next four months. Recommend
whether she should reschedule her payments or take
out an overdraft. Give reasons for your advice.
(9 marks)

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608
Topic 6.3

Financial terms and

calculations
Managers and entrepreneurs need to have a basic
understanding of business finance or their businesses are
very unlikely to be successful. This topic introduces you to
some important terms and shows you, with a number of
examples, how managers can calculate their business’s
costs, decide whether an investment is worthwhile and
determine whether it will make a profit or a loss.
By the end of this topic, you should know:
• some basic financial terms and calculations, including
the difference between variable costs, fixed costs and
total costs
• the reasons why businesses invest
• how to calculate the average rate of return for an
investment
• how to interpret break-even charts and the value of
break-even analysis to a business.

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Basic financial terms
Revenue
A business’s revenue is the income that it receives from selling
its products. It is calculated by multiplying the quantity of
products that are sold by the average selling price. As an
example, a car manufacturer may produce 10,000 cars in a year,
which it sells for an average selling price of £20,000. Its revenue
for the year would be:

Key term
Revenue is the income that a firm receives from selling
its goods or services. It is also referred to as ‘turnover’. It
is measured by the number of units sold multiplied by the
price.

Apple sold 232 million iPhones in 2015. If it received an average

price of £500 for each one, its revenue would have totalled £116
billion!

Price
Price is the amount a business asks a customer to pay for a
single product. Deciding what price to charge for a product is an
important decision for managers. The price that is chosen
generally depends on two factors:
• the prices set by other businesses for similar products
• how much it costs to produce the good or service that the

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 business sells.

Sales
Sales is the number of products sold by a business over some
time period, normally a week, a month or a year. For example, a
dentist might treat 125 patients in a week. In each case, the
number given is the sales achieved by the business. It is
important to remember that sales are not stated in terms of
money. Revenue is sales expressed in monetary terms.

Costs
Costs are the spending that is necessary to set up and run a
business. A business normally has to pay two main types of
costs: fixed costs and variable costs.

Fixed costs
Fixed costs do not alter when a business changes its output.
For example, a shopkeeper has to pay the same amount of rent
whether the business is attracting large or small numbers of
customers. Other examples of fixed costs include insurance for
the business’s buildings and fees paid to the business’s
accountant. Fixed costs can be a burden for a small business as
they have to be paid even if the business is not producing and
not selling large amounts of its products.

Variable costs
Variable costs vary directly with the business’s level of
output. If a shopkeeper is serving an increasing number of
customers, then the business will have to buy more inventories
to sell. The shopkeeper might also have to hire more staff to

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serve in the shop. So, costs such as raw materials and wages
vary with output and are called variable costs.

Key terms
Sales refers to the number of products sold by a
business.
Costs are the spending that is necessary to set up and
run a business.
Fixed costs are those costs that do not change when a
business changes its output.
Variable costs are the costs that vary directly with the
business’s level of output.

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It is possible to calculate a business’s total variable costs by
calculating the variable cost of producing a single unit and
multiplying this by the number of units of output produced by
the business. For example, if the variable cost of manufacturing
one kettle is £15 and a business makes 30,000 in a year, its total
variable costs for the year will be:

Total costs
Total costs are a business’s expenditure over a time period.
Adding together fixed and variable costs gives the total costs that
a business has to pay over a certain time period, such as a month
or a year. Total costs are calculated using the following formula:

Key term
Total costs are fixed costs plus variable costs.

Total costs are a very important figure for managers and

entrepreneurs. As we shall see, they are an important part of
calculating whether or not a business has made a profit. Figure
6.5 shows the differences between total costs, fixed costs and
variable costs. It shows that when a business’s production is at
zero, total costs are equal to fixed costs because there are no
variable costs. We shall look again at this when we discuss
break-even charts later in this topic.

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Profits
Profit is the amount by which a business’s revenue from all its
sales exceeds its costs. A loss is the amount by which a
business’s costs are larger than its revenue from all sales. The
formula used to calculate profits (or losses) is simple:

Key terms
Profit measures the difference between the values of a
business’s revenue (sales) and its total costs.
Loss is the amount by which a business’s costs are larger
than its revenue from all sales.

If a business’s revenue is greater than its total costs over some

period of time, such as a month or a year, then the business will
make a profit. However, if the total costs are greater than the
revenue earned by the business, it is said to make a loss. Figure

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6.6 illustrates the relationships between revenue, total costs,
losses and profits.

Profit is an important measure of success for many businesses.

Most managers hope that their business will make a profit,
although some have objectives other than profits, as we saw in
Chapter 1. Profit is the reward for taking the risk of investing in
a business.

Investment and the average

rate of return
Why do businesses invest?
Businesses need assets such as buildings, machinery and
vehicles to produce goods and services. They buy these assets to

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use in producing goods and services and in the hope of making
a profit.

Land and buildings

Most businesses require land and buildings to be able to supply
goods and services. For example, farms, clothing manufacturers
and hospitals all need land and buildings to engage in
production. Businesses invest in additional land and buildings
when they wish to expand production of existing goods and
services or to produce new ones. In 2016, the luxury car
manufacturer Aston Martin announced it was to build a second
factory in Glamorgan to build a new car. The company would
require land and buildings for its new factory.

Machinery and vehicles

Machinery is used by businesses that supply services as well as
on manufacturers’ production lines. Advances in technology
mean that more productive machinery becomes available for
most industries over time. Investing in such machinery can help
businesses to become more competitive and profitable.

Business insight
Investment in liver scanner saves time
New technology that can check the condition of a patient’s
liver in minutes has been made available to patients from
across west Suffolk. The £70,000 Fibroscan machine
helps doctors and nurses at West Suffolk Hospital to
diagnose liver diseases. The machine scans from outside
the body and quickly gives clear, accurate results.
Before the equipment was introduced, patients needed to
have a biopsy to monitor the severity of their liver

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 disease, which meant they would have to be admitted as a
day case. The new machine is portable, which means it
can be used during outpatient appointments.
Explain why the £70,000 investment in the new
machine should improve productivity at West
Suffolk Hospital.
(4 marks)

Similarly more efficient vehicles can help to reduce a business’s

costs and thus make it more profitable. Buses in Aberdeen in
Scotland have been fuelled by hydrogen since 2015. They are
nearly four times more fuel-efficient than diesel buses, reducing
operating costs significantly.

New products
To remain competitive, businesses invest in developing new
products. In some industries such as computing, software
development and pharmaceuticals, continuous investment is
essential for a business to compete with rivals. The Association
of the British Pharmaceutical Industry estimates that a new
medicine requires an average investment of £1,150 million.

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The average rate of return
The average rate of return (ARR) is a method of deciding
whether an investment is likely to be worthwhile. It compares
the average yearly profit from an investment throughout its life
with the cost of the investment. The ARR is stated as a
percentage.

Key terms
Investment takes place when a business buys an asset,
such as a factory, in the hope of making a profit from its
use.
The average rate of return (ARR) compares the
average yearly profit from an investment with the cost of
the investment and is stated as a percentage.

For example, if a new delivery van costs £40,000, but increases a

business’s profits by £6,000 a year, the ARR would be calculated
as follows:

As a further example, a pharmaceutical company may invest

£500 million in developing a new medicine to help to control
diabetes. The new drug is expected to produce annual profits of
£40 million. Here the ARR would be calculated as:

The calculation of the ARR from an investment project is a little

more complicated if the average yearly profits have to be
calculated first. Figure 6.7 summarises how to calculate the ARR

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for an investment project and the Business insight on AES Ltd
provides an example of this.

Business insight
AES Ltd calculates its ARR
AES Ltd is planning to invest in some new production line
machinery. The machinery will cost the company
£200,000 and will have a working life of ten years. Over
the ten years, the company’s profits will rise by £150,000
because the machine is more productive and fuel-
efficient. In this case, the calculation of the ARR would be:

619
 Suppose that AES Ltd’s new machinery costs
£250,000 and that it will produce profits totalling
£125,000 over the ten years of its working life.
Calculate the ARR in these circumstances.
(4 marks)

Interpreting the result of an ARR

calculation
A higher figure for an ARR calculation is preferred as it shows
the return on the investment is greater. Managers will simply
choose the investment which offers the highest percentage
return. So, in the case of AES Ltd above, if the 7.5 per cent
return on its investment was higher than an alternative, it would
decide to invest in the production line machinery. This does,
however, assume that profits are the sole factor influencing the
decision.
One major advantage of calculating the ARR to help to make a
decision on whether or not to invest in a project is that the
answer is stated as a percentage. This makes it easy to compare
with the returns from an alternative investment, such as holding
the funds in a savings account.
Average rate of return calculations are not always accurate. For
example, if the forecast for yearly profits is wrong, the ARR will
also be wrong.

Maths moment
An entrepreneur is considering a project which will require
an investment of £250,000. She wants an average rate of
return of 10 per cent to go ahead with the investment.
Calculate the average yearly profit her investment

620
 project would need to make to achieve an ARR of 10
per cent.

Break-even analysis
A business can only make a profit when its sales revenue is
greater than its costs. If revenue is less than costs, the firm will
make a loss. Break-even is a level of production (or output) at
which revenue from sales equals the total costs of production. In
this situation, a business will not make a loss or a profit.

Break-even charts
It is possible to illustrate a business’s break-even output on a
break-even chart as shown in Figure 6.8. This chart
illustrates the position of Viv Burns, who owns a business
making glass paperweights. She sells her paperweights for £25
each. The variable cost of making a single paperweight is £10.
Her business’s fixed costs are £7,500 a year.

Key terms
Break-even is the level of production at which a
business’s total costs and revenue from sales are equal.
A break-even chart shows a business’s costs and
revenues and the level of production needed to break-

621
even.

Study tip
You will not be expected to calculate the level of break-
even production or output in an examination.

A break-even chart, such as the one shown in Figure 6.8, is

made up of four lines:
• Fixed costs. These do not change as the level of production
rises or falls. Viv’s business has fixed costs of £7,500 each
year. These remain the same no matter how many
paperweights she makes. Her fixed costs are £7,500 if she
makes 10 paperweights or if she makes 100 paperweights.
This is why it is drawn as a straight and horizontal line.
• Variable costs. We saw earlier that variable costs rise and fall
directly with the level of production. This means that, at a
higher level of output, Viv’s business will have to pay higher

622
 variable costs. For example, if we look at her variable costs
when she produces 500 paperweights, we can see that her
variable costs are £5,000. As a result, the variable costs line
slopes upward from left to right.
• Total costs. As we saw earlier, total costs are simply fixed
costs and variable costs added together. So, for example, at a
production level of 1,000 paperweights each year, the total
costs of Viv’s business would be £17,500. This is made up of
fixed costs (£7,500) plus variable costs (£10,000). The figures
are added together in the same way as other levels of
production.
• Total revenue. This is also called ‘revenue from sales’. This
is calculated by multiplying the level of output by the selling
price of the product. Thus, Viv’s business would have no
revenue if production did not take place and would have a
revenue of £12,500 if it produced 500 paperweights (500 ×
£25). Finally, at an output of 1,000 paperweights, the
business’s total revenue would be £25,000.

Maths moment
What fixed costs have to be paid by Viv’s business when

623
 she produces:
(a) 400 paperweights?
(b) 800 paperweights?

The level of break-even output

Break-even output occurs when the total costs of production
equal the revenue from sales. In a break-even chart, this occurs
at the level of production at which the total costs line intersects
the total revenue line. In Figure 6.8, break-even output is
achieved at a production level of 500 paperweights per year. At
this level of production, the total cost line intersects the total
revenue line.
• Levels of output below break-even. At these levels of
production, total costs will be greater than total revenue. As a
consequence, the business will make a loss.
• Levels of output above break-even. At these higher levels of
production, total revenue will be higher than total costs
meaning that the business will make a profit.
This break-even chart shows that Viv’s business will make a
profit if it produces and sells more than 500 units. If it produces
and sells fewer than 500 units, the business will make a loss.

The margin of safety

The margin of safety measures the amount by which a
business’s current level of production exceeds its break-even
level of output. For example, if Viv produced and sold 750
paperweights in a year, her business would make a profit. Its
margin of safety would be 250 paperweights – as production
and sales of 750 paperweights exceed break-even output by 250
units. This means that Viv’s production and sales could fall by

624
250 paperweights before her business started making a loss.
Viv’s margin of safety is shown on Figure 6.9.

Key term
The margin of safety measures the amount by which a
business’s current level of production exceeds its break-
even level of output.

Having a high margin of safety can be reassuring for the

managers of a business. It means that sales and production can
fall significantly before the business is at risk of making a loss.

Business insight
Break-even and BP
BP is one of the world’s largest oil companies. Analysts
think that the company can break-even if the price of a
barrel of oil is $60. At the time of writing, the price of a

625
 barrel of oil on world markets is $52.
Explain what these figures mean for BP’s profits
from selling oil.
(4 marks)

Study tip
A question may ask you to interpret a break-even chart
that has already been provided, identifying the level of
break-even output and the margin of safety rather than
asking you to draw a break-even chart yourself.

The value of break-even analysis

Managers use break-even charts to help to analyse the business’s
future financial performance. They have a number of
advantages and disadvantages.

The advantages of using break-even

analysis
• Break-even charts help managers to see the effects of any
changes in costs. A rise in costs will increase the level of
output and sales a business will need to break even. It will
also reduce or eliminate the business’s margin of safety. A fall
in costs will have the opposite effects. This helps managers to
prepare for future changes in costs.
• Break-even charts show the effects of changes in price. A rise
in the price at which the business sells its products will reduce
the business’s break-even output and increase its margin of
safety. A fall in price has the opposite effects. For example,
managers can use break-even charts to analyse whether a fall
in price might lead to the business making a loss rather than a

626
 profit.
• Many businesses use bank loans and overdrafts as a source of
finance. Banks are more likely to agree to a loan if the
business’s managers provide evidence of planning future
finances. This helps the bank to judge whether its loan will be
repaid. A break-even chart can be an important part of
financial planning.

The disadvantages of break-even

analysis
• The main disadvantage of break-even analysis is that it
assumes that a business sells all of the output it produces. This
is unlikely, even for a well-known business. Break-even
charts are of much greater value to managers if supported by
market research showing that future sales will match
production levels.
• Many businesses operate in markets where costs and prices
change rapidly and frequently. This makes break-even charts
of less value as they are inaccurate almost as soon as they are
prepared. For example, businesses that import raw materials
and components may face changing costs when the exchange
rate of the pound changes. This happens regularly and some
of the changes can be large.

627
Summary
Businesses’ total costs of production are made up of fixed
costs and variable costs. Businesses invest in a range of
assets including new buildings and machinery. It is
possible to measure the return on these investments by
calculating the average rate of return. Break-even output
is a level of production at which total costs are equal to
total revenue from sales. Businesses can receive a
number of benefits from using break-even analysis. For
example, its use can help to persuade a bank to grant a
loan to a business.

Quick questions
1 Explain the difference between costs and profit.
(3 marks)
2 At a certain level of production, a business has fixed
costs of £100,000 and total costs of £240,000. Which
of the following is its variable costs?
(a) £340,000
(b) £240,000
(c) £140,000
(d) £40,000
(1 mark)
3 A business increases its production by 5 per cent; no
other changes occur. Which of the following
statements will be true following the increase in
production?
(a) The business’s fixed costs will not change.
(b) The business’s fixed costs will rise.

628
 (c) The business’s variable costs will be unchanged.
(c) The business’s variable costs will fall.
(1 mark)
4 State two assets in which businesses might invest.
(2 marks)
5 Explain what is meant by the ‘average rate of return’ or
‘ARR’.
(3 marks)
6 A business plans to invest £5 million in new machinery.
This will make a total profit of £2 million over four
years.
Which of the following is the ARR on this investment
project?
(a) 400%
(b) 40%
(c) 10%
(d) 0.5%
(1 mark)
7 What is meant by the term ‘break-even’?
(2 marks)
8 Which line on a break-even chart is drawn parallel to
the x-axis (the axis which shows the business’s level
of production)?
(a) The fixed costs line
(b) The variable costs line
(c) The total costs line
(d) The total revenue line
(1 mark)
9 Explain the benefits of a high margin of safety to a
business.

629
 (2 marks)
10 State two advantages to managers from the use of
break-even analysis.
(2 marks)

Case study
A sweet business
Nigel Gilpin has recently retired and is considering starting
a business to supply honey to local shops in the area in
which he lives. He has attended bee-keeping classes and
has done a little market research with possible customers.
He has the following financial forecasts for his business:
• Investment required – £40,000
• Average yearly profit – £4,500
• He has forecast sales of 7,000 jars of honey a year.
• He expects to set a price of £2.50 per jar of honey,
though prices do vary a lot.
He has also prepared the break-even chart shown below.

630
Nigel plans to ask his bank for a loan of £15,000, as he
has only £25,000 of the money needed to start the
business. It is currently in a savings account receiving
interest of 5 per cent a year.
1 Calculate the average rate of return from investing in
the business, if Nigel’s forecasts are correct.
(3 marks)
2 Explain how knowing the average rate of return on the
new business might help Nigel to make a decision.
(4 mark)
3 Analyse how using his break-even chart might help
Nigel to decide whether or not to start the new
business.
(6 marks)
4 Recommend whether Nigel should use break-even
analysis to help him to decide whether or not to start the
business.
(9 marks)

631
632
Topic 6.4

Analysing the financial

performance of a business
Most businesses have to draw up financial statements.
This is a legal requirement, and the law sets out how these
statements should be structured. This topic looks at the
two most important financial statements that large
businesses keep: the balance sheet and the income
statement. It will look at ways in which these financial
statements can be useful to stakeholders such as
managers and owners.
By the end of this topic, you should know:
• why businesses prepare financial statements
• the components of financial statements
• how to interpret financial statements
• the importance of financial statements.

Why businesses prepare

financial statements
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Two of the most important financial statements prepared by
businesses are the income statement and the balance
sheet. Businesses need to prepare these financial statements for
a number of reasons:
• The law. Publishing financial statements in the UK is a legal
requirement under the Companies Acts. If a company fails to
prepare these statements in the agreed format, it may be fined
or, in extreme cases, forced to cease trading. Smaller
businesses, such as sole traders and partnerships, do not have
to follow the same legal rules.
• To help the business’s managers make decisions. These two
financial statements are very helpful to the business’s
managers. They assist the managers in making a range of
decisions on how to improve the business’s performance. For
instance, if the business’s profits were lower than expected,
the managers might take action to improve profitability,
possibly by raising prices.
• To guide investors. People and other businesses that are
planning to invest money into a business will gain a lot of
information from its income statement and its balance sheet.
This will help them to judge how safe the investment is and
whether the investment will earn a profit.

Key terms
An income statement is a financial statement showing a
business’s revenues and costs, and thus, its profit or loss
over a period of time.
A balance sheet sets out the assets and liabilities that a
business has on a particular day.

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Components of financial
statements
Components of income statements
An income statement shows three key pieces of information for
a business over a period of trading, normally one year:
• the revenue earned by the business – revenue is also called
‘sales income’
• the costs of production that have been paid by the business
• the amount of profit earned by the business or the loss it has
made.
Figure 6.11 shows the main components of an income statement
as well as its structure. An income statement has six main
sections:

635
• Revenue. This is the income received by a business from the
sale of its goods and services over the period covered by the
income statement. As an example, Marks & Spencer’s income
statement would include the revenue the company received
from selling food, clothes and other products.
• Cost of sales. These are the costs involved in directly
supplying the good or service. Marks & Spencer’s cost of
sales include the costs of:
• the wages of employees involved in transporting and selling
products
• buying the products which are sold in its shops
• energy costs such as gas and electricity.
• Gross profit. Gross profit is revenue minus the cost of
sales. A restaurant would calculate its gross profit as follows:

• Revenue is the income received from selling meals and

drinks to customers.
• Cost of sales is the cost of buying food, etc. and employees’
wages.
• Overheads. They are costs that do not alter when the level of
production changes. Overheads will include the salaries of
managers, insurance costs, interest on loans and also the cost
of maintaining buildings. Overheads are sometimes called
‘expenses’.
• Operating profits. A business’s operating profits are
calculated by subtracting its overheads from its gross profits.
• Net profit. Net profit is the final component of the income
statement. It is calculated by taking taxes and interest
payments from operating profits. Net profit is a good measure
of the performance of a business.

636
Key terms
Gross profit is a business’s sales revenue minus its cost
of sales over a period of time, normally a year.
Net profit is a business’s sales revenue minus its cost of
sales, its overheads and other costs over a period of time,
normally a year.

Business insight
Starlight in Coventry
Susie West runs Starlight, one of Coventry’s most popular
nightclubs. Starlight has two bars and a large dance floor.
Susie runs her business as a private limited company and
her main business objective is to make profits. Her
accountant is preparing her income statement for last
year. This is shown below, with her income statement for
the year before.

637
Susie thinks that, looking at the two income statements,
Starlight’s financial performance was better last year than
in the year before last.
Use the income statement in Table 6.6 to analyse
why Susie thinks that Starlight’s financial
performance was better last year than in the year
before last.
(6 marks)

638
639
Components of the balance sheet
A balance sheet sets out the assets and liabilities that a
business has on a particular day (see Figure 6.12). It shows
where a business’s finance has come from and how the business
has spent the money that it has raised. It shows this financial
information for a business on a particular day. It thus provides a
snapshot of the business’s financial position.

Key term
A liability is a sum of money that is owed by a business
to another business or an individual.

We shall consider the structure of balance sheets as used by

640
companies. Sole traders and partnerships prepare balance sheets
slightly differently. A balance sheet is sometimes called ‘a
statement of financial position’.
A company’s balance sheet will contain the following
information about the business.

Assets
An asset is anything that is owned by a business. Assets can be
divided into two types:
• Non-current assets. A business will normally keep this type
of asset for many years. Examples of non-current assets
include shops and vehicles. Non-current assets create revenue
for the business and enable it to earn profits.
• Current assets. These are assets that the business only
expects to have for a short time (normally less than one year).
Examples of current assets include cash and inventories of
raw materials. Current assets (especially cash) are used by the
business to settle debts such as paying for raw materials.

641
Liabilities
Liabilities are the amounts owed by a business to other
businesses and individuals. There are two types of liabilities:
• Non-current liabilities are debts that will be paid back over
many years. Loans from the bank or a loan to buy property
(called a mortgage) are examples of this type of liability.
• Current liabilities are debts that a business will pay within a
year. Examples of current liabilities include money owed to
suppliers and tax the business has to pay.

Total equity

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Total equity is the part of a company’s money that belongs to
shareholders. If a company stops trading and sells all its non-
current and current assets, it would normally have a large sum
of money remaining. This would be used to pay all the
company’s liabilities (its debts). The money that is left once this
is done is called ‘total equity’.

Balancing assets and equity

A balance sheet gets its name because the two parts of the
document will equal each other. The value of the assets owned
by the business (once it has paid its liabilities) is called ‘net
assets employed’. This will exactly equal the amount of money
put into the business by the company’s shareholders, which, as
we saw, is called ‘total equity’. Thus, the reason that the balance
sheet balances is because:

If the shareholders of a business raised extra finance to buy, say,

new vehicles, then the value of the business’s non-current assets
and the shareholders’ total equity will increase by the same
amount. As Figure 6.13 shows, this means that the balance sheet
will continue to balance.

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How to interpret financial
statements
A business’s stakeholders such as its managers, suppliers and
owners will be very interested in the information that is set out
in its balance sheets and income statements. They may look, for
example, at trends in profits to see if the business is making
higher levels of profit than in previous years.
On the other hand, they may consider the figure for ‘net assets
employed’ to see if the value of the business has increased over
time.
To make better judgements about businesses’ performances, it is
important to compare a profit figure to something else to
understand how successful the business has been. There are a
number of possible comparisons that can be made.

A comparison with previous years

An obvious way to judge a business’s profits is by a simple
comparison with profits in previous years. However, it is
important to note that not all businesses operate with the aim of
making the largest possible profits.
Key indicators of a business’s performance over time from its
income statement are:
• the revenue from sales of goods and services
• gross and net profits.
If profits are higher than in previous years, the business is likely
to consider that it has had a successful year in financial terms.
Table 6.7 shows the net profits for AstraZeneca plc, a
pharmaceutical company that develops and sells drugs

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throughout the world.

AstraZeneca plc’s revenue was significantly lower in 2015 than

in 2014 and its gross profit fell as well. However, the company’s
managers would have been pleased with the company’s net
profits for 2015 as it was more than double that achieved in
2014. The company must have reduced its overheads as well as
the amounts paid for interest.
In 2014, AstraZeneca’s revenue increased compared with 2013,
but its net profits were much lower. The company spent heavily
on overheads, interest payments and taxation in 2014.

Business insight

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 ASOS’s profits rise
ASOS plc is an online retailer of fashion clothing. The
company is based in the UK. It sells its own brand clothing
as well as that supplied by other companies.
Table 6.8 shows the company’s revenues and profits for
2014 and 2015.

Analyse the changes in the performance of ASOS

plc between 2014 and 2015.
(6 marks)

A comparison with the performance of

competitors
An effective way to judge the financial performance of a
business is to compare information from its income statement
with that of competitors. If a business can increase its revenues
and profits more quickly than others in the same industry, it is a
good sign that the business is performing strongly in financial
terms.
Table 6.9 compares the financial performance of AstraZeneca
plc and GlaxoSmithKline plc in 2014 and 2015.

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Although AstraZeneca’s financial performance in 2015 looked
quite good in comparison to 2014, it is not as impressive when
compared to that of its rival, GlaxoSmithKline (GSK). GSK’s
revenue rose in 2015 and was higher than that achieved by
AstraZeneca. However, the most significant figure is GSK’s net
profits for 2015. They are nearly four times higher than those of
AstraZeneca, from sales revenue that are only a little smaller.
This suggests that GSK managed to control its costs much better
than AstraZeneca.

Using profit ratios

There is internal data that can be used to compare a business’s
financial performance. Managers can use information from the
business’s income statement to calculate financial ratios.
Financial ratios compare two figures from a business’s
financial statements.

Key term
A financial ratio compares two figures from a business’s
financial statements.

It is common for managers and other stakeholders to calculate

profits ratios. These ratios compare a business’s profits to

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another figure from the business’s financial statements. One of
the most obvious figures to compare with a business’s profit
figure is the revenue that it has earned.
There are two profit figures we can use in such a calculation:
gross profit and net profit. The figures for gross and net profit
are on the business’s income statement. Using the gross and net
profit figures allows us to calculate two profits ratios: the gross
profit margin and the net profit margin.

Gross profit margin

This profit ratio compares a business’s gross profit for a trading
period with the revenue figure for the same year. It is calculated
using the formula below and the answer is a percentage:

As an example, if a business’s gross profit for a year was

£30,000 and its revenue for the same period was £120,000, its
gross profit margin will be:

A gross profit margin of 25 per cent means that 25p in each £1

of revenue is gross profit. Is 25 per cent a good figure for a
gross profit margin? This can only be answered by comparing
the figure to one of the following:
• the business’s target for its gross profit margin
• the business’s gross profit margin for earlier years
• the gross profit of other similar businesses.

Net profit margin

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This profit ratio compares a business’s net profit for a trading
period with the revenue figure for the same year. It is calculated
using the formula below and the answer is a percentage:

Study tip
It is important for you to learn the formulae for calculating
gross and net profit margin.

As an example, if a business’s net profit for a year was £12,000

and its revenue for the same period was £120,000, its net profit
margin will be:

The net profit margin can be a better indicator of a business’s

financial performance as its calculation includes all the costs
paid by a business. In contrast, the gross profit margin only
includes a business’s cost of sales.
Is 10 per cent a good figure for a net profit margin? As with the
gross profit margin, it needs to be compared with figures for the
business from earlier years, the expectations of the business’s
managers and owners, and the net profit margin achieved by
similar businesses.

Business insight
Profits ratios in the pharmaceutical industry
Table 6.9 showed the profits and revenues for
AstraZeneca plc and GlaxoSmithKline plc for 2014 and
2015. The figures for 2015 are shown again in Table
6.10.

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 In 2014, AstraZeneca’s net profit margin was:

In 2014, GSK’s net profit margin was:

1 Calculate the net profit margins for AstraZeneca

plc and GlaxoSmithKline plc for 2015.
(6 marks)
2 Explain which company might be more satisfied
with its financial performance on the basis of
these net profit margin results.
(4 marks)

Judging financial performance from

the perspective of different
stakeholders
There are numerous stakeholders who look at the financial
statements of a business to judge its financial performance.

Key term
Stakeholders are individuals and organisations that are
affected by, and affect, the business.

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Shareholders and owners
The owners of businesses (shareholders and partners, for
example) will be interested in a business’s profitability. This is
because profit is the reward to business owners for taking a risk
by investing in the enterprise. The income statement provides
vital information on:
• the level of sales achieved
• the costs the business has had to pay
• the amount of profit or loss that has been made.
In addition, a balance sheet can show whether or not the value
of a business has increased.
Owners such as shareholders would hope that a business’s sales
and profits will grow over time. If a business’s financial
performance is better than that of a rival in the same industry,
then owners such as shareholders will most probably be
impressed. Such positive financial performance may persuade
the owners to invest more money into the business.

Managers
Managers use the information in financial statements to assess
whether or not their decisions are effective. Thus, the managers
of GlaxoSmithKline might have thought at the end of 2015 that
their decisions had been effective (see Business insight above).
The company’s profits had risen strongly, as had its net profit
margin.
The balance sheet also gives managers further information,
especially when looked at over a period of time and if compared
to competitors’ balance sheets. For example, it shows the
amount that the businesses are borrowing – this is shown by

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liabilities, especially non-current liabilities. This can help
managers to judge whether borrowing is too high.

Suppliers
Suppliers will be interested in the business’s financial
performance as revealed by a business’s financial statements. A
business’s income statements show whether or not it has made a
profit and this can guide a supplier on whether it is likely to be
paid in the future. A business that is recording a large loss may
not be able to pay for supplies of raw materials and components
in the future.

Employees
Employees will also be interested in a business’s financial
performance, and especially the information on its income
statement. We saw in Topic 4.3 that some businesses operate
profit-sharing schemes. Therefore, employees’ pay may depend
on the business’s level of profits. It can also guide employees
regarding job security. A business that records a substantial loss
on its income statement may seek to cut costs to improve its
performance. This might mean that it employs fewer people and
that some employees lose their jobs.

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The importance of financial
statements
The income statement and the balance sheet are important
documents to a business’s stakeholders for two main reasons.

Assessing business performance

We have seen that financial statements provide information on a
business’s financial performance. They show the business’s
revenue from sales, its profits and increases in the value of the
business. Financial statements often show this data for several

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years, making it possible to judge the trend of the business. For
example, if a business’s revenue and profits are rising over a
period of time, it provides evidence that the business’s
performance is improving. This is especially true if the
performance of competitors over the same time period has not
improved.
Financial statements allow managers and other stakeholders to
conduct ratio analysis. By comparing two pieces of financial
information, it is possible to make a better judgement of a
business’s performance. A rise in profits is a good sign for a
business. If the business also has a rise in its net profit margin,
this shows that the business is being run more efficiently. This
happened in the case of GlaxoSmithKline plc in the Business
insight feature earlier.

Helping managers to make effective

decisions
Financial statements provide a great deal of information which
can help a business’s managers to make better decisions. For
example, they may be able to uncover the reasons for falling
profits and take appropriate action to improve the situation. The
income statement will show whether costs have risen and
whether it is the cost of sales or overheads (or both) that has
risen. Managers can take decisions to cut costs as necessary – or
perhaps to increase prices.

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Alternatively, it may be a fall in sales that has caused the decline
in profits. This is shown by the data on the income statement. In
this case, managers may take a decision to increase advertising
to provide a boost to the business’s sales figures.

Summary
Financial statements such as income statements and
balance sheets provide a business’s stakeholders with a
lot of information about the business. This helps them to
make judgements about the business’s performance and
to make decisions, such as whether or not to invest in the
business. Income statements record a business’s
revenues, costs and profits over a trading period. Balance
sheets record a business’s assets and liabilities on a
particular day. The information in an income statement
allows the calculation of gross profit margins and net profit
margins.

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Quick questions
1 State two reasons why UK companies might prepare
financial statements.
(2 marks)
2 Name three stakeholders who may want to look at a
business’s financial statements.
(3 marks)
3 If a business’s cost of sales is deducted from its
revenue from sales, the resulting figure is which of the
following?
(a) Gross profit
(b) Operating profit
(c) Net profit
(d) Net assets employed
(1 mark)
4 Using examples, explain the difference between a
business’s assets and its liabilities.
(4 marks)
5 Which of the following is an example of a non-current
asset?
(a) Inventories
(b) Cash
(c) Vehicles
(d) Total equity
(1 mark)
6 State two ways a business’s profits can be judged by
using comparisons.
(2 marks)
7 What is meant by the term ‘financial ratio’?

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 (2 marks)
The following information relates to a business and is
used for questions 8 and 9.
• Net profits – £250,000
• Cost of sales – £900,000
• Revenue – £1,900,000
• Overheads – £700,000
8 Which of the following is the business’s gross profit
margin?
(a) 52.63%
(b) 47.37%
(c) 27.78%
(d) 26.55%
(1 mark)
9 Which of the following is the business’s net profit
margin?
(a) 52.63%
(b) 47.37%
(c) 27.77%
(d) 13.16%
(1 mark)
10 State two reasons why financial statements are
important to a business.
(2 marks)

Case study
Winter Ltd

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Winter Ltd is a private limited company that owns and
operates two garden centres in Essex. It competes with
larger competitors such as Wyevale Garden Centres.
Winter Ltd has completed its income statement for the
financial year which has just finished. An extract from this
is shown in Table 6.11.

The year before last:

• Winter Ltd’s net profit was £85,000.
• Its gross profit margin was 45.52%.
• Its net profit margin was 15.16%.
The company is planning to buy a third garden centre in
Braintree. It has raised some of the finance needed for
this, but has asked its bank for a loan of £200,000 to
enable it to complete the deal. However, Winter Ltd’s
major shareholder is concerned about her company’s
recent financial performance.
1 Calculate Winter Ltd’s gross and net profit margins for
the financial year which has just finished.
(4 marks)
2 Use the information in Table 6.11 to explain the
difference between gross profit and net profit.
(4 marks)
3 The case study shows information relating to Winter
Ltd’s income statements. Analyse the other financial

658
 information that the bank might want before deciding
whether or not to lend the company £200,000.
(6 marks)
4 Recommend whether or not Winter Ltd’s major
shareholder is correct to be worried about the
company’s recent financial performance. Give reasons
for your answer.
(9 marks)

Chapter review – Finance

Read question 1, the sample answers and the comments.
Then try question 2.
1 Read Item A and answer the questions that follow.
Item A
Rio Ives is the largest shareholder in Super Smoothies Ltd
– she has 51 per cent of the shares. The company has
been very successful, and Rio has been very satisfied
with its profits. However, at times, it has faced cash flow
difficulties. Rio’s bank manager has advised her that it is
very important for her to prepare cash flow forecasts for
the company.
The company owns and runs six smoothie bars in the
north of England. Rio is planning to open two new bars in
Sheffield. To do so, her company needs to raise £400,000
to buy property and equip it. Rio is unsure which source
(or sources) of finance to use. She has considered using
a mortgage or selling more shares in her company. She
has to consider a lot of factors including the views of other
shareholders who want increased profits and are not sure
about the expansion into Sheffield. Also, she is worried

659
that interest rates may rise significantly over the next few
years.
Rio thinks that Super Smoothie Ltd’s latest income
statement may help her to make a decision as to how to
raise the finance for the two new smoothie bars. Key
figures from this are shown in Table 6.12.

Rio thinks that the income statement is important in

making this decision as well as the company’s balance
sheet.
(a) State two assets that Super Smoothies Ltd would
need to carry out its business successfully.
(2 marks)
(a) Super Smoothies Ltd would need a lot of
assets if it is to carry out its business
successfully and to make sure that its
customers were satisfied. These assets would
be shops, machines to make smoothies, tables
and chairs for customers and cash in its tills.

The student uses the term ‘assets’ and is able

to give examples of the types of assets that
this business would need. This is a very long

660
 answer for two marks and much unnecessary
detail is given.
(b) Calculate the following figures for Super Smoothies
Ltd for the period shown by the income statement:
(i) net profit
(ii) net profit margin.
(4 marks)
(b) (i) Net profit is revenue less all costs of
production.
Net profit = £500,000 − (£305,000 + £95,000) =
£100,000
(ii) Net profit margin = net profits × 100 ÷ sales
revenue
Net profit margin = £100,000 × 100 ÷
£500,000 = 20

By including formulae, especially when

calculating profit margins, shows knowledge
and helps to structure answers. The answer to
(i) is entirely correct. However, (ii) is
incomplete. The formula and the calculation
that follows is fine. The final answer, however,
should have a percentage sign as all profit
margins are percentages.
(c) Analyse why Rio’s bank manager has said that ‘it is
very important for her to prepare cash flow
forecasts for the company’.
(6 marks)
(c) Cash flow is the money that flows into and out
of a business every day. Without cash a

661
 business cannot continue to trade as it will
not be able to pay its bills when they are due
for payment. The bank manager may be
worried that Rio’s business is at risk of being
short of cash as it has had cash flow
problems before. Also Rio is planning a big
expansion and to buy two new smoothie bars.
This will involve a lot of cash outflows and
could make the business’s cash position
weak. Forecasting cash flow will help to show
when problems might take place and to have
solutions ready.

The student has combined subject knowledge

with the information from the case study and is
focused closely on the question. The student
understands what is meant by cash flow (and
does not confuse it with profit) and why it is
important for any business to prepare cash
flow forecasts. He or she also uses material
from the case study selectively to support the
arguments – such as the fact that the business
has had cash flow difficulties in the past.
(d) Rio is planning to open two new smoothie bars and
needs to raise £400,000 to do this.
Analyse the sources of finance she might use. In
your answer, you should consider:
• the advantages and disadvantages of using a
mortgage
• the advantages and disadvantages of selling more
shares.

662
 Should Rio use a mortgage or sell more shares as
a means of raising capital? Justify your answer.
(12 marks)
(d) A mortgage is a long-term loan used to buy
property and can be for up to 50 years. If Rio
decides to use a mortgage, this will be
suitable as she is planning to buy property
and this can be used as collateral for the
mortgage. She is also planning to borrow a lot
of money – £400,000 – and a mortgage can be
arranged over a long period of time. This
means that the company will not have to pay
too much back each month. This will help to
keep it profitable. However, interest rates are
forecast to rise and this could make the
repayments of the mortgage more expensive
over time. Profits could be damaged.
Selling more shares means that the business
will not have to make repayments on a
mortgage each month and this could help the
business’s profits. This is something that the
other shareholders are keen to see. However,
Super Smoothies Ltd is a private company and
Rio and the other shareholders would have to
agree, and this might be difficult as they are
unsure about the expansion anyway.
Rio would be better making a decision to
arrange a mortgage. The other shareholders
might be happier with this as they would
receive a larger proportion of the profits as
they would not have to share them with new
shareholders. It is also a better option for Rio.
She has 51 per cent of the shares at the

663
 moment. If she sells more shares, she is
bound to lose control and the business might
end up making decisions which she does not
agree with.

The student has followed the structure

suggested by the question and has developed
arguments for and against the two sources of
finance. The final paragraph offers a clear
decision and reasons for the choice. The
student also makes good use of the
information in the case study to develop
arguments and support the judgement. For
example, the fact that Rio owns 51 per cent of
the company’s shares is used effectively.
2 Read Item B and answer the questions that follow.
Item B
Ritula Shah has a decision to make. She is an
experienced baker and has worked for a well-known
company for many years. She has the opportunity to buy
her own bakery in nearby Corbridge and is unsure whether
or not to buy it.

She has calculated the following costs and revenues for

her bakery for its first year of trading:
• Revenue – £ 200,000
• Fixed costs – £60,000
• Variable costs – £115, 000
• Amount needed as an investment to start the bakery –
£200,000.
Some of these figures are uncertain as existing

664
businesses may change their prices, and the costs of
ingredients such as flour can alter rapidly.

Ritula has £200,000 available to invest in the business – it

is in a bank account receiving just 2 per cent interest. She
would not need to use any other source of finance. A
friend has advised her that using break-even analysis
might help her to reach a decision. Ritula is worried that
her forecast might not be very accurate, and she does not
like risk. It is a big decision to make as she currently has a
well-paid job.
(a) Identify two examples of variable costs that Ritula
will have to pay if she opens the bakery.
(2 marks)
(b) Calculate the expected average rate of return for
the bakery in its first year of trading.
(4 marks)
(c) Analyse how using break-even analysis might help
Ritula to make a decision.
(6 marks)
(d) Recommend whether or not Ritula should open the
bakery.
(9 marks)

665
Glossary
Advertising – involves paid for communications
Aim – a general goal of a business
Apps (or applications) – pieces of software designed for a
specific purpose and for use on smartphones and tablets
Asset – something that is owned by a business; examples
include land, buildings, vehicles and machinery
Authority – the power to control others and to make decisions
Average rate of return (ARR) – compares the average yearly
profit from an investment with the cost of the investment and is
stated as a percentage
Balance sheet – sets out the assets and liabilities that a
business has on a particular day
Boston Matrix – a way of analysing a product’s share and
growth in their market
Break-even – the level of production at which a business’s
total costs and revenue from sales are equal
Break-even chart – shows a business’s costs and revenues
and the level of production needed to break even
Building societies – organisations that offer a range of
financial services; their major business is providing savings

666
accounts and lending money for the purpose of buying property
Business plan – a document setting out what a business does
and what it hopes to achieve in the future
Business planning – the process of producing a business
plan
Cash cow – a product with a high market share in a low-
growth market
Cash flow – the money that flows into and out of a business
on a day-to-day basis
Cash flow forecast – a plan of the expected inflows and
outflows to and from a business over a period of time
Cash flow statement – a record of the cash inflows and
outflows that took place over an earlier period of time
Centralisation – when a small number of senior managers in
a business take all the important decisions
Chain of command – the line of authority within a business
along which communication passes
Cloud computing – a general term for the delivery of
specialist computing services, such as the storage of very large
amounts of data, provided by businesses using the internet
Collateral – an asset that a bank holds as security for the
repayment of a loan
Communication – the exchange of information between two
or more people
Company – a business that has its own legal identity; it can
own items, owe money, sue and be sued
Competition – exists when more than one business is
attempting to attract the same customers

667
Competitive pricing – matching the prices that competitors
charge
Consumer – someone who uses goods and services produced
by businesses
Consumer laws – laws that have been introduced to prevent
businesses from treating their customers unfairly
Consumer spending – the value of goods and services
bought by consumers over a time period, usually a month or a
year
Contract of employment – a legal document stating the
hours, rates of pay, duties and other conditions under which a
person is employed
Cost plus pricing – products are priced by covering the cost
of it to the retailer and adding a percentage on top
Costs – the spending that is necessary to set up and run a
business
Curriculum vitae (CV) – provides information about a
person, including qualifications, employment history and
interests
Customer – someone who buys a product from a business
Customer engagement – when customers have a positive
experience from their contact with the business
Customer loyalty – when a business’s customers make repeat
purchases because they prefer the business’s products to those
of its rivals
Customer service – that part of a business’s activities that is
concerned with meeting customers’ needs as fully as possible
Data analysis – gathering and examining data to provide

668
useful information that can be used for decision-making
Decentralisation – allows employees working in all areas of
the business to take decisions
Deed of Partnership – an agreement between partners that
sets out the rules of the partnership, such as how profits will be
divided and how the partnership will be valued if someone
wants to leave
Delayering – the removal of one or more levels of hierarchy
from a business’s organisational structure
Delegation – the passing down of authority to more junior
employees
Digital communication – the transmission of information
electronically between computing devices
Direct marketing – a direct link from the producer to the
customer with no intermediaries
Discrimination – treating one person differently from another
without having good reasons to do so
Diseconomies of scale – when the cost per unit increases as
a business expands
Distribution channel – how the ownership of a product
passes from the producer to the final customer
Diversification – when a business starts selling products in
new markets
Dividends – the financial rewards paid out to shareholders
each year
Dog – a product with a low market share in a low-growth
market
E-commerce – the act of buying or selling a product using an

669
electronic system such as the internet (also referred to as
electronic commerce)
Economic climate – the state of key factors within a country
such as the level of goods and services produced and the
number of jobs available
Economies of scale – when a business’s unit costs of
production fall as its output rises and the business expands
Economy – made up of millions of individual consumers,
many thousands of businesses and governments; all take
decisions on what to buy and produce
Enterprise – another word for a business; it also refers to the
skills of the people involved in the business to identify business
opportunities and bring together resources to meet these
opportunities
Entrepreneur – someone who is willing to take the risks
involved in starting a new business
Entrepreneurship – the ability to be an entrepreneur – to take
risks to develop a business idea
Environment – the natural world in which we live; it is the
landscape and its natural features such as the seas, rivers, forests
and mountains
Environmental reporting – the publication of a business’s
environmental performance to the general public
Environmental responsibility – the taking of decisions by
businesses, consumers, governments and other groups with the
intention of protecting the environment
Ethics – whether a business decision is thought to be morally
right or wrong; an ethical decision is made on the basis of what
is judged to be morally right

670
Exchange – when someone gives up something in return for
something else, e.g. a business exchanges a product for money
Exchange rate – the price of one currency expressed in terms
of another
Exports – goods and services produced by a business in one
country and sold in a different one
Extension strategies – attempts to maintain the sales of a
product and prevent it from entering the decline stage of the
product life cycle
External costs of production – when a business’s activities
result in harmful effects on other people not directly involved in
production
External growth – when a business gets bigger by joining or
buying other businesses (also known as integration)
External recruitment – filling a job vacancy from any
suitable person not already employed by the business
External source of finance – money that comes from
outside the business, for example, a loan from a bank
Extranets – similar to intranets, but are also accessible to other
organisations such as suppliers
Fair trade products – those for which customers pay higher
prices and offer better trading terms, such as payments with
orders; the aim is to improve the living standards of people in
poorer countries
Financial ratios – compares two figures from a business’s
financial statements
Fixed costs – the costs that do not change when a business
changes its output

671
Flotation – when a private limited company (ltd) becomes a
public limited company (plc) and has its shares listed on the
Stock Exchange
Flow production – when an item moves continuously from
one stage of the process to another
Franchise – when a franchisor sells the rights to its products
to a franchisee; this is usually in return for a fee and percentage
of turnover
Franchisee – someone who buys a franchise usually in return
for a fee and percentage of turnover
Franchisor – someone who sells a franchise usually in return
for a fee and percentage of turnover
Fringe benefits – the ‘extras’ that employees may receive in
addition to their pay, for example, a company car
Full-time employment – when someone works a number of
hours equal to the normal working week, normally between 35
and 40 hours
Global markets – markets made up of customers from across
the world
Global warming – the gradual heating of Earth’s surface,
oceans and atmosphere
Globalisation – the trend for markets to become worldwide in
scope
Good – a physical product, such as a car
Gross Domestic Product (GDP) – measures all the income
earned in a country’s economy in a year
Gross profit – a business’s sales revenue minus its cost of
sales over a period of time, normally a year

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Growth – when a business sells increased quantities of its
products
Income elastic products – those whose sales are sensitive to
changes in consumers’ incomes
Income statement – a financial statement showing a
business’s revenues and costs and thus its profit or loss over a
period of time
Induction training – the training given to an employee when
he or she first starts a job
Inflation – the rate at which prices are increasing; for example,
if inflation is 2 per cent, prices are generally growing by 2 per
cent that year
Information and communications technology (ICT) –
the computing and communications systems that a business
might use to exchange information with stakeholders
Imports – goods and services purchased from overseas by
consumers of businesses
Interest – a payment made in order to borrow money; it means
a business pays back more than it borrows
Interest rates – the cost of borrowing money or the reward
for saving money, expressed as a percentage
Intermediary – a link in the distribution chain between the
producer and the customer
Internal growth – when a business gets bigger by selling more
of its products (also known as organic growth)
Internal recruitment – takes place when a job vacancy is
filled from within the existing workforce
Internal source of finance – money that is available from

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within the business, for example, last year’s profits
International trade – the selling of goods and services across
national frontiers
Intranets – communication networks which can only be
accessed by an organisation’s employees
Inventories – raw materials that have not yet been used or
products that have been made, but not sold (also called stocks)
Investment – takes place when a business buys an asset, such
as a factory, in the hope of making a profit from its use
Inward investment – when governments, businesses and
individuals invest capital into another country, for example,
building new factories or buying companies
Job analysis – the collection and interpretation of information
about a job
Job description – states information about the duties and
tasks that make up a particular job
Job enrichment – designing a job to give interesting and
challenging tasks
Job production – a method of production in which a product
is supplied to meet the exact requirements of a customer
Job share – when two or more employees agree to share the
responsibilities of a single job
Just-in-case (JIC) production – holds stocks just in case
there is a delay from supplies or a sudden unexpected increase
in demand
Just-in-time (JIT) production – holds as little stock as
possible; items are ordered just in time to be used
Kaizen – ‘continuous improvement’; an approach to

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production that aims to achieve change from a series of small
steps
Lean production – an approach to production that aims to
minimise waste
Legislation – a set of rules that governs the way society
operates (another term for ‘laws’)
Levels of hierarchy – the layers of authority within a
business
Liability – a sum of money that is owed by a business to
another business or an individual
Line manager – an employee’s immediate superior or boss
Loss – the amount by which a business’s costs are larger than
its revenue from all sales
Loss leader – a product sold at a loss in the hope that the
customer will buy other items from the business where they
make a profit
Margin of safety – measures the amount by which a
business’s current level of production exceeds its break-even
level of output
Market capitalisation – measures the value of all a
business’s shares: market price of a share × the number of
shares
Market research – the process of gathering, analysing and
processing data relevant to marketing decisions
Market segment – a group of customers or buyers with
similar needs
Market share – the percentage of sales in a particular market
recorded by a business

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Marketing mix – all the activities influencing whether or not a
customer buys a product; the elements of the mix can be
analysed using the four Ps: price, place, product and promotion
Markets – exist where there are buyers and sellers
M-commerce is the buying and selling of products through
wireless handheld devices such as smartphones (also referred to
as mobile commerce)
Merger – when two or more businesses join together to form a
new business
Monopoly – exists when a business does not face any
competition in a particular market
Mortgages – loans from banks and building societies that are
used to buy land and buildings, such as offices and shops
Motivation – the range of factors which influence the way a
person behaves at work
Multinational company (MNC) – produces goods and
services in more than one country (also called transnational
corporations)
National Living Wage – an hourly rate of pay which is set by
the government; all employees above a certain age must receive
at least this rate of pay
Need – something that needs to be fulfilled for us to survive
Negotiation – when two sides discuss what they want and try
to reach a solution
Net profit – a business’s sales revenue minus its cost of sales,
its overheads and other costs over a period of time, normally a
year
Non-renewable resources – those of which only a limited

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amount exists such as coal and oil
Not-for-profit organisations – set up to achieve objectives
other than profit; for example, a charity
Objective – a specific target that is set for a business to achieve
Off-the-job training – training outside the employee’s place
of work
On-the-job training – training given in the workplace
Organisational chart – a plan showing the roles of, and
relationships between, all the employees in a business
Organisational structure – the way a business arranges
itself to carry out its activities
Outsourcing – when a business uses another business to
produce for it
Overdraft – a flexible loan which businesses can use,
whenever necessary, up to an agreed limit
Owners’ funds – money put into a business by its owner or
owners
Partnership – when two or more people join together in a
business enterprise to pursue profit
Part-time employee – works for a proportion of the working
week, for example, three days each week, rather than five
Part-time employment – when an employee works for fewer
than the normal number of working hours per week
Penetration pricing – launching a new product at a low price
to achieve fast sales
Person specification – sets out the qualifications and skills
required by an employee to fill a particular job

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Piecework – a method of payment under which employees are
paid according to the quantity of products they produce
Post-sales (or after-sales) service – the meeting of
customers’ needs after they have purchased a product, for
example, by repairing or servicing the product
Premises – the buildings used by businesses; these may
include offices, shops and factories
Pressure group – a group of people with a common interest
who influence public opinion and decisions by businesses and
governments
Price – the amount a business asks a customer to pay for a
single product
Price skimming – setting a high price for a product when it
first enters the market
Primary market research – uses data gathered for the first
time
Private sector organisation – owned by individuals
Procurement (or purchase)– selecting suppliers,
establishing the terms of payment and negotiating the contract
Product design – translates the needs of consumers, or the
inventiveness of entrepreneurs, into a saleable product
Product life cycle – shows how the sales of a product may
change over time
Product portfolio – the collection of products that a firm
produces
Production – the process of changing inputs such as labour
services into goods and services that can be sold

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Production (or operations) management – all the
activities in managing the transformation process
Productivity – the quantity of goods or services produced by
an employee over a period of time, such as one year
Profit – measures the difference between the values of a
business’s revenue (sales) and its total costs
Promotional activities – the different ways in which a firm
tries to communicate with its customers
Promotional mix – the combination of promotional methods
used by a business to communicate with its customers
Protectionist measures – policies that governments use to
protect their own businesses against foreign competition
Public sector organisation – owned by the government
Purchasing economies of scale – when the cost per unit
falls if large orders are placed with suppliers due to a bulk
discount
Quality – the extent to which a consumer is satisfied with a
product
Question mark – a product with a low market share in a fast-
growth market
Quota – a limit on the number of foreign goods imported into a
country
Recession – when the value of an economy’s output of goods
and services falls for six months or longer
Recruitment – the process of finding and appointing new
employees
Recycling – the reuse of raw materials used in making

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products, often for many time; examples include the reuse of
glass, paper and metals
Resources – the inputs that businesses use to provide their
goods or services
Retailers – shops that sell direct to the customer
Retention – the proportion of a business’s workforce who
remain with the business over a period of time, usually one year
Revenue – the income that a firm receives from selling its
goods or services; it is also referred to as ‘turnover’; measured
by the number of units sold multiplied by the price
Risk – the possibility of something going wrong
Sales promotions – short-term incentives to encourage
customers to buy
Sales – the number of products sold by a business
Sales value – measures the revenue generated
Sales volume – measures the number of items sold
Secondary market research – uses data that has been
gathered already
Segmentation – when a market is divided into different
groups of needs and wants
Selection – choosing the right employees from among those
who have applied for a job
Service – an intangible product (that is, you cannot touch it),
such as financial advice or a bus journey
Shareholder – a person or organisation that owns part of a
company; each shareholder owns a ‘share’ of the business
Social enterprise – a business that is set up to help society

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rather than to make a profit
Social media – methods of online communication such as
websites and applications; they share information and help to
develop social and professional contacts
Social responsibility – an approach to managing businesses
in which the interests of all groups in society are taken into
account when making decisions
Software robots – advanced computer programs that can
operate a range of administrative activities previously carried out
by employees
Sole trader – someone who sets up in business on his or her
own
Span of control – the number of employees managed directly
by another employee
Specialisation – when individuals focus on a limited number
of tasks
Stakeholders – individuals and organisations that are affected
by, and affect, the activities of a business
Star – a product with a high market share in a fast-growth
market
Stock Exchange – a market for buying and selling shares of
public limited companies; large numbers of shares are being
bought and sold all the time
Supply chain – all the businesses, people and activities that
take part in the production processes from the start until it gets
to the customer
Sustainability – methods of production which can be
continued in the long term without damage to the environment

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Takeover – when one business buys control of another one
Tariff – a tax on foreign goods imported into a country
Total costs – fixed costs plus variable costs
Total Quality Management (TQM) – an approach to quality
in which everyone is focused on preventing errors occurring
and ensuring quality at each stage of the production process
Trade credit – a period of time which suppliers allow
customers before payment for supplies must be made
Trade union – a group of workers who act together to
improve their pay and working conditions
Training – a range of activities giving employees job-related
skills and knowledge
Uncertainty – occurs where there is a lack of information
about a situation; this means the outcome or consequences are
very difficult to predict
Unlimited liability – the personal possessions of the owners
of a business are at risk if there are any problems; there is no
limit to the amount of money the owners may have to pay out
Variable costs – the costs that vary directly with the
business’s level of output
Want – products we would like to have that are not essential
Webchat – a simple means of communicating in real time (that
is, instantly) using only web browsers such as Firefox or
Internet Explorer
Wholesalers – break bulk; they buy in large quantities from a
producer and sell to retailers
Zero hours contracts – allows employers to hire staff

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without any guaranteed hours of work

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Photo credits
pg. 3 (top), Hetman Bohdan/Shutterstock; pg. 3 (bottom),
Eckel/ullstein bild via Getty Images; pg. 6 (left), Vyacheslav
Svetlichnyy/Shutterstock; pg. 6 (centre), Rainer
Plendl/Shutterstock; pg. 6 (right), Vytautas
Kielaitis/Shutterstock; pg. 9, Kathy Hutchins/Shutterstock; pg.
12, Jacob Lund/Shutterstock; pg. 15 (left), Taina
Sohlman/Shutterstock; pg. 15 (centre),
Michaelpuche/Shutterstock; pg. 15 (right), Barry
Barnes/Shutterstock; pg. 17, Olly Curtis/T3 Magazine via Getty
Images; pg. 19, ArthurStock/Shutterstock; pg. 21,
rvlsoft/Shutterstock; pg. 22, Alexander
Kondratenko/Shutterstock; pg. 23, Martin Good/Shutterstock;
pg. 26, Tony Baggett/Shutterstock; pg. 34, Zhang
Peng/LightRocket via Getty Images; pg. 38, Xinhua / Alamy
Stock Photo; pg. 39, Kim Kulish/Corbis via Getty Images; pg.
42, BURGER/Getty Images; pg. 46 (left), rvlsoft/Shutterstock;
pg. 46 (centre), rvlsoft/Shutterstock; pg. 46 (right),
rvlsoft/Shutterstock; pg. 59, Daxiao Productions/Shutterstock;
pg. 60, Scanrail1/Shutterstock; pg. 66, amirraizat/Shutterstock;
pg. 71, pio3/Shutterstock; pg. 73, Ian Gavan / Staff/Getty
Images; pg. 76, Rich Carey/Shutterstock; pg. 77,
MikeDotta/Shutterstock; pg. 78, Reproduced by permission of
RSPB © 2017 All Rights Reserved. Source:
http://www.rspb.org.uk; pg. 85, John Keeble/Getty Images; pg.
86, Jason Alden/Bloomberg via Getty Images; pg. 88, 1000
Words/Shutterstock; pg. 91, TonyV3112/Shutterstock; pg. 95,
Sheila Fitzgerald/Shutterstock; pg. 97, O n E
studio/Shutterstock; pg. 100, Reproduced by permission of
Merrythought Ltd (www.merrythought.co.uk); pg. 104,
Sorbis/Shutterstock; pg. 108, kali9/Getty Images; pg. 110,
Rawpixel.com/Shutterstock; pg. 112, Nicholas Reuss/Getty

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Images; pg. 113, ChameleonsEye/Shutterstock; pg. 115, Daniel
Zuchnik/WireImage/Getty Images; pg. 117, Tom
Gowanlock/Shutterstock; pg. 119, Mark Daffey/Getty Images;
pg. 123, Andrew Findlay / Alamy Stock Photo; pg. 125, Simon
Dawson/Bloomberg via Getty Images; pg. 133 (top left),
ifong/Shutterstock; pg. 133 (top right), Alter-ego/Shutterstock;
pg. 133 (bottom left), Imran’s Photography/Shutterstock; pg.
133 (bottom right), Creative Lab/Shutterstock; pg. 136,
Stanislaw Tokarski/Shutterstock; pg. 146, Martin Witte / Alamy
Stock Photo; pg. 166 (top), wavebreakmedia/Shutterstock; pg.
166 (bottom), ASDF_MEDIA/Shutterstock; pg. 167,
FACUNDO ARRIZABALAGA/AFP/Getty Images; pg. 170,
SpeedKingz/Shutterstock; pg. 171, Pavel L Photo and
Video/Shutterstock; pg. 173, Andia/UIG via Getty Images; pg.
176, Pavel L Photo and Video/Shutterstock; pg. 181,
BasPhoto/Shutterstock; pg. 184, James Sebright / Moment/Getty
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Olena Yakobchuk/Shutterstock; pg. 191 (top), Ant
Clausen/Shutterstock; pg. 191 (bottom),
InsectWorld/Shutterstock; pg. 192, Andrey_Popov/Shutterstock;
pg. 194, THOMAS COEX/AFP/Getty Images; pg. 195,
Aisyaqilumaranas/Shutterstock; pg. 198, ESB
Professional/Shutterstock; pg. 200, Monkey Business
Images/Shutterstock; pg. 202, Andia/UIG via Getty Images; pg.
203, Geography Photos/UIG via Getty Images; pg. 204 (top),
Fred de Noyelle/Getty Images; pg. 204 (bottom), Jeff J
Mitchell/Staff/Getty Images; pg. 213, Roman
Evgenev/Shutterstock; pg. 214, Chris Ratcliffe/Bloomberg via
Getty Images; pg. 215, Ben Pruchnie/Stringer/Getty Images; pg.
219 (left), Andrei Kholmov/Shutterstock; pg. 219 (centre),
Charlie Hutton/Shutterstock; pg. 219 (right), Art
Konovalov/Shutterstock; pg. 228, Whitebox Media / Alamy
Stock Photo; pg. 236, Ethan Miller/Getty Images; pg. 237,

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Imran’s Photography/Shutterstock; pg. 238,
Moviestore/REX/Shutterstock; pg. 240, Roger parkes / Alamy
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Images; pg. 265 (top), Loop Images/UIG via Getty Images; pg.
265 (bottom), Chesnot/Getty Images; pg. 267, Realimage /
Alamy Stock Photo; pg. 268 (top), MARK
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Alamy Stock Photo; pg. 277 (bottom), Gordon Ball
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Keenretail / Alamy Stock Photo; pg. 283,
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Images Group via Getty Images; pg. 287, Paul
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目录
Title Page 2
Copyright 3
Contents 6
Introduction 9
1 Business in the real world 13
1.1 The purpose and nature of businesses 14
1.2 Business ownership 33
1.3 Setting business aims and objectives 56
1.4 Stakeholders 75
1.5 Business location 85
1.6 Business planning 98
1.7 Expanding a business 109
2 Influences on business 133
2.1 Technology 134
2.2 Ethical and environmental considerations 156
2.3 The economic climate of business 183
2.4 Globalisation 205
2.5 Legislation 232
2.6 The competitive environment 255
3 Business operations 284
3.1 Production processes 285
3.2 The role of procurement 302
3.3 The concept of quality 318
3.4 Good customer service 328
4 Human resources 350
4.1 Organisational structures 351
4.2 Recruitment and selection of employees 377
4.3 Motivating employees 408
4.4 Training 428
5 Marketing 453

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 5.1 Identifying and understanding customers 454
5.2 Segmentation 466
5.3 The purpose and methods of market research 479
5.4 Elements of the marketing mix 498
5.5 Using the marketing mix: product and pricing 510
5.6 Promotion and distribution 535
6 Finance 560
6.1 Sources of finance 561
6.2 Cash flow 587
6.3 Financial terms and calculations 609
6.4 Analysing the financial performance of a business 633
Glossary 666

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