HOW

BUSINESS
WORKS
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$ $

$
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 HOW
BUSINESS
$ WORKS
The FACTS visually explained

$
 Contents
Produced for DK by Dynamo Limited
1 Cathedral Court, Southernhay East, Exeter, EX1 1AF
Senior editor Georgina Palffy
Project art editor Saffron Stocker
Editors Anna Fischel, Alison Sturgeon,
Suhel Ahmed, Hannah Bowen,
Joanna Edwards, Alex Beeden
Designers Natalie Clay, Stephen Bere,
Introduction 8
Phil Gamble, Vanessa
Hamilton, Jemma Westing
US executive editor
US editor
Lori Hand
Heather Wilcox
HOW COMPANIES WORK 10
Managing editors Stephanie Farrow, Gareth Jones
Senior managing Lee Griffiths
art editor
Publisher Liz Wheeler
Deputy art director Karen Self Business ownership 12
Publishing director Jonathan Metcalf Sole proprietorships and partnerships 14
Art director Phil Ormerod Limiting liability 16
Senior jacket designer Mark Cavanagh Private and public companies 18
Jacket assistant Claire Gell Multinationals 20
Jacket design manager Sophia MTT Franchises 22
Pre-production producers Ben Marcus, Nikoleta Parasaki
Not-for-profit 24
Producer Christine Ni
This American Edition, 2022
First American Edition, 2015
Start-ups 26
Published in the United States by DK Publishing Start-ups from concept to launch 28
1450 Broadway, Suite 801, New York, NY 10018
Types of start-up 30
Copyright © 2015, 2022 Dorling Kindersley Limited
DK, a Division of Penguin Random House LLC Business plans 32
22 23 24 25 26 10 9 8 7 6 5 4 3 2 1 Raising money 34
001– 325014–Mar/2022
Business accelerators and incubators 38
All rights reserved.
Without limiting the rights under copyright reserved above,
no part of this publication may be reproduced, stored in or introduced Buying & selling businesses 40
into a retrieval system, or transmitted, in any form, or by any means
(electronic, mechanical, photocopying, recording, or otherwise), without Mergers and acquisitions 42
the prior written permission of the copyright owner. Divestitures 44
Published in Great Britain by Dorling Kindersley Limited
A catalog record for this book is available from the Library of Congress
Vertical vs. horizontal integration 46
ISBN 978-0-7440-4216-0 Management buy-ins and buyouts 48
DK books are available at special discounts when purchased in
bulk for sales promotions, premiums, fund-raising, or educational use.
For details, contact: DK Publishing Special Markets, 1450 Broadway, Who’s who 50
Suite 801, New York, New York 10018 or [email protected]. Board of directors 52
Printed and bound in China Company hierarchy 56
Stakeholders 60
www.dk.com Business cultures 64

This book was made with Forest

Stewardship Council™ certified
paper—one small step in DK’s
commitment to a sustainable future.
For more information, go to
www.dk.com/our-green-pledge.
 HOW FINANCE WORKS 100

Financial reporting 102

The accounting cycle 104
Financial statements 106

Financial accounting 112

Profit and loss statement 114
Corporate structure 66 Balance sheet 116
Functional structure 68 Cash-flow statement 120
Divisional structure 70 Environmental accounting 122
Matrix structure 72 Depreciation 124
Network structure 74 Amortization and depletion 128
Team-based structure 76
Management accounting 130
Human resources 78 Cash flow 132
The human resources cycle 80 Budgets 136
Recruitment and selection 82 Assets and inventory 138
Evaluating staff 84 Costs 140
Motivation and rewards 86 Product costing and pricing 142
Leadership strategy and styles 88
Leadership for team building 90 Measuring performance 144
Employee relations and Key performance indicators (KPIs) 146
communications 92 Financial ratios 148
Project management 94 Forecasting 150
Negotiating strategy 96 Tracking fraud 152
Flexible working 98
Raising financing 154
Internal financing 156
External financing 158
Going public 160
Shares and dividends 164
The capital market 170
Gearing ratio and financial risk 174
HOW SALES AND
MARKETING WORKS 176

Marketing mix 178 Inbound marketing 220

Product 180 Outbound vs. inbound marketing 222
Product positioning 182 Blogging 224
Product life cycle 184 Social media marketing 228
Price 186 Search engine optimization (SEO) 230
Place 188
Promotion 190 Business development 232
Market research 192 Branding and rebranding 234
Market segmentation 194 Lead generation 236
Lead conversion 238
Marketing approaches 196 Customer retention 240
Niche vs. mass marketing 198 Return on marketing
Traditional marketing 200 investment (ROMI) 242
Digital marketing 202 Intellectual capital 244
Engagement marketing 204
Sensory marketing 206 Information management 246
Relationship marketing 208 Business intelligence 248
Business analytics 250
Outbound marketing 210 Marketing and IT 252
Traditional offline advertising 212 Collecting consumer data 254
Online advertising 214 Data warehousing 256
Direct mail 216 Customer profiling 258
Telemarketing 218 Big data 262
Customer relationship
management (CRM) 264
Compliance 266
HOW OPERATIONS Resources 336
AND PRODUCTION WORK 268 Index 344
Acknowledgments 351

Manufacturing and production 270

Job production 272
Batch production 274
Flow production 276
Mass customization 278
Continuous production 280
Hybrid processes 282

Management 284
Economies and diseconomies of scale 286 Contributors
Lean production 288
Just-in-time 290 Dr. Julian Sims (consultant editor) entered academia
Total quality management 292 after a successful career in industry in the U.S. and the U.K. He
is a lecturer in the Department of Management at Birkbeck,
Time-based management 294
University of London, U.K.; a Chartered Accountant (CPA Aus);
Agile production 296 and a Chartered Information Technology Practitioner (CITP). His
Kaizen 298 work is widely published in academic journals.

Philippa Anderson is a business writer and communications

Product 300 consultant who has advised multinationals, including 3M, Anglo
New product development 302 American, and Coca-Cola. She collaborated with
Innovation and invention 304 Lord Browne, former CEO of BP, on his memoir, Beyond
Design 306 Business, and was a contributor to DK´s The Business Book.
Quality management 308
Alexandra Black studied business communications before
Product-process matrix 310 writing for financial newspaper group Nikkei Inc. in Japan. While
in Tokyo, she was an editor at the Risk Analysis division of
Control 312 investment bank JP Morgan. Now based in Cambridge,
U.K., she covers subjects as varied as business, technology,
Managing capacity 314
and fashion. She was a contributor to DK’s The Business Book.
Inventory 316
Quality control 318 Joe Stanley-Smith is a reporter at the International Tax
Six Sigma 320 Review in London, U.K., where he specializes in indirect tax
and tax disputes. He graduated in journalism with a business
specialty from Kingston University, U.K., and has previously
Supply chain 322 worked in social media and local news.
Value chain 324
Outsourcing 326 Paul McDougall (U.S./Canada writer) is Deputy Technology
Editor for the International Business Times. He has written
Offshoring 328
for Scientific American, InformationWeek, SHAPE magazine, and
Reverse supply chain 330 others. A native of Toronto, Canada, he currently resides
Benchmarking 332 in New York City.
Corporate social responsibility 334
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 HOW BUSINESS WORKS
Introduction 8 9

Introduction
The term “business” refers to an organization or commercial
enterprise engaged in producing and trading goods and services for
money. We can trace the origins of business to the very foundations
of human society. When Homo sapiens evolved, humankind left behind
the nomadic hunter-gatherer lifestyle to become farmers. This allowed
for specialization of work, where individuals would become skilled
at specific tasks to serve a particular community need. Over time, this
enabled more complex goods and services to be produced and traded
in order to provide for all members of society. Thus, human society has
been engaging in “business” for thousands of years.

Today, the world of business is inescapable—businesses no

longer are just local providers of goods and services but extend
to vast corporate enterprises operating on a global scale. At the
same time, technological advances have made it easier than ever
for entrepreneurs to start their own companies and propelled
Internet-based businesses to the heart of the global economy.
But whether businesses are small or large, public or private, for
profit or nonprofit, they each play a key role in allowing governments
to function and economies to flourish, and together they form the
backbone of the modern world. Business underpins every aspect of
the world we live in today, and understanding how it works is the
key to understanding society.

This book explains the complex world of business in a simple and

graphic way. It examines every aspect of how a business works,
including forming a company, raising capital, product development
and marketing, management strategies, tracking revenue, financial
reporting, and legal, social, and environmental responsibilities.
Through visual explanations as well as real-life examples to make even
the most complex concept immediately accessible, How Business
Works offers a clear understanding of what business is all about and
how business, in its many forms, shapes modern society.
HOW
COMPANIES
WORK
Business ownership ❯ Start-ups
Buying & selling businesses ❯ Who’s who
Corporate structure ❯ Human resources
 Business
ownership
Every type of business has to choose an ownership structure. Although there
are global variations, most countries offer analogous legal entities, from a single-
person private enterprise to a large organization trading on a stock exchange.
There are three key considerations: how big the venture is expected to grow; the
complexity of financial recording, management, and reporting that the owner is
willing to take on; and the amount of liability that the owner is willing to accept.

Public companies

❯ Companies that go public

Private are large businesses, and they
companies have many legal and financial
reporting obligations.
❯ More complex to set
Small and simple up and run, private ❯ The general public and other
companies are legal institutions can buy shares in
entities that are separate public companies.
❯ Basic structures, such as a
sole trader or partnership, from their owners. They ❯ The public company structure is
are simple to set up and may have some financial good for a major capital injection,
require little capital. reporting obligations. allowing the business to expand.
❯ Owners are not usually See pp.16–19.
❯ One or more people own
the business—usually a personally liable for
small enterprise—and business debts.
trade as a legal entity. ❯ Shareholders, who are
❯ Owners are personally often the companies’
liable for business debts. managers, own them.
See pp.14–15. See pp.16–19.
 HOW COMPANIES WORK
Business ownership 12 13

7%
of global economic
NAMING A COMPANY
Do
❯ Use a domain suggestion
tool to search for available
Don’t
❯ Include your name, so if
the venture fails, your name
internet domain names and will be associated with it.
activity is accounted work backward from there. ❯ Copy competition, because
❯ Be descriptive so potential if your name is unique, you
for by the world’s customers instantly grasp the
nature of the business.
have a much better chance of
topping search-engine results.
100 largest companies. ❯ Say the name out loud, If your name is similar to that
of competitors, customers
as it may sound different than
intended. The goal is for can’t tell you apart from them.
people to find it just from ❯ Spend time thinking of a
hearing it. name until your product and
❯ Check what the name brand are finalized. Get the
means in other languages. product right first, and the
name will naturally follow.
❯ Keep it short and simple and
avoid puns.

Multinationals

❯ Multinationals have operations Franchises

in various countries, enabling
growth and flexibility. ❯ In this model, a business
❯ Multinationals can save money by (the franchisor) authorizes an Not-for-profit
setting up operations in countries individual (the franchisee) to set sector
where costs are cheaper. up a branch, in return for a fee.
❯ Foreign branches can adapt to ❯ The franchisor needs less capital ❯ Common not-for-profit
the local market and also find than it otherwise would to develop organizations include
new markets. See pp.20–21. the business. charities, mutuals, and
cooperatives.
❯ The franchisee takes on a known,
successful business model and ❯ Their organizational
name, minimizing the risk. structure is similar to
See pp.22–23. that of a company.
❯ NPOs may generate
substantial sums of
money but reinvest it in
beneficial causes rather
than distribute profits.
See pp.24–25.
 Sole proprietorships
and partnerships
The simplest business structures are those formed by one person as a
sole proprietorship or by two or more people as a partnership for
commercial activity. Many cost little to set up, and some are easy to run.

How it works
Many businesses start out as the most NEED TO KNOW
basic unit—either a sole proprietorship
❯ Firm Collective term for
or a partnership. A sole proprietor is an individuals in a partnership
individual who is the only owner of
❯ Limited liability partnership
the business. This structure is easy to Unlimited liability: (LLP) Partners not personally
set up, and there are no extra taxes to business debts accountable for business debts
paid personally
pay, unlike with a company. Instead,
the sole proprietor files a personal tax
return. There is risk attached, though.
A sole proprietor has unlimited liability,
so if the business fails, the owner must
personally pay debts. Partnerships have
more than one owner, and each can be
held liable for the whole debt of the
business in case of failure. Tax-efficient Simple
way to be registration process
self-employed

Pros and cons $ $

Both sole proprietorships and partnership
Little Easy to move from
structures are excellent for anyone starting capital sole proprietor to
out or running a small business—as long as needed company status
partners have a good working relationship
and the business stays out of debt: owners
are personally liable for business debts. $

Schedule C Trade under own Keep all business

filed with IRS name or chosen profits after paying
Form 1040 business name tax on them

Sole proprietorship
Working alone requires only
simple administration and
relatively few start-up costs.
 HOW COMPANIES WORK
Business ownership 14 15

FROM INDIVIDUAL
TO MULTINATIONAL
Sole proprietorships and partnerships
may grow into global names.
66%
of E.U. private- WHEN TO MO
❯ Richard Branson Sole proprietor- COMPANY STVE TO
ship that expanded into Virgin empire sector jobs are in ATUS
❯ Steve Jobs and Steve Wozniak
Partnership that created Apple brand small or medium-
❯ Bill Hewlett and David Packard
Partners who founded HP technology size enterprises.
❯ Fusajiro Yamauchi Sole trader
whose playing card shop became
the Nintendo video-game company

If the need fo
r ca
increases (and pital
potential
debts grow),
forming
a company m
Profit and control ay be
beneficial. Se
of the business e pp.16–17.
shared

Allows for Option to set up a

specialization by limited liability
each partner partnership

If partner leaves, Each partner pays

$
new partnership tax on own
needed portion of profit $

Furnish Schedule More partners New partners

K-1 (IRS Form mean more capital bring new
1065) to partners and expansion business skills

Partnership
Like sole proprietors, partners
file only personal tax returns and
are liable for business debts.
 Limiting liability
By setting up an organization that is legally and financially
independent business owners can limit their level of risk,
as personal assets are largely protected.

How it works reporting and structural requirements, but it also

Business owners can structure their business so provides more protection from liability for the owners.
that it is legally the same entity as the owner (sole There are several different types of corporations that
proprietorship), or they can choose a structure that is a an owner can register as, but all issue shares of the
separate legal entity (limited partnership, corporation, corporation and the owners become shareholders, with
or limited liability company [LLC]). Choosing one of the profits of the corporation distributed as dividends.
these limits the owner’s personal liability for debts and
protects them from the risks of running a business.
LLCs and corporations are by far the most common
for small businesses and entrepreneurs because of
the tax implications. An LLC is less structured and has
fewer reporting requirements than a corporation, so
many entrepreneurs choose it. A corporation has more

Corporation
US business structures A corporation is a business
entity that is completely
The four main business structures in the US are: sole proprietorship, limited separate from its owner. The
partnership, corporation, and limited liability company (LLC). A sole owner are issued shares that
proprietorship treats the business as the same as the person who owns it, and they may sell to end their
does not protect the owner from any debts or liabilities. A limited partnership, ownership of the corporation.
corporation, and LLC protect the owners from debt and liability, to different
degrees depending on the form. The four forms file taxes differently, and have
different reporting requirements.

NEED TO KNOW
❯ Members People or institutions Types of corporations
(such as pension funds and insurance ❯ C corp is most commonly referred to as a
firms) that own shares in a company; “corporation.” It taxes profits of the company.
directors may own shares but are
❯ S corp allows some profits to pass through to the
not required to do so; also known
owners without being double-taxed at corporate rates.
as subscribers
❯ B corp is treated the same as a C corp for taxation, but
❯ Doing business as (DBA) Operational has to produce “a public benefit” along with any profits.
rather than registered company name
❯ Close corporation is less structured version of a
❯ Professional corporation (PC) B corp that may not have a board of directors.
Corporate form used in the US and
suitable for doctors, lawyers, and
similar professional service providers
 HOW COMPANIES WORK
Business ownership 16 17

NAMING CONVENTIONS
Limiting liability The names given to different types of business entities differ from
country to country. In the US, a corporation ends with Corp. or Inc.
Companies structured to limit (short for Corporation or Incorporated) and an LLC ends with LLC.
liability come in various forms, In the UK, a corporation ends with Ltd or Plc. In Canada, a corporation
but all operate as entities that are ends with Inc, Corp, or Ltd.
legally and financially independent
from their owners.

LLC
An LLC is a hybrid format
that protects the owner from
personal liability and from
debts, but allows profits and
losses to be passed through
directly to the owners without

35%
being taxed at a corporate rate.

of small
businesses in the Quirks of LLCs

US are LLCs. 52% ❯ No shares issued, so owners are not shareholders

❯ Profits are taxed at a lower rate than corporations

are some type ❯ Rules may vary by state, unlike corporations

❯ When an owner leaves, the entire LLC may be
of corporation. dissolved and have to be redrawn
 Private and public
companies
While the owner-shareholders of a private company may buy and sell
their shares privately (usually with director approval), any investor in
the financial market can trade the shares of a public company.

How it works
Although most of the world’s companies are set up as
private, public companies are seen as more prestigious
Differences between private
and profitable. For business ventures requiring large and public companies
amounts of capital, a public company offers greater Private company directors have to consider the potential
opportunity for raising funds because shares can be capital increase of joining the stock exchange against the
sold to public investors to generate cash. Private legal red tape aimed at protecting public shareholders.
companies must rely on private investors or use the
capital investment of their owners. Public companies
are subject to more stringent legal controls than private
ones and are expected to disclose financial details. Private

27 million
the number of companies
Directors
Usually control all the shares.
Reporting
in the US, fewer than In the UK, it is mandatory to file accounts at

1% of which are public Companies House; no disclosure is required

outside the company in the US.
Shareholders and management
FAMOUS PRIVATE COMPANIES Shareholders are often actively involved in
management, so decisions can be made quickly.
❯ Mars Confectionery and pet food; Financing
third-largest private US company Company must rely on private investment, which
❯ Aldi German supermarket chain is often harder to attract because there are fewer
comprising two private firms, Aldi Süd financial details available.
and Aldi Nord, trading under one name Valuation
❯ The LEGO Group Danish company Value of the company is more likely to fluctuate; it
producing household-name toy bricks is more difficult to assess because there are fewer
❯ Hearst Corporation Mass-media available financial details.
multinational based in New York City Size
❯ IKEA Swedish retailer registered in
Number of shareholders is limited, usually to
Netherlands selling flatpack furniture
fewer than 2,000.
❯ PwC Professional services network
 HOW COMPANIES WORK
Business ownership 18 19

3,800
companies are listed on
GOING PUBLIC
There are legal requirements at each stage of converting
a company from private to public, including voting in the
board of directors and deciding on a new name.

the Tokyo Stock Exchange. Choose board members

Usually at least three directors to
allow future board decisions to
be made with only two members
present (representing a majority)

Inform staff
Must notify in writing anyone with

Public
an interest (including employees
and proposed board members)
that company intends to go public

Vote for conversion

Board meeting held to vote in
favor of changing company’s
Articles of Association (specifying
private or public company)

Register company
Directors
Documents setting out board
Not necessarily shareholders. resolutions sent to company
Reporting registry, which issues certificate
Company has legal obligation to disclose accounts declaring the company is public
and submit regular financial reports.
Make public announcement
Shareholders and management
Press releases issued, events for
Clear boundary is drawn between the role business held, and emails sent to
of shareholders and management; there may inform contacts of change
be conflicts of interest between them. Freely
transferable shares mean that original owners
could lose control if major shareholders
launch a hostile takeover bid.
Financing NEED TO KNOW
Company can tap financial markets to raise capital
❯ Unquoted/unlisted company Another term for
by selling stock or bonds.
a private company
Valuation
❯ Initial public offering (IPO) Stock-market launch
Value of the company is easier to assess, from the ❯ Secondary stock offering Second-round sale of shares
trading price of shares and financial statements. to raise more capital
Size ❯ Ticker symbols Unique codes assigned to publicly
Number of shareholders is unlimited. traded companies and used by stock exchanges
 Multinationals
A multinational corporation has business operations in more than
one country. It usually starts as a national company and sets up
subsidiary (branch) companies abroad for production and sales.

How it works to local cultural/market differences.

Multinationals have several goals: A company may achieve such goals United Kingdom
to increase revenue by finding new by outsourcing (using external London
markets, to streamline operations suppliers) or offshoring (relocating One of many country HQs in major
and production by taking advantage functions). Companies may also European cities, the London office
of global locations with lower labor insource (move operations in-house) serves the U.K. market.
and/or transport costs, and to adapt to rightsource (find a good balance).
Regional HQ Management
and core admin functions

Case study: mapping a multinational Marketing U.K. campaigns

Sportswear company Nike has successfully spread around the globe from and merchandising
its corporate base in the U.S. It has manufacturing functions where technical
expertise maximizes efficiency and keeps costs down, distribution hubs in
strategic locations, and marketing and retail departments in countries where
it is establishing local markets.

GLOBAL VS. MULTINATIONAL United States

Beaverton, Oregon
A global company has facilities in different countries
Senior management are located at the company’s corporate
but operates as a single corporate culture with
base, or “campus,” its center for decision making on global
common processes. A multinational has facilities in
strategy, design, marketing, and core functions. Facilities of
different countries, but each functions as its own
Nike subsidiary Air Manufacturing Innovation (AMI), which
entity, adapting locally, with little communication
develops and supplies materials, are here as well as in
between geographic divisions.
St. Charles, Missouri.
Global
Regional HQ
Operations for Americas,
Apple is an example of hello hola!
Asia-Pacific, and U.S.
a global company—the
product is essentially World HQ Global marketing
the same except for a Management, finance, Branding and
language change. legal, IT, and admin marketing
Multinational R and D Sports Supplier Subsidiary
research lab and AMI develops and
McDonald’s is a design facilities supplies materials
multinational—the
product changes to suit Memphis, Tennessee
the market. For example,
it serves a shrimp burger Distribution Four high-tech centers in location
in Japan and chicken rice with good links. Other centers in Indianapolis,
porridge in Malaysia. Indiana, and Dayton, Tennessee
 HOW COMPANIES WORK
Business ownership 20 21

The Netherlands NEED TO KNOW

Hilversum
Based in a central location, a European ❯ Transnational corporation ❯ Platform corporation
headquarters supports operations Similar to a multinational but Multinationals that do not
across Europe, the Middle East, and does not identify itself with manufacture but outsource
Africa and is close to the company’s any particular parent nation products they have designed
European distribution hub in Belgium.

European HQ Management, China

finance, legal, IT, and admin
Shanghai
Distribution European logistics The company’s fastest-growing market, China is also a manufacturing and
center based in Laakdal, Belgium distribution base due to local expertise and low production costs.

Chinese HQ Operations Manufacturing Sportswear

and core support functions factories and innovation hubs

Marketing Campaigns for Distribution Centers in

the Chinese market Taicang and Suzhou

Japan & South Korea

Tomisato & Incheon
Major company-owned
distribution centers

Distribution Hubs for

retail stores across Asia

Vietnam
Dong Nai province
Home to facilities of Nike’s AMI
subsidiary, which supplies
materials. Most manufacturing is
carried out by contract factories
in Vietnam and Cambodia,
benefiting from expertise and
Rest of the world lower wages.
Multiple locations
Supplier Subsidiary
Nike runs international branch offices and subsidiaries in around 50 countries as AMI supplies materials
well as 1,000 retail stores and 45 digital commerce platforms across the globe. to factories

Regional HQ Core operations Retail Online sales and stores Manufacturing Sites
and marketing around the world in several countries
 Franchises
A franchise is a business model in which an independent
entity—the franchisee—is entitled to set up a branch of an
established brand. There are advantages for both parties.

How it works business with modest capital

Rather than developing an original outlay, while the franchisee takes NEED TO KNOW
business idea, the franchisee on a proven business model and
pays for the right to represent brand name, so everyone reaps ❯ Franchise disclosure documents
(FDD) Pre-agreement
an existing, successful brand the benefits.
information
in a particular location. The size
❯ Microfranchising Support and
of a franchise can vary from a
single unit—one outlet only— “I put the training for small-scale businesses
in the developing world
to an area development in which
the franchisee takes on the option hamburger on ❯ International Franchise
Association (IFA) Oldest
to represent the brand through
several branches in a city or region. the assembly line.” and largest franchise organization

The franchisor can develop the Ray Kroc, founder of McDonald’s

Three types of franchise

The franchisor’s level of control varies from managing the contracts for the entire supply chain
to input on every detail down to the last French fry. In a product franchise, the franchisor lends
its trademark and brand but not an entire business system.

Manufacturing franchise Product franchise

This is a supplier-dealer relationship in which
the franchisee sells the franchisor’s products.
Examples include tires, cars, and gas.

A company that manufactures a specific range

of products grants retailers, or franchisees, the right to
distribute its products and use its brand name and
trademark. For example, beverage-makers sell syrups
to the franchisee, who then bottles the drink.
 HOW COMPANIES WORK
Business ownership 22 23

TOP 10 CASE STUDY

Fastest-growing franchises Business-format franchise: fast-food outlets
worldwide
The business-format franchise, in A limited and uniform menu was
1. Century 21 Real Estate which a franchisee takes on a whole the key to the success of these
property blueprint for running the business franchises. The consistency of the
2. KFC fast-food outlets as well as the product itself, was menu, service, and surroundings
3. Circle K convenience stores pioneered in the US in the 1940s. helped establish a strong brand
Fast-food outlets were a new identity because customers were
4. Jan-Pro commercial cleaning concept at the time and were assured that the product and
5. McDonald’s fast-food outlets generating great demand. To increase experience would be the same
6. Taco Bell fast-food outlets the rate of expansion, these original anywhere in the country.
7. 7-Eleven convenience stores fast-food entrepreneurs developed McDonald’s is one of the most
a franchise system under which successful examples, collecting
8. F45 Training fitness the franchisee was contractually a 4 percent service fee and rent
9. Stratus Building Solutions required to run the outlet according from its 36,000 franchises worldwide.
commercial cleaning to strict guidelines.
10. Anytime Fitness gyms

Business-format franchise

The most common type, this has high input from

the franchisor, including brand name and trademark,
training, store identity, marketing plan, and company
culture. The franchisee buys supplies from the franchisor
and pays fees and royalties. Fast-food outlets are
typical business-format franchises.
 Not-for-profits
Some organizations are run not for the benefit of shareholders but
for the benefit of their members or an external community or charity.
Unlike conventional businesses, profit is not the goal.

8.6%
How it works
Organizations that do not intend to generate profit
for their shareholders, are self-governing, and are
committed to a common cause are categorized as
not-primarily-for-profit, not-for-profit, and nonprofit
entities. On this spectrum, cooperatives may disburse
of all wages and salaries
profits to members, but charities are strictly nonprofit.
Although their goals differ, not-for-profits have a similar
paid in the US come from
type of company status and structure as businesses. the not-for-profit sector.

The not-for-profit universe Cooperative

There are many forms of not-for-profit Owned by members;
organization (NPO). Joel L. Fleishman, can benefit from profit;
professor of public policy and law at clear ethos of pursuing
common economic, social,
Duke University, has characterized
or cultural goals; one
the not-for-profit sector as a
member, one vote
universe that embraces
all NPOs, whatever
their mission.
Social
Private foundation organization
Similar to a charity but Based on common
funded by one source, as interests or beliefs, such as
opposed to the general public; social or academic interest
generates revenue from or a benevolent cause; civic
investments; makes grants to clubs and college
other charitable bodies fraternities/sororities
are examples

THRIVING SECTOR
Despite being NPOs, many cooperatives ❯ Japan Zen-Noh cooperative: $56 billion
and mutuals have a sizeable annual turnover ❯ US State Farm mutual: $43 billion
(gross revenue transacted).
❯ Korea Nonghyup (NACF): $41 billion
❯ France Crédit Agricole Group of cooperatives
❯ UK Co-operative Group: $14 billion
and mutuals: $89 billion
❯ Spain Mondragón cooperative: $14 billion
❯ Germany REWE Group: $63 billion
 HOW COMPANIES WORK
Business ownership 24 25

NEED TO KNOW NOT-FOR-PROFIT

STRUCTURE
❯ Philanthropic sector Alternative ❯ 501 c3 Tax code designation that
umbrella term for the not-for-profit indicates that an organization is Chair coordinates the
sector or universe legally a tax-exempt charity work of the directors.
❯ Charity Navigator An ❯ Associated charity Organization
organization that monitors and related to a main charity that
publishes information about takes on a particular aspect of Board of directors
charities to help consumers decide the charity’s work is usually unpaid;
which charities to support may also be called
the board of trustees.

Committees formed
by board members
carry out specific tasks,
Nongovernmental such as fundraising.
organization (NGO)
Funded by government Administration
or by international donor staff often includes
agencies, such as the World a proportion of
Health Organization (WHO); volunteers.
operates independently

Mutual
Raises funds from
its members (usually
customers); often takes the
form of financial institutions;
profits reinvested in the
mutual or to sustain or
grow the organization
Chamber of commerce
Group of business people
that gathers to promote trade,
investment, and cooperation;
usually funded by subscriptions
from local businesses

Charity
Must be registered as
charity status; tax exempt;
Social enterprise all resources must be devoted
May sell goods or to the charity’s stated charitable
services to fund community activities; may be organized
projects; any surplus revenue as a trust, corporation,
is reinvested in the enterprise or association
for the community
 Start-ups
A start-up is a new business in the early stages of development and operation,
during which an entrepreneur or founding group comes up with an idea for
a product or service, researches it, develops a business plan, raises funds,
and launches. Registering intellectual property (IP)—a unique creation, not
just an idea—in order to protect it is an important stage of the start-up
process. Protection includes trademarks, patents, and copyright.

The early days

Before a company is fully developed
with a working business model, it
is known as a start-up. The start-up
evolves from an entrepreneur, or
4.35 million
new business applications were
group of entrepreneurs, with an idea
or invention. It can take a few years to
turn the initial concept or prototype
submitted in 2020 in the US.
into a viable, profitable venture, so the
start-up founder tries to attract
support and financial backing to
achieve rapid growth. During this
phase, which can take anywhere from INTELLECTUAL PROPERTY (IP) VALUE
a few months to several years, the
business changes quickly. The term ”start-up” became
commonplace during the dot.com
boom of the late 1990s, when

NEED TO KNOW
thousands of entrepreneurs with
web-based products and services ™®
©
found funding, many on the
strength of their intellectual
❯ Internal start-ups Start-ups property alone. Giants Google
that originate from inside a and Amazon both started up at
large organization this time. Since then, technology
❯ Patent trolls Individuals or businesses have become one of the
companies who buy the patents of most talked-about start-up types.
failed start-ups and attempt to Their value is often based 100
collect licensing fees from potential percent on intellectual property.
infringers of the patents
 HOW COMPANIES WORK
Start-ups 26 27

he big idea
T

Consider Launch
the IP ❯ Win? Lose?
❯ Register IP. ❯ Research indicates
❯ Find a name. that, in most Western
❯ Buy a domain. countries, 80–90 percent
of start-ups fail.
❯ Research market.

Choose a Prepare to launch

start-up type ❯ Plan a marketing campaign.
❯ With a social conscience? ❯ Run a test launch and refine
❯ Primed to grow big? message and offer.
❯ To fit lifestyle? See pp.196–197.
See pp.30–31.

Make a Find funding

business plan ❯ Invest savings.
❯ Explain how the
business will make money.
❯ Ask friends
and family. € €
❯ Describe the unique ❯ Take out a bank loan.
aspects of the business. ❯ Seek venture capital.
❯ Determine how much ❯ Try crowdfunding.

49.6%
money the business will
need and will make. See pp.34–37.
See pp.32–33.

Seek help ❯ Enter a business

incubator.
of adults in Angola
❯ Join a business
accelerator. ❯ Go it alone. are starting or
❯ Find an investor.
See pp.38–39. running a new
business.
 Start-ups, from
concept to launch
A new business can be described as a start-up in the early phases of
its launch, when an entrepreneur comes up with the idea for a
product or service and develops it into something that will sell.

How it works start-up, so it is worth spending

The idea is just the start. Next some time doing online research NEED TO KNOW
comes the process of expanding to check that no one else is using
the concept into a viable business. a desired name, especially in a ❯ Lean start-up Method of
learning fast and discarding what
Specialized help may be needed in negative context. Location is
does not work to keep start-up
some areas—a digital marketing another consideration—it may costs down
advisor or an accountant to advise be possible to create a virtual
❯ Start-up pivot Quickly changing
on the best structure and financial office and work from home. direction or correcting mistakes
set-up, for example. What the Finding offices is an extra based on customer feedback or
business and product or service stage, but the aim at start-up technology changes
are called can make or break the is to keep costs low.

Come up with a Register IP

good idea For an invention or
innovation, register
START Develop a product or
an idea for a product intellectual property
or service. (IP) with copyright,
trademark, or patent.

Set up an online Decide on a name

presence Check to determine whether your

@ Register the domain

name and set up
web hosting.
proposed name is available; check
that the domain name is available;
search online for competitors with
similar names.

Create a look Make a website

Design a logo and Build a website.
visual brand for the Research search engine
business. optimization (SEO)
words to include (see
pp.230–231).
 HOW COMPANIES WORK
Start-ups 28 29

CASE STUDY
Om Engineering Works
Om Engineering Works was started
in 1987 by Om Prakash Jaiswal.
Now known as Highflow Industries
and run by Om Prakash Jaiswal’s
8%
of start-ups
Operating from a shop in Uttar
Pradesh, in northern India, he used
son, Sumit Jaiswal, the company
makes batteries for e-rickshaws, go on to
to sell rubber containers and plates
to battery companies, but in 2000,
solar panels, inverters, cars,
tractors, two-wheeled vehicles, become
he came up with the idea of and more.
producing the batteries himself, “There is a huge market potential successful
and later, with the idea of smelting
and recycling them.
with the advent of solar and
e-rickshaw segments,” says Sumit businesses.
Since then, the market for Jaiswal. “This is because they help
these batteries has grown, and cut down air pollution and reduce
breakthroughs in manufacturing overall carbon emissions. The
technology have allowed the firm batteries have always played a vital
to go from making 20 to 300 role in this.”
batteries a day.

Research market Decide structure

Study your proposed Choose a business
target market and structure that suits
potential competitors your initial needs but
and evaluate the also allows flexibility
viability of the idea. for growth.

Obtain backing Devise a plan

$ funds Draw up a plan (see pp.32–33),
Consider a business including your goals, mission
incubator (pp.38–39) if statement, and key financial
the business requires information.
large-scale support.

Set up finances Start marketing

Include an accounting Plan a marketing
and cash-flow system, campaign. Run a
LAUNCH
$ sales tax if applicable,
and bank account.
test and make any
refinements to the
message or strategy.
 Types of start-up
Entrepreneurs go into business for many reasons: some start-up
decisions are based on personal convictions; some are founded
on the desire to make money, and others are a mix of the two.

How it works those that are intended from the

Not all start-ups fit the same mold. outset to be large ventures within NEED TO KNOW
Although they often follow a similar a corporate environment and
process in their initial evolution, those intended to work on a more ❯ Enterprise portal Dedicated
website providing content
they are as varied in type as the personal scale to suit the lives
for staff, usually intended for
personalities behind them. Start- and passions of individuals. larger companies
ups can broadly be divided into
❯ Micropreneur Entrepreneur
who keeps their business small
so they can control and manage
Lifestyle it alone
Motivation ❯ Burn rate How fast the start-up’s
initial cash balance is going down,
Working is a passion
month by month

o cial start-ups
S
Motivation
Making a difference

Example
Ex-athlete starts
fitness-consulting
business

72%
growth in
Type of funding
Self, friends,
peers, bank loan
Example
Malaria blood-test kit
for smartphone

the number of
fintech start-ups
between 2018 Type of funding
Community, charity,
and 2020 government, donation,
crowdfunding
 HOW COMPANIES WORK
Start-ups 30 31
a large
ithin co le start-
ve
w Motivation r p c alab up
Innovating S Motivation

or
i
iat
Readiness to grow

a ti
Init

on
0101010011
0100010101

Example
PC manufacturer starts
a separate business
Example
all business providing cloud
Phone app
Sm data storage
developer
Motivation
Feeding the family

Type of funding Type of funding

Internal company Crowdfunding,
funding angel funding
on
quisiti target
Ac Motivation s
Example Looking to sell the business
Neighborhood grocery from the beginning
shop

Type of funding
Self, family,
bank loan
Example
Biotech
laboratory

Type of funding
Outside
investment
 Business plans
Writing a business plan is one of the most important steps in
developing a start-up. The plan provides the new business’s
goals, market analysis, and projected income and profit.

How it works new business will be uniquely positioned to capture

Before a start-up entrepreneur can write a business that market, given the services or product being offered.
plan, they need to have done enough research to An outline of existing finances and an accurate
identify a clear opportunity in the market for the projection of sales and profit are essential components,
product or service and to define how the proposed especially if the owner is seeking external funding.

Key elements
Executive summary Business
Preparing a business plan can take
several weeks, and it is worth doing
Complete this section last, bearing
in mind that it may be the only part
background
thoroughly. It is a vital document Provide details of each person in
that a busy person reads:
for securing funding, so the financial the business:
forecast must be both realistic and ❯ Business summary Company
structure, name, product or ❯ Experience Relevant
accurate. If it is being shown to others, work carried out to date,
service, and customer profile
pare the executive summary down to achievements, contacts made
two A4 pages, write it in plain ❯ Business aims Three objectives
over one, three, and five years ❯ Qualifications Credentials,
language, and explain any technical such as diploma in horticulture
terms. ❯ Financial summary Expected for a gardening service
sales, costs, and funding
❯ Training Past and future,
❯ Elevator pitch Two-minute talk including business skills, such
to sell your idea to an investor as assertiveness

Products and The market

69% services Set out specific details of the

potential market:
Describe what the business
is going to sell: ❯ Typical customer Businesses
or individuals and their profile;
❯ Product or service With
of current a picture if the product is new
local, national, or international
❯ Market research What the
❯ Range If more than one, such as
small business garden design and maintenance
local market is like for similar
products or services
❯ How it is different What makes
owners the product or service stand out
from the crowd?
recommend
writing Marketing strategy
a plan. Choose about three
of these methods:
❯ Word of mouth
❯ Advertising
❯ Social media ❯ Business literature
❯ Website ❯ Direct marketing
 HOW COMPANIES WORK
Start-ups 32 33

TOP FIVE REASONS TO WRITE A PLAN NEED TO KNOW

❯ The process Working through each ❯ Areas of expertise Making a ❯ SWOT analysis Stands
element ensures nothing is forgotten. business plan clarifies where outside for Strengths, Weaknesses,
❯ Costing The only way to find out help is needed—for instance, for Opportunities, and Threats
whether the business is viable is to bookkeeping or marketing.
❯ Unique selling point (USP)
work out details of costs and sales. ❯ Getting to know the competition Feature that makes a product
❯ Funding A good business plan Conducting market research is the different from competition
improves chances of getting a loan. best way to give a business an edge.

Competitor analysis Operations

Show how the business idea
compares with the competition:
and logistics
Describe how the business
❯ Table of competitors Who and will run day to day:
where they are, what they sell and
for how much, how good they are ❯ Supply and delivery How the
goods or service will get from A to B
❯ SWOT analysis Including how
to remedy any weaknesses and ❯ Equipment Transportation, office
combat known threats, such as items, and location
a garden center opening nearby ❯ Payment, legal, and insurance
❯ USP Unique selling point of the How customers will pay and
product or service how that translates into salaries;
compliance with the law
See Need to Know panel, above.

Costs and pricing Financial forecasts

strategy Predict sales and costs over the year,
allowing for seasonal fluctuation, such
Work out how much the product or
as spring demand for garden services:
service costs and its sale price:
❯ Sales calculations For each month,
❯ Cost How much each unit or
the expected number of sales
batch costs to make and deliver
❯ Costs calculations The costs of
❯ Price How much each unit or
the predicted sales each month
batch will sell for
❯ Cash-flow forecast The money
❯ Profit margin The difference
coming in and out of the business
between cost and price per unit
See How Finance Works, pp.98–175.

Back-up plan
Make a Plan B in case something goes ❯ Longer-term changes Shifts, such
unexpectedly wrong: as working online, not on-site
❯ Short-term changes Cutting costs ❯ Closure Lessons learned and skills
or boosting sales immediately acquired if the business closes
 Raising money
Almost every new enterprise needs funding to get it going and to
keep it afloat until it turns a profit. Financial help is available from
a variety of sources, suitable at different stages of start-up growth.

How it works capitalists (VCs), provide equity

Capital for new enterprises comes capital in the form of a share
from two main sources—lenders in the business that includes
and investors. Lenders, such as a proportionate share of control
banks, provide debt capital in the and rewards. Both types of
form of a loan that is returned funding can be corporate—from
with interest. Investors, such a company—or come from other
as business angels and venture sources, such as crowdfunding.

Types of start-up funding $ Lenders

Debt capital most often takes
Corporate and traditional funding, which tend to the form of loans paid back
be substantial, come largely from banks and VCs, with interest.
while smaller sums come from individuals instead
of institutions.

Term loan Paid back regularly Bank overdraft or credit card Factoring/invoice discounting
over a set period of time Interest charged monthly if balance Unpaid invoices sold at a discount
not paid in full to a company that collects them
for commission

❯ Bank Offers either personal or ❯ Bank or credit company ❯ Factor or discounter

business loans Finance organization that makes Company that offers advances
❯ Building-and-loan association loans to commercial ventures on unpaid invoices, for a profit
Offers loans to buy a property
❯ Government Offers low-interest
start-up loans
❯ Credit union Cooperative that
NEED TO KNOW
offers members low-interest loans $
❯ P2P lending Loans made
❯ Peer-to-peer (P2P) lending
Unsecured personal loans $ between individuals over Internet
❯ Crowdfunding Debt or equity
❯ Friends and family May offer raised via internet platforms
interest-free loans
 HOW COMPANIES WORK
Start-ups 34 35

36%
-up fund
rt

in
Sta

g
of prospective small
business owners say
that getting start-up
funding is a priority.

Investors Grants
Equity capital is paid to the Financial awards and
start-up in return for a share prizes are provided
of the business. by public bodies.

Founders, friends, family (FFF) Local, national, global

May buy shares in the company Funded by a local, state, or
rather than lending money federal government initiatives,
an agency, or a charity

Crowdfunding Large number

of supporters, each contributing
$ a small amount of money,
usually online
TYPES OF CROWDFUNDING
Crowdfunding is becoming a more acceptable source
of alternative funding. There are four main types:
Angel investors Investors who ❯ Equity-based The company sells shares to raise
give favorable terms, as their capital. In return, investor owns part of the business.
focus is on the company’s ❯ Debt-based Where individuals lend money to the
success rather than on profit company. In return, the company agrees to pay it
back at given intervals, with or without interest.
❯ Royalty-based Crowdfunders receive a percentage
Venture capitalists (VCs) of the company’s revenues once it generates returns.
Companies that provide capital ❯ Incentive-based Investors donate money in
for new businesses in the hope exchange for free products or merchandise, or
of reaping profit other incentives from the business.
RAISING MONEY

Alternative models
In the wake of the economic CREDIT ANALYSIS CRITERIA FOR LENDING
downturn that started in 2008,
several innovative and more Capacity Collateral
personal types of funding, such The borrower’s ability to repay the The borrower is often expected to
as crowdfunding and peer-to-peer loan is shown by the business plan. pledge an asset that can be sold to
(P2P) lending, have evolved and Capital pay off the loan if funds are too low to
blossomed on the Internet. All pay the monthly interest or repay the
Many lenders assess a borrower’s net capital at the end of the term.
involve the principle of raising worth to verify assets versus debts.
small amounts of money from Conditions
Character
large numbers of individuals, The lender is swayed by the current
The borrower needs to show a good economic climate as well as by the
who pool their resources to
credit history and ability to succeed. sum requested.
provide the loan or equity needed.

Life cycle of , fr
iends, fam owd
funde
rs
rs Cr
investment
ily
de
Foun

(FFF
The key to successful funding is to
choose the right type of finance at
each stage of a company’s early )
$
growth. Start-ups usually begin
modestly, with self-funding and help
from friends, family, and anyone else
who is prepared to take a high risk.
Crowdfunders are amateurs who
are willing to help the entrepreneur
succeed, while angel investors and
venture capitalists will likely take RISK
more risks than other lenders, such
as banks, if they believe that injecting
substantial funds will return them a
healthy profit. As sales soar and success
looks probable, public markets, such as
stock exchanges, can provide an extra T
MEN
VEST
funding boost. At all stages, investors IN
will conduct credit analyses to assess
a firm’s ability to repay its debt.

REVENUE

TIME
Idea Seed
 HOW COMPANIES WORK
Start-ups 36 37

Financing 5,000 startups over the last decade

The chart shows sources of start-up finances from over 5,000 entrepreneurs in the US from 2005 to
2015, taken from a 2015 survey by the Kaufman Foundation. By far, the most funding comes from
bank loans and individual savings.

30% Personal
savings 6.2% Credit
card

34.9% Bank or
other loan $ 18.5% Other
$
nv marke
gel i estor tur
e capita
lis blic ts
An s en ts Pu
V

SALES

Early Mid Late

 Business accelerators
and incubators
Starting a new venture can be a long process. Business (also called
venture) accelerators and incubators are specialist organizations
devoted to developing and supporting start-ups.

How it works including mentorship, business advice,

Business accelerators and incubators provide expertise and connections to potential sources of finance.
and connections in the formative stages of a business Business incubators, on the other hand, provide a
in return for a percentage of ownership. They are two supportive environment in which fledgling start-ups
separate types of service. Business accelerators are can develop, offering technical assistance, working
short-term programs that offer wide-ranging support, space, and networking opportunities.

Business accelerators
Suited to start-ups that have limited financing, accelerators offer short–term (one to three months)
boot camps. Individual accelerators may specialize in a specific area, such as software development.

Help with bank

loans, funds, € Links to
and guarantees
programs € € potential
investors
Introduction
to potential
partners
Access to
Accounting
mentors and
and financial
advisory
services advice
boards

Marketing
Networking
Start-up pays advice
accelerator % of
equity in the business.

Management
Seed capital In return, accelerator of intellectual
provides help and property
services.
 HOW COMPANIES WORK
Start-ups 38 39

Business incubators
Start-up pays
Often sponsored by nonprofit incubator %
organizations, incubators tend to be of equity in the
longer term (one to five years) and business. It may
cater to a variety of clients, many also pay rent to
science-based. share part of the
incubator’s work
space. In return,
it receives a range
of benefits.
Start-up
introduced
to incubator

NEED TO KNOW
❯ Incubator networks Support and education Mentorship
Collaboration of incubation
centers, research facilities,
and science parks
❯ Virtual business incubator
Online hothouse for start-ups

$107 Specialized facilities, such as Office space to

million
science laboratories work from

invested globally
by US and Canadian
accelerators from
2012 to 2017. Interaction with
other start-ups
Seed money
to get started
 Buying & selling
businesses
Both private and public companies regularly change hands—they are bought,
sold, and restructured to reflect changing business conditions. These deals
all come under the umbrella term of mergers and acquisitions (M and A).
Acquisition financing is usually needed to pay for the purchase of another
company, often in the form of a loan or venture capital.

How to acquire a company

A company is typically acquired in one of two ways—either by a
management team or by another company. When a company is
buying, the result can be a merger, in which two companies join
ompany
tc
forces; an acquisition, or an outright purchase; or a demerger, in
which part of a company is broken off and may be sold.
e
rg
Management team purchases are often funded by private equity. Ta

Mangement team acquiring FOR

SALE
Private equity firms look for companies
to buy and then sell their shares when
profits have maximized. They fund the
management team. See pp.48–49.

Buy-out Demerger
The existing management team buys out Part of a company
the company that they work for. is split off to form a
Buy-in new company; may
become acquisition
An external management team buys into target. See pp.44–45.
the company.
 HOW COMPANIES WORK
Buying & selling businesses 40 41

M AND A KNOW-HOW

45,652
Measuring a big deal
The corporate world categorizes acquisition
deals according to the capitalization size (the
value of the company’s shares).

the number of M and A $ Small Under $500 million

deals, globally, in 2020 Mid-market $500 million

$ $

to $2 billion

$ $ $ Large $2 billion
to $10 billion

$ $ $ $ Megadeal More
than $10 billion

Another company acquiring Due diligence

Companies may want to expand by Before any company sale, the potential buyers
joining up with another business. see a detailed report prepared by lawyers,
covering key aspects of the target business.
❯ Financial Identifies problem
Merger areas that could affect the future
The company combines with value of the company.
another company. See pp.42–43.
❯ Legal Gauges possible legal
risks attached to corporate
status, assets, securities,
intellectual property, and
employee restructuring.
Acquisition
Horizontal The company ❯ Commercial Includes industry
buys another company that $ trends, market environment, the
makes similar products or offers company’s capabilities,
similiar services. and the competition.

Vertical The company buys ❯ Environmental Uncovers

another company that makes potential liabilities, such as
different products or offers land or water contamination,
different services. See pp.46–47. and estimates remedial cost.
 Mergers and
acquisitions
Two of the quickest ways to accelerate expansion are
for a business to buy out another—an acquisition—or
REASONS TO PURSUE
M AND A
to combine with another business in a merger.
❯ Improved economies of scale
Wider operations streamline
How it works on reasonably equal footing to
production and sales.
“Mergers and acquisitions” create a new company, which will
❯ Bigger market share
(M and A) is a general term used benefit both parties, an acquisition
Combining the existing markets
to describe the ways in which is usually a purchase of a smaller expands share of the total market.
companies are bought, sold, and company by a larger one. This
❯ Diversification A different
recombined. In the case of either benefits the company making the product lineup gives the chance
a merger or an acquisition, two purchase but may not necessarily to cross-sell or create more
separate legal entities are unified benefit the target company. efficient operations if the
into a single legal entity. While a M and A can be friendly or products are complementary.
merger combines two companies hostile, agreed to or imposed.

Merger Company A
manufactures
Company B
manufactures
luxury cars in the US. luxury cars in Italy.

merges with
A B

B
Acquisition

A takes over

Company A produces films. Company B creates animations.

 HOW COMPANIES WORK
Buying & selling businesses 42 43

FRIENDLY VS. HOSTILE NEED TO KNOW

❯ Pacman strategy The target
company tries to take over the
very company attempting the
hostile buyout
❯ Swap ratio An exchange
❯ The target company’s board of ❯ The acquiring company bypasses rate between the value of
directors and management agree management and goes straight to the shares of two companies
to be bought out. the target company’s shareholders. when merging
❯ The acquiring company makes an ❯ The target company’s management ❯ Defensive merger Undertaken
offer of cash or stock to the target fights the deal. to anticipate a merger or takeover
company’s board and management. ❯ The buying company convinces attempt that threatens a company
❯ The stock or cash offer is set at a shareholders to vote out the ❯ Economies of scale Benefit to a
premium level. management (a proxy fight), or it company of M and A expansion
❯ Because the offer is above actual makes an offer to shareholders to
market level, shareholders usually buy shares at an above-market price
agree to it. (a tender offer).

$734
New company A + B now has
an expanded market spanning
Europe and North America.

A+B
billion
the value of all
mergers and
A acquisitions in
the Asia-Pacific
Expanded region in 2020
company A
now has
in-house
expertise for

A
producing
animated films.
 Demergers
While a merger results in a bigger company, a demerger reduces
the size of a business by breaking it down into smaller components
or divisions, which are then sold off or dissolved.

How it works view, those that have promise but

The typical scenario for a demerger are not yet profitable. The process SUCCESSFUL
is a company that is struggling of restructuring by demerger is SPIN-OFFS
to pay off debt it has taken on to designed to free the company of
Mondel z The spin-off of Kraft
expand into new areas of business divisions with low return, to reduce
Foods owns the Oreo, Ritz, and
that are not yet profitable. To debt and financing requirements, Trident brands.
save the rest of the company from and to give the shareholders a
Paypal Formerly part of eBay, the
the burden of debt, management stronger return. The market price of online payments service became a
decides to start a demerger. the parent company’s shares often stand-alone firm in 2015.
Generally, the aim is to shed the bounces back strongly, and its Tripadvisor Expedia spun off the
least profitable areas of operation or, spin-off companies may thrive too. online travel firm in 2011.
from the potential buyer’s point of

Demerger in practice
An industrial paint conglomerate, Power Paints Ltd., has grown rapidly over the past
five years, due to an increase in profits from its expanding sales in China. The company
diversified into agricultural chemicals, textiles, and biotechnology and set up a separate
division for each. Share prices fell in response to poor financial performance.

Making a decision Announcing the sale

Faced with a downturn in business, the company Power Paints Ltd. now announces the sale of its three
demerges the newer business areas that have not yet remaining divisions: agricultural chemicals, textiles,
shown strong returns despite positive signs of growth. and biotechnology.

INDUSTRIAL TEXTILES INDUSTRIAL

PAINT PAINT

Power Paints Ltd. Power Paints Ltd.

FOR SALE FOR SALE FOR SALE

AGRICULTURAL BIOTECHNOLOGY
CHEMICALS
AGRICULTURAL TEXTILES BIOTECHNOLOGY
CHEMICALS
 HOW COMPANIES WORK
Buying & selling businesses 44 45

NEED TO KNOW
❯ Spin-off New company formed as
the result of a demerger
❯ Tracking stock Special type
❯ Reverse merger Not to be
confused with a demerger, this is a
quick and cheap method for a
private company to go public by
3.3%
the average rise
of shares issued by a parent
company for the division or
subsidiary that they will sell; tracking
buying a shell stock—a public
company that is no longer operating
in a company’s
stock is tied to the performance
of the specific division rather than to
because it went bankrupt or was
simply closed
share price
the company as a whole; also known
as targeted stock
❯ Divestiture Term commonly
used for a demerger
following a
❯ Letter of intent Letter stating
serious intention to do business,
demerger
often concerning M and A announcement

The shareholders benefit

Shareholders in the original company also receive the same
percentage holding in shares of the three new companies.

One company becomes four

The three divisions are sold off to separate Chem Ltd. Fabric Inc. Bio Ltd.
investors and become three separate
companies. Shares for each are sold on the
stock market. The parent company is reduced
to its core business. Its share price rebounds.
AGRICULTURAL TEXTILES BIOTECHNOLOGY
CHEMICALS

Power Paints Ltd.

INDUSTRIAL
PAINT
 Vertical vs. horizontal
integration
Companies that want to expand through a merger or an acquisition
may decide on a strategy of either horizontal or vertical integration,
combining businesses involved in similar or dissimilar activities.

How it works merger or acquisition, the newly

Companies can choose from several formed company can save costs in NEED TO KNOW
strategies when they merge or are production, distribution, sales, and
part of an acquisition. Two of the marketing. Vertical deals are ❯ Lateral integration Another
most common are horizontal and usually made between businesses term for horizontal integration
vertical integration. involved in the same industry but ❯ Horizontal monopoly When
Horizontal deals are made at different stages—for example, a company controls the market
after buying up the competition
between competitors that produce a computer and a component
similar types of products, such as manufacturer. These deals can ❯ Synergy Potential of merged
companies to be more successful
cars or cell phones, and often be upstream (toward the market)
as a single entity
share—or compete for—the same or downstream (in the direction
suppliers and clients. As a result of of operations and production).

Integration models in practice

In these hypothetical examples, a cluster of printers, publishers, and bookshops
merge or acquire each other in horizontal or vertical deals that aim to strengthen
their market position, take advantage of economies of scale, and exploit synergy.

Horizontal integration
Two publishing companies, both involved
in the process of book creation but with
different areas of specialization, agree to a
merger deal to gain a larger market share.

PUBLISHER AB
Publisher A, a general publisher,
acquires specialist academic
PUBLISHER A Publisher B to strengthen its PUBLISHER B
textbook division.
 HOW COMPANIES WORK
Buying & selling businesses 46 47

ONLINE
BOOKSHOP
A
86%
of M and A
deals do not
exceed initial
expectations
PUBLISHER/ONLINE for income or
BOOKSHOP A
Forward
(upstream)
Publisher A buys Online
rate of return.
Bookshop A to improve
its brand presence and provide
a direct channel for sales.

Vertical
integration MERGER AND
A publisher acquires two ACQUISITION TYPES
related businesses—a
PUBLISHER A
printer and a bookshop— Horizontal
so that it can have greater When two firms in a similar field
control over both the merge, usually to take advantage of
production of its books economies of scale, share skills and
and their route to market. resources, and reduce competition.
The merger of Facebook and
Instagram is one example.
Vertical
Backward When firms in the same supply chain
(downstream) PUBLISHER/ come together. It is sometimes done
PRINTER A to ensure supply and control over
Publisher A buys Printer A raw materials—for example, when a
to improve print capacity and garment manufacturer acquires a
production costs and to provide cotton producer.
more warehouse space.
Conglomerate
When firms in different industries
come together. One advantage is
the cross-selling of products or
services to a larger customer base.
One example is food corporation
PRINTER A
Danone’s acquisition of Dutch
company Numico, which helped
it expand into the baby food and
nutrition market.
 Management buy-ins
and buyouts
A company’s ownership may undergo a change, which can be
driven either externally, known as a management buy-in, or
internally, known as a management buyout.

How it works company’s existing management

In a management buy-in (MBI), team purchases all or part of the NEED TO KNOW
a group of managers or investors company that they work for.
❯ Earn-out Percentage of the
from outside the company raises Despite the name, MBOs are not
purchase price paid to the sellers
the money to buy a majority stake restricted to managers, and they after acquisition if the business has
in the company and then takes can include employees from any performed as expected
over its management. This type level of the organization who wish ❯ Leveraged buy-out Acquisition
of action occurs when a company to make the transition from of a company using equity and
appears to be either undervalued employee to owner. borrowed money, with the
or underperforming. In a typical company as loan collateral
management buyout (MBO), the

Buy-in
Some companies, such as investment banks or venture capitalists, can make
sizeable profits by purchasing undervalued businesses and transforming them.

Company Company

+
$ – =
An outside management They raise funds They fire and replace the They overhaul the business
team or investment group to buy a majority previous management team. to improve performance and
sees that a company is shareholding. realize its true value.
undervalued.
 HOW COMPANIES WORK
Buying & selling businesses 48 49

BUY-IN MANAGEMENT BUYOUT (BIMBO)

In this type of transaction, the existing management of a company stages a
buyout, but additional external management is brought in by financers to
strengthen the company’s leadership and to provide expertise in particular
areas that might be lacking in the original team.
9:1
the typical ratio
of debt to equity
Company Company
in a leveraged
buyout

+ =
Existing management Outside management New management team
buys company. is brought in.

Buyout
A buyout allows a company to sell off all or a part of the business
or it helps a small business owner retire or move on.

Company Company Company

+
$ + =
The management team They raise funds via They buy the business. The management
sees an opportunity to bank loans, private team, who now
take ownership when investors, their own owns the company,
their corporate division is capital, or a loan from streamlines the
put up for sale. the seller. business to make it
more profitable.
 Who’s who
A company’s structure and hierarchy will develop as the business grows.
The tendency now is to cut down on unnecessary layers of management and
to ensure that everyone in the organization knows what their role is and to whom
they report. Most important is that the hierarchy fits the type of business and that
authority is delegated to the appropriate level to enable timely decision making.

Who’s who in an organization

Stakeholders and Board of directors C-suite executives
shareholders The board of directors makes sure that The top level operates the company
Stakeholders are anyone with a vested the company is run profitably to day to day and sets strategy. Known as
interest in the company. Shareholders provide returns to shareholders. The the C-suite because all job titles begin
are stakeholders who have bought board votes in a chair, who is with a “C” for “chief,” it is headed by the
stock in the company. See pp.60–63. sometimes also the chief executive CEO. See pp.56–59.
officer (CEO). See pp.52–55.
 HOW COMPANIES WORK
Who’s who 50 51

1/3
of global employees
FRONT LINE AND BACK OFFICE
Some employees are directly involved in
operational activities, such as making goods and
delivering services, or marketing and selling them.
They are sometimes said to be working on the front
strongly agree line. Their work is important, but they cannot
function without the support of back-office staff.
that they trust the These staff include people working in such roles as
finance, IT, and human resources. It is important

leadership of to ensure that both groups work well together to

enable the business to run smoothly.

their organization.

Mid-level management Junior management Nonmanagement employees

Division and department heads are Supervisors, managers, or team leaders These include skilled and nonskilled
usually called directors or managers. directly manage groups of employees workers but also people recruited for
Jobs at this level are often the first carrying out specific tasks. Examples their expertise, such as tax specialists
to go when a company downsizes include a head nurse or a foreman. See and scientists involved in research.
or restructures. See pp.56–59. pp.56–59 and pp.74–75. See pp.56–59 and pp.74–75.
 Board of directors
Public companies are required by law
to appoint a board of directors to Board of directors
provide oversight. The board of directors of a publicly listed company
sits between the company and its shareholders.
How it works
All companies must have at least one
director. If a company goes public and REPORTS TO
issues shares, it is legally required to have
a board of directors. The board is made Secretary
up of experienced business advisers who
provide independent oversight of the Appointed by
company for shareholders and are mandated The board or shareholders
by law to govern the company responsibly.
Responsible for
Board members may come from within
the company or be independent outsiders ❯ Keeping records and other
administrative tasks
and should cover a range of expertise—
such as legal, financial, and marketing— ❯ Ensuring rule compliance
or have specialized industry knowledge.
Networkers are also highly prized for their
ability to build connections with influential Financial director
figures in the corporate and governmental
spheres. Shareholders or board members Appointed by
elect roles, such as chair (president in some The board or shareholders
organizations), vice chair (or vice president),
Responsible for
EVALUATES

secretary, and financial director, although

the exact structure will vary from company ❯ Producing annual accounts
and financial strategy
to company.
of the business

Shareholders
Any person or
institution that has
bought shares in
a publicly listed
company is a
shareholder. The
board works for
the shareholders,
who effectively $ $
own the company.
 HOW COMPANIES WORK
Who’s who 52 53

Chair

Appointed by
The board or shareholders
Responsible for
16
the average
❯ Publicly representing the company’s policies
❯ Leading the board, conducting board meetings
board size in
❯ Determining the composition of the board Austria, versus
❯ Mentoring and monitoring the CEO or
managing director (MD) 10 in the U.K.
❯ Communicating with shareholders
Company
Responsible for day-to-day
Vice chair production, sales and marketing
operations, and finance. The
Appointed by company reports to the board via
its chief executive officer (CEO),
The board or shareholders who executes the board’s decisions.
Responsible for
❯ Standing in for chair
CEO
❯ Undertaking special
projects for chair
EVALUATES
Appointed by
❯ Assisting chair in balancing
REPORTS TO

experience, personality, and The board or

age of directors on board shareholders
Responsible for
❯ Performance of
the company
❯ Implementing
Directors board strategy
❯ Leading senior management
Appointed by ❯ Reporting back to chairman
The board or shareholders and board
Responsible for
❯ Determining strategy REPORTS TO EVALUATES
❯ Monitoring achievement of
implemented policies
❯ Appointing managers
Management
❯ Accounting for company’s activities to Managers pass the CEO’s
shareholders and other stakeholders decisions down to employees.
❯ Non-executive directors are not
employees of the company and offer
objective advice and expertise
BOARD OF DIRECTORS

Balancing the board of company executives, and call

The board has three clear areas of them to account. When potential NEED TO KNOW
responsibility: developing business conflicts of interest arise between
strategy, advising the company, and management and shareholders, ❯ NEDs Non-executive directors,
overseeing how the firm is run. independent directors can weigh also known as independent,
Selecting the right mix of directors decision-making in favor of acting in external, or outside directors
to fulfill these functions is crucial. the company’s best interests. ❯ Executive directors Board
Board members may come from The ideal balance is a hot topic members who also work for the
company—not to be confused with
inside or outside the company. in corporate governance. In US
the term executive director when
Those who work for the company companies, CEO and chairman roles used as a title for the CEO
(executive or internal directors) have traditionally been combined,
❯ Model Business Corporation Act
have more expertise in running but following a spate of corporate Developed by the American Bar
the business, but independent scandals, the roles are now more Association, this model is used as
members (non-executive or external often vested in two individuals. In the basis for corporate governance
directors) are better placed to offer Europe, keeping the roles separate in the US
perspective, scrutinize the actions has long been seen as best practice.

Board structure variations

Independent board of directors CEO as chairman
The board sits between shareholders and company. The A setup in which the company’s CEO serves as the board’s
CEO is the main channel of communication between board chairman. While this offers less independent scrutiny of
and company, while the chairman is the principal conduit finances, strategy, performance, and pay, it avoids duplication
between shareholders and board. This structure gives the of roles. This setup is found in US corporations and in many
board most independence. small- and medium-sized companies in other countries.

Shareholders Shareholders

Board of directors Board of directors

Chairman
CEO
and CEO

Management and Management and

employees employees

Key Shareholders Chairman Treasurer Secretary

 HOW COMPANIES WORK
Who’s who 54 55

WHAT DO BOARD MEMBERS DO?

The board exists to ensure the
success of the company and to
meet the appropriate needs of its
Different companies face different
legal requirements for their boards,
depending on whether the
97%
of French boards
stakeholders. It must enable the company is public or private,
business to move forward but also
exercises control. Some tasks are
and where it is located globally.
These requirements typically relate
have at least 30%
carried out by the members of the
board themselves – these include
to matters such as the filing of
accounts and the accurate recording
female directors,
establishing the vision and values for
the company and setting strategy.
of board meetings. Company board
members are answerable to both
compared with
Others are delegated to senior
managers, such as deciding how to
shareholders and to regulators.
43% in the US
implement a particular strategy.
and 3% in Japan

Senior management as directors Two-tier board

A structure in which senior managers also sit on the board. An arrangement that is made up of separate supervisory
The chief financial officer (CFO) is appointed board treasurer and executive boards. The supervisory board is composed
and the chief operations officer (COO) is vice-chairman. In of outside directors, led by a chairman. The executive board
some countries (Germany, for example), employees must be comprises senior managers, including the CEO.
included on the board by law. The two boards always meet separately.

Shareholders Shareholders

Supervisory board

Board of directors Executive board

Chairman Treasurer Vice-chairman CEO and board Employee and

and CEO and CFO and COO member board member

Management and Management and

employees employees

Vice-chairman Other directors CEO Management and employees

 Company hierarchy
Almost every organization has a structured arrangement of levels for
members, from the board of directors at the top to junior employees
at the bottom. There is a trend toward reducing the number of levels.

How it works executives, as their job titles often

C-suite executives
There are five levels in the begin with a “C.” Below the C-level
conventional corporate structure, is management, in tiers that differ These are the most senior jobs in
with a line of authority from top to from company to company, with the company, with the CEO at the
bottom. The chief executive officer employees forming the bottom level. top, the COO and CFO traditionally
(CEO) is the highest-ranking person As well as skilled and unskilled on the next level down, and other
in the company, reporting to the employees, there may be staff on C-positions below that. In many
board of directors and sometimes fixed-term contracts, taken on for companies, the C-level positions
have equal authority, and all report
also sitting on the board. Reporting the duration of a project or for a
directly to the CEO.
to the CEO are a number of high- set length of time, in addition to
level executives, known as C-level consultants brought in for special
purposes. There could also be
casual temporary workers as
C-SUITE VARIATIONS
well as outsourced workers—the Mid-level management
The range of C-level positions varies employees of an external company
for each company. As well as the contracted to operate in a certain Responsible for overseeing specific
three top posts, there may be: area of the business. functions in the organization, the
CAO Chief Administrative Officer most senior managers at this level
head up different departments or
CIO Chief Information Officer divisions. These managers are often
CTO Chief Technology Officer called directors (not to be confused

51%
CPO Chief Product/Production with the board of directors) or vice
Officer, responsible for overseeing presidents. The exact job titles and
product development and the number of mid-level managers
production vary, depending on the company.
CMO Chief Marketing Officer,
responsible for marketing strategy
and business development
of CIOs and CTOs say
C-level positions are evolving, they are pioneering
adapting to market conditions and
business priorities. New roles are
digital approaches
emerging, while some traditional within their business.
roles are disappearing. The role of
COO, for example, is less popular
in modern organizations. Some of Junior management
the new roles include: and other employees
CPO Chief Privacy Officer
Team leaders, such as supervisors and assistant managers,
CSO Chief Sustainability Officer
implement management plans. They also coordinate
CDO Chief Digital Officer teams of skilled and unskilled workers in,
CKO Chief Knowledge Officer for example, production, customer service, and sales
CCO Chief Customer Officer to carry out the core tasks needed for the company to
function efficiently and profitably.
 HOW COMPANIES WORK
Who’s who 56 57

US$21
CHIEF EXECUTIVE
OFFICER (CEO)
Decides on corporate
CHIEF OPERATING policy and strategy
OFFICER (COO)

million
Responsible for
day-to-day operations;
reports to CEO and
acts as second
in command CHIEF FINANCIAL
OFFICER (CFO)
Manages company’s
financial risk; reports the average
salary of a US
to CEO

CEO in 2019

MARKETING FINANCE
MANAGER MANAGER
Directs marketing Puts CFO’s plans
department or directions into
day to day action, instructing
junior managers

OPERATIONS R AND D MANAGER

MANAGER Heads up research
Oversees operations and development
division; may also (R and D) of new
direct production products
department

SUPERVISORS AND TEAM LEADERS

NONMANAGEMENT EMPLOYEES
COMPANY HIERARCHY

Flattening hierarchies division heads now reporting

The trend in management over directly to the CEO. In such NEED TO KNOW
the past few decades has been to cases, some degree of hierarchy is
eliminate layers from company maintained, but other companies go ❯ Span of control The number
hierarchies, which means they are even further, evolving to completely of employees reporting to
becoming flatter—in other words, flat hierarchies with no bosses at all. a manager or other senior
level; the greater the span
there are not as many levels to go However, such approaches tend to
of control, the more workers
through in order to reach the top. work best for smaller firms, proving reporting to an individual above
In most cases, this has involved less scalable in larger organizations.
❯ Line position Job role with
stripping away management Sometimes companies decide to responsibility for achieving the
positions in order to increase restructure the other way around goals of the organization
communication and collaboration instead—from flat to tall—by ❯ Staff position Job role providing
across all levels. For example, the eliminating a number of senior expertise to assist someone in a
role of chief operating officer (COO) management posts and replacing line position
has been disappearing in recent them with a greater number of
years, as have layers of middle junior supervisory roles.
management, with many more

Tall vs. flat hierarchies

There are pros and cons for both
types of hierarchy, and each Tall hierarchy
company has to find the number
of levels and positions within The traditional model is suitable for a formal chain
each level that suit the nature of command, such as in the military.
of its business. ❯ Several layers from top to bottom
CEO ❯ Fewer employees reporting to each manager;
close supervision possible
❯ More room for career advancement, as there
are many levels to rise through

Mid-level
CH

management
AIN
OF
CO
MM
AN

Supervisors and
D

team leaders

Nonmanagement
employees
 HOW COMPANIES WORK
Who’s who 58 59

CASE STUDY
Going flat at Valve
Valve is the developer behind such
hit video games as Half-Life and Portal.
saw numerous projects abandoned
after they failed to gain momentum.
14%
of executives
Believing that its hierarchical structure The experience led Valve to tweak its
was holding back innovation, radical approach, maintaining its flat believe that a
management decided to switch to a structure but uniting staff temporarily
flat structure. Now, Valve has no
bosses, and staff are free to work on
to focus on a new Half-Life title. As
one developer admitted, “We were
traditional
the projects they want. In return, they
take responsibility for their mistakes
wrong on the premise that you will be
happiest if you work on something
hierarchical
and the products they create. While
many people thrived in the freer
you personally want to work on the
most.” Released in 2020, Half-Life: Alyx
model makes
environment, others struggled to
adapt and departed. The firm also
was immediately acclaimed as a
landmark in virtual reality gaming.
their business
highly effective.

Flat hierarchy

This looser model is more flexible and suitable for

companies that foster creativity.
❯ Only a few layers, so mid- and low-level
management are merged
❯ Large number of employees reporting to each
manager; close supervision not possible
❯ More freedom for employees to make their
own decisions

CEO

CH
AI
NO
FC
OM
MA
Supervisors and ND
team leaders

Nonmanagement
employees
 Stakeholders
A stakeholder is anyone who is affected by the operations of the
company, directly or indirectly. Stakeholders include such groups
as employees, shareholders, regulators, suppliers, and customers.

How it works Sometimes, the needs of stakeholders conflict.

Companies have an impact on many groups of people For example, a community may rely on a business
through their operations. These include employees, to provide local employment opportunities but
who rely on them to pay salaries, and customers, who will likely be unhappy if the operations of the
want the products and services that they supply. It is business are noisy or cause pollution. In such
important for managers to understand what all these cases, the managers of the company must find
various stakeholders are looking for from them, ways to maximize the benefits to stakeholders
whether they can meet their needs, and if so, how. and minimize the drawbacks.

Stakeholders’ areas of interest

Different stakeholder groups take different levels of interest in different factors. Some predominantly care about
a company’s environmental, social, and governance (ESG) factors. Others may be more interested in its financial
performance, while still taking ESG concerns into account. Shareholders, for example, want profits, but they also
understand how sustainability is key to long-term growth and may want to invest their money ethically.

Stakeholders with ESG concerns

Stakeholders have no direct involvement but
believe that companies have a responsibility to
the communities they operate in to respect the
environment, human rights, and animal welfare.
Nongovernmental Community
organizations

$892
❯ Impact on local
❯ Contribution to inhabitants
environmental and ❯ Concern for broader
social causes social welfare
❯ Legal compliance

million
the average drop in market
value triggered by negative
news about a company’s
human rights record
 HOW COMPANIES WORK
Who’s who 60 61

Government Shareholders Customers

$ ❯ Tax payments ❯ Ability to pay dividend ❯ Quality product
❯ Legal compliance ❯ Increase in share value ❯ Value for money
Stakeholders
❯ Customer service
with economic
and ESG concerns
Stakeholders use
ESG—a recognized
part of policy and
reporting for most
companies—to
evaluate corporate
behavior and to
determine future
financial performance.
Concerns range from
profits to ethics.

$
Trade unions and Suppliers Employees Lenders
labor unions ❯ Ability to pay debt ❯ Pay and benefits ❯ Ability to repay loans
❯ Treatment of workers ❯ Enough liquidity ❯ Longevity of the ❯ Integrity of
❯ Fair pay, benefits, and company management
working conditions ❯ Employment prospects ❯ Financial strengths
of the company
STAKEHOLDERS

Stakeholders in action responsibility (CR), whether social media, stakeholders

Compared with other stakeholders, or not they are socially and can generate a storm of public
shareholders have the most interest environmentally conscious disapproval, leading to angry
in the financial performance of a themselves. Several high-profile consumers and nervous investors.
company. They are also forced to cases have shown how stakeholder
take an interest in how seriously reaction has caused a significant
the company takes its corporate decline in share prices. By using
$60

How stakeholders affect share value $30

In April 2010, an offshore oil rig owned by British Petroleum (BP)
exploded in the Gulf of Mexico. BP attempted to alleviate stakeholder
concerns, but stakeholders responded negatively, starting their own $0
social media campaigns to shame the company. Sixty-six days after BP shares are trading at
the oil spill, BP’s share value on the New York Stock Exchange had
dropped by 52 percent. $60.57
on April 20, 2010.

News breaks that spill is Stakeholder social media News media report on the
worse than BP claims. campaign intensifies. stakeholder backlash.

$60
Bill

$69
BILLION
$30

$0
US government’s Obama Obama administration Share price drops 7 percent
administration criticizes BP advises that it could take legal in London trading.
and sends company $69 action to stop BP from paying
billion bill for cleanup. dividends to shareholders.
 HOW COMPANIES WORK
Who’s who 62 63

$132 billion invested in European

ESG funds in 2019

BANG!
BANG!
@
#
Oil rig explodes, killing News media report on BP starts social media
11 employees and spewing the event. campaigning on Twitter,
millions of gallons of oil into initially to minimize the
the Gulf of Mexico. impact of the spill.

Stakeholders of the BP oil spill

Stakeholders use social
❯ Inhabitants along the ❯ BP shareholders media to voice anger and

!
affected coastline ❯ Gas customers concern over perceived
❯ Local fishermen ❯ Tourists and tourist lack of responsibility by
❯ Oil spill cleanup businesses BP. Conservationists warn
workers of wildlife devastation.
❯ Media
Celebrities offer to help with
❯ Environmental ❯ Government the cleanup. Stakeholders
activists
❯ General public call for more disclosure
❯ BP employees from BP.

$60

$$ $30

$0
Five of BP’s top 10 By June 25, BP’s share price BP shares are trading at
shareholders sell off stock. has more than halved; more
than 34 billion shares have $23.91
been bought and sold. on June 25, 2010.
 Business cultures
Every organization has a particular workplace culture, consciously
or unconsciously shaped by the personalities, values, and behavior
of the people leading it and working in it.

How it works crackle, whereas in a firm relying

The organizational culture of every on creativity for its products, the NEED TO KNOW
business is different, reflecting mood is likely to be more relaxed.
❯ Control systems Used by
the ethos of the company, the The type of incentives offered to managers to set standards and
workplace habits, and the image management and employees may measure performance
the company projects. It is also tied also affect the workplace, creating ❯ Leverage Power to influence
to the type of work that is done. either a competitive or collaborative a person or situation
In a high-stakes financial trading culture, or a mix of both. The ❯ Paradigm Value system of
company, the pace and pressure increase in remote working is also goals, mission, and beliefs
of the work makes the atmosphere leading to many changes in cultures.

Types of corporate culture

Management experts have tried to explain how organizational cultures work.
Charles Handy, a former professor at the London Business School, describes
them in terms of four major types: power, task, role, and person.

Role culture Power culture

Where a company is based on the structural support of Driven by a powerful individual at the center of the
specialized roles. Each role is crucial and will persist even if organization, who is relied on for decision making and
the person occupying it leaves. Procedures and systems the company’s successes. Those closest to the center have
are strictly followed, as in a government department. the most influence. Typical of a family-owned business.

DECISIONS MADE
DESCRIPTIONS

PROCEDURES

SYSTEMS
RULES
JOB

POWER

bureaucratic / controlling
 HOW COMPANIES WORK
Who’s who 64 65

WHAT SHAPES CORPORATE CULTURE?

Many factors reinforce a culture. To bring about change, the workforce needs
to be inspired by different motivations, values, and types of role model.
84%
of senior
Organization size Leaders
Big business or
small company
Their personality
and behavior
managers
in global
Company structure
Strict hierarchy
Symbols
Titles, dress codes,
organizations
or power shared
among many people
interior aesthetic agree that
Founding values Control systems
organizational
Includes origination
myths and stories
Rewards, incentives,
performance
culture is critical
assessment to success.

Task culture Person culture

Project-oriented work where a project’s completion is Company power and influence is shared among individuals
the motivating force. Relies on teamwork and individuals’ who work semiautonomously. Individuals count for more
expertise, but results are more important than personal than the company, which is made up of people with similar
objectives. Found in technology companies, for example. specialist training, such as in an architects’ firm.

P
SHI
NER
RT
PA

TASK

TASK

TASK

entrepreneurial / flexible
 Corporate
structure
A company’s structure—the way in which it is organized—can have a major
impact on the way it performs. There are several models of corporate structure
typically used in the business world, and they continue to evolve—all the more so
now as businesses embrace remote working. The first consideration is whether
power should be centralized at the top, with decision making in the hands of a
few key senior employees, or decentralized, with more power in the hands of staff.

Choosing a structure
A company’s structure changes as it grows. More complex structures will either evolve or be designed as
a firm moves forward, depending on the nature and size of the business, the complexity of the work,
any requirement for instant expertise, and the geographical location of parts of the business.

Centralized Functional Divisional Matrix

Power rests in the hands of a Good for strict Suits companies with Good for large
few people, with a long chain control and formal many global offices corporations with
of command. relationships, as in or product lines. complex projects in
❯ Power at the top the military. See pp.70–71. different locations.
See pp.68–69. See pp.72–73.
❯ Rigid
❯ Conventional
❯ Inflexible
❯ Slow response to change

CEO COORDINATES CEO COORDINATES DIVISIONAL AND

AND EACH DIVISION FUNCTIONAL
IS RESPONSIBLE FOR MANAGERS
GENERATING PROFIT COORDINATE
 HOW COMPANIES WORK
Corporate structure 66 67

78% 100%
of groups reach of groups reach
WARNING
When change is needed
Signs that a structure is not working
include low morale and high staff
turnover, no new products being
solutions to solutions to developed, and profit suddenly
accelerating or decelerating. Tools to
simple tasks complex tasks amend poor structure include:

faster in faster in ❯ Business process reengineering

(BPR) Analyzing and redesigning
the workflow within a company.
centralized decentralized ❯ Altering the reporting line

structures. structures. In a traditional solid-line reporting

relationship, one line manager
oversees goals and performance. It
can be beneficial to switch to the
weaker chain of a dotted-line
reporting relationship, in which
a manager sets some of but not all
the objectives.

Network Team-based
Decentralized
Suits creative For companies that Power is spread through the company, and staff
and technology rely on innovation make their own decisions.
companies in which and are customer ❯ Power shared
everyone is online. focused.
❯ Organic
See pp.74–75. See pp.76–77.
❯ Experimental
❯ Flexible
❯ Fast response to change

CORE COMPANY STAFF SELF-

COLLABORATES WITH COORDINATE
VIRTUAL
COMMUNITY
 Functional structure
The classic way to organize a company is by dividing it into
departments that reflect the main functions of the business,
each headed by a director or manager.

How it works
The chain of command is straightforward. The
business typically consists of a chief executive
Typical departmental hierarchy
officer (CEO) or president at the top, with the The departments operate independently, with the managers
various specialist departments or divisions, reporting to the CEO or president, who has overall
such as marketing and finance, aligned below. command. The sales and marketing department usually
takes responsibility for managing product lines.
Each department operates as an independent
unit, with its own budget, and reports directly to
the CEO, who takes responsibility for the operation
of all the departments. A functional structure is the
most common type of organization.

WARNING
Dangers of silo mentality
Silo mentality describes a scenario in which each

$
department has a different, closed view of its role within
the overall scheme, and information does not get shared.

2 for 1

1 Sales and marketing 2 Finance is not briefed and Production/ Research and Finance
decides to launch a special processes the order for one
online two-for-one offer. item only. operations development manager
manager manager

Deciding what to sell

The marketing department is closest to the
market and is best able to analyse which
3 Operations is not briefed 4 Customer service is not product lines may do well. The sales and
and sends customers one item briefed and is unprepared for marketing manager can suggest what new
instead of two. calls from angry shoppers. products the company could make.
PRODUCT A
 HOW COMPANIES WORK
Corporate structure 68 69

34%
of companies say
FUNCTIONAL: PROS
AND CONS
Pros
❯ Allows for the development of
specialization and expertise
the structure of their ❯ Enables efficient use of resources

organization is a and potential economies of scale

❯ Offers obvious career path for
barrier to improving employees in each department
❯ Simple, efficient structure for

CEO customer experience. manufacturers producing a limited

range of goods for sale
Cons
❯ Formal lines of communication;
stifles innovation and creativity
❯ Departments fail to coordinate
with one another efficiently
❯ Response time on problems
and queries between different
departments slow
❯ Many decisions referred up
to the top, creating a backlog

Sales and Information Human Customer

marketing technology resources service NEED TO KNOW
manager manager manager manager
❯ Line relationship Chain of
command down the structure
❯ Reporting structure Who
reports to whom
❯ Silo Pejorative term for a
department that works in isolation:
a vertical, closed structure, like a
grain silo

PRODUCT B PRODUCT C PRODUCT D

 Divisional structure
Some companies arrange their staff into divisions devoted to a
specific product or market. Each division is a self-sufficient team
employing the personnel for the various functions within it.

How it works
Under the overall control of a CEO Division by
or president, several divisions work geography
alongside one another to design,
For businesses with
research, produce, and sell a
products that need to
particular product or to service
be adapted to local
a specific market. Each division runs markets, an organization
its own specialized functions, such can be structured
as operations or sales, although according to each of the
some, such as finance, may remain regional markets it serves.
centralized to save on costs. A These may be domestic
company may arrange its divisions or international. Food and
according to the types of product it drink corporation PepsiCo
makes, the regions in which it broadly follows this North America Latin America
operates, or the customers to whom structure, with seven Three divisions: PepsiCo Miami HQ
divisions serving five Beverages, Frito-Lay,
it sells. Large companies may adopt
regions (see case and Quaker Foods
hybrid structures—by product
study, right).
and geography, for example.

DIVISIONAL: PROS Division by product

AND CONS Businesses selling different
types of products may pick
Pros a structure by which each
❯ If one division fails, there is no division handles one category.
threat to the rest of the business Samsung Electronics, part of
❯ Can respond quickly to changes in South Korea’s larger Samsung
the market Group, is organized by
product division.
CEO
❯ Focused on customer needs
❯ Performance of each division
clearly measurable
Cons
❯ Duplicating resources—for
example, each division employing
finance personnel
❯ Lack of expertise-sharing between
divisions
CONSUMER IT & MOBILE DEVICE SOLUTIONS
❯ Career path for staff restricted ELECTRONICS COMMUNICATIONS Chips, processors,
❯ Heightened sense of competition TVs, appliances, Phones, tablets, PCs, sensors
among divisions medical equipment networking
 HOW COMPANIES WORK
Corporate structure 70 71

CASE STUDY
PepsiCo
Food and beverage company
PepsiCo’s global operations have
undergone various transformations
CEO
over the decades, as it has acquired
new brands and expanded around
the world. Today, it comprises seven
divisions in a hybrid structure
arranged by product and geography.
Three divisions are in North
America—PepsiCo Beverages
North America (drinks),
Frito-Lay North America
(snacks), and Quaker Foods
North America (cereals and
snacks)—while the remainder
look after both food and drink
Europe Africa, Middle East, Asia Pacific, products in four global regions.
Geneva HQ and South Asia Australia/ This allows those making the
Dubai HQ New Zealand, decisions about popular local
and China brands—including Walkers in the
Shanghai HQ U.K. and Pioneer Foods in South
Africa—to be close to the
customers who buy them.
Division by customer type
Businesses with distinct
customer markets may
be organized by customer
division. For example, the
financial institution Bank

$6.9
of America Merrill Lynch
caters to individuals, small
businesses, and corporate
CEO
and institutional clients.

billion
in net revenue
CONSUMER
Typically the
BUSINESS
Products adapted or
INSTITUTIONAL
Large-scale provision
generated by
original market favorably priced to a single client PepsiCo Latin
America in 2020
 Matrix structure
Unlike a conventional company hierarchy organized either by
function or division, a matrix combines the two approaches so that
staff work in functional and divisional units and report to two bosses.

How it works
A business that uses a matrix setup often begins Matrix structure
with the more traditional functional structure. As
In this example, an oil exploration and
the business develops, it may make sense to overlay
production company has several oil-
a divisional structure to meet changes in business refining projects to manage. The matrix
conditions—for example, if a company is managing guardian oversees the matrix and ensures
several large projects for a client or expands globally that it works efficiently.
and is selling its products in several regions. A matrix Engineering
grid may start out as temporary—perhaps formed to director
manage short-term projects—and become permanent.
The two chains of command in a matrix create the
grid. Staff report along a vertical line to a functional
manager, such as the marketing director, and along Matrix
a horizontal line to the project manager of a specific guardian
business line, brand, project, or region.

Project Drilling
FOUR BIG MATRIX ORGANIZATIONS manager team
Arctic drilling
Each of the following companies has been cited as a
model for making the matrix structure work:
❯ Procter & Gamble (P&G) To help it innovate and
respond faster to the market, the consumer-product
company is segmented into baby and feminine care,
beauty, family care and P&G ventures, health care,
grooming, and fabric and home care.
❯ Nestlé The Swiss conglomerate is managed
by geographical divisions across most of its food Project Oil-extraction
and drink business, although some product-centered manager team
businesses, including Nespresso and Nestlé Health Malaysia oil wells
Science, are managed globally.
❯ Sony The Japanese media, tech, and financial services
conglomerate is primarily organized around business-/
product-type divisions and function-based groups, such
as research and development, although it also
uses geographic divisions. This flexible structure
allows it to effectively address market challenges.
❯ Starbucks The global coffee-shop chain is arranged by
product, geographic, and business function divisions to
Project Liquefied natural
ensure that quality and innovation meet customers’ manager gas team
expectations and anticipate their desires. New Zealand
natural gas fields
 HOW COMPANIES WORK
Corporate structure 72 73

CEO 90%
of top multinationals
have adopted a
matrix structure.

Operations Marketing Financial

director director director NEED TO KNOW
❯ Matrix guardian Senior
professional appointed to
oversee the matrix and make
sure that it works efficiently
❯ Mature matrix Matrix structure
in which functional and divisional
bosses have equal power
❯ Solid-line reporting A direct
Undersea Marketing Finance reporting relationship between
production team team team a worker and primary supervisor
❯ Dotted-line reporting A more
indirect reporting relationship
with a secondary supervisor

MATRIX: PROS
Site-supervision Sales Finance AND CONS
team team team Pros
❯ Faster decision making
❯ Potential for improved
productivity
❯ Flexible use of staff
Cons
❯ Expensive to set up and run
❯ Possible confusion regarding the
Line operations Marketing and Finance reporting line
team PR team team ❯ More potential for interpersonal
conflict as team goals conflict
 Network structure
Also called a virtual organization or virtual corporation, a network
structure is centered on a streamlined company, with digital
connections linking it to external, independent businesses.

How it works The various parties often work remotely around the
The company at the center of the structure is stripped globe and are connected by the internet. Together, they
back to basic functions that are essential to the type of provide all the services needed for the network to
business being operated—research and development, function as one entity. This type of business structure
for example, in the case of a technology company. All is based on the idea of the social media network and
other functions are outsourced to external specialists. is therefore known as a network enterprise.

NEED TO KNOW Network structure in practice

❯ Agile business Term A small film production company based in Los Angeles is operating from a
to describe a networked studio space with two employees—a producer and an assistant. For each
organization; the opposite
project, the producer connects with outsourced talent around the world,
of a traditional bureaucracy
and everyone collaborates to create the finished film. The producer
❯ Decentralized Organization with contracts and pays these external suppliers.
a wide span of control and often
an upward flow of ideas

VARIATION: MODULAR STRUCTURE

In a business with a modular structure, parts of a single product are outsourced
(functions or processes, not products, are outsourced in a network structure). A
modular structure is especially suitable for organizations producing appliances,
computers, cars, and mechanical consumer goods. Toyota is an example of a
27%
of networked
company with a modular structure, managing hundreds of external suppliers to
produce its finished vehicles. organizations
Pros Cons report higher
❯ Potential for round-the-clock
work because of global locations
❯ Extreme reliance on technology
means that network errors can
profit margins
❯ Can source the best expertise
wherever it is in the world
stop effective performance
of the business than their
❯ Low overhead, as there are
minimal staff in the core company
❯ Potential for less control and
missed deadlines
competitors.
❯ Can develop a flexible and highly ❯ Difficult to find common time across
creative environment different time zones for virtual
meetings
 HOW COMPANIES WORK
Corporate structure 74 75

Post-production
effects in
Cophenhagen,
Denmark
Cinematographer in
London, UK

tion com
uc
pa
Prod

Film Film editing

ny
10 production in Osaka,
+ - £ company, Los
Angeles, USA
Japan
£
X =

Accounting
and finance
in Boston,
USA

Set design
Location scout in Sydney,
in Istanbul, Turkey Australia
 Team-based
structure
As its name implies, a team-based organization (TBO) is made up
entirely of teams. Managers and staff from different departments join
to form teams handling specific projects in the short or long term.

How it works tools, such as Slack, and video

In a TBO, teams reach decisions conferencing software, including NEED TO KNOW
through brainstorming and mutual Zoom and Microsoft Teams.
agreement among team members One step beyond the team-based ❯ Cascading Successful passing
rather than from a senior structure is a Holacracy (see box, of information or objectives down
through the workforce
management member issuing right), an unconventional type of
orders from the top of the chain organization in which there are ❯ Lateral structure Decentralized
structure in which departments
of command, as in a traditional no managers and even the CEO
work to a common goal
organizational structure. relinquishes power, allowing
❯ Flat lattice Structure with no
Communication is less formal in employees to self-govern through
chains of command, in which
TBOs, often carried out using regular committee meetings, workers choose to follow leaders
messaging apps and social media which they organize themselves.
as well as online collaboration

Team-based hierarchy
While TBOs still have a CEO, little other hierarchy exists. Team leaders are
part of the team rather than above it in a chain of command. At its best, a
team-based model fosters a culture of trust, so individuals take pride in their CEO
work and responsibility for carrying out tasks well, on time, and on budget.

Team Team
leader leader
Team A Team B

$
 HOW COMPANIES WORK
Corporate structure 76 77

HOLACRACY—BREAKING BOUNDARIES
In a Holacracy, staff are grouped into teams that set their own roles
and goals and choose their own leaders. The idea is that if power and
responsibility are shared, employees will give their very best. In 2014, the Las
Vegas–based online shoe and clothing shop Zappos adopted the model for
74%
of global
its 1,500 staff. The term “Holacracy” is a trademark of HolacracyOne, the
company spearheading the adoption of the management system. It follows organizations
the same principle as a flat lattice but takes the idea one step further by
presenting a comprehensive management structure with clear processes for have seen
internal operations and governance.
improvements
TRADITIONAL HOLACRACY—A STRUCTURE OF in performance
since switching
HIERARCHY SELF-MANAGED TEAMS
Decisions
handed
down
from top to a team-based
structure.
Decision
making by
committee

TEAM-BASED: PROS
AND CONS
Pros
❯ Quick decision making and
rapid response to problems
and challenges
Team
leader ❯ Reduced overhead, as there is
no heavy management structure
Team C
❯ Open communication, as there
is no fear of management reaction
Cons
❯ If staff lack expertise, decisions
$ may be flawed
❯ Limited sharing between teams
may affect business performance
❯ Decisions by consensus are harder
to reach
 Human
resources
The human resources (HR) department is responsible for all policies and
processes relating to the people employed by a business. To help the
business achieve its goals, HR has to make sure it employs a diversity of
people with the right skills, irrespective of their gender, race, or faith. It
must treat them consistently and fairly, providing a framework to look
after their well-being, supply training, and foster their progress.

Business goals
HR framework Business goals are the
The starting point for any decision driver for every business
in an organization is its business decision, and HR
goals. HR supports the delivery of polices support them.
these goals by ensuring that there
is a staffing strategy to support
the business plan. Typically, an HR
framework sets out a people
strategy, including the
competencies of the people who
best suit the organization. This is
then implemented in a range of
SELECTION SUCCESSION PERFORMANCE LEARNING
areas, from recruitment and AND AND TALENT MANAGEMENT AND
selection to learning and RETENTION PLANNING See pp.84–85. DEVELOPMENT
development. Diversity and See pp.82–83. See pp.82–83. See pp.82–83.
inclusion (D&I) is increasingly
important, with companies that
have higher levels of gender,
ethnic, and cultural diversity
consistently performing better.
HR professionals work closely
with business leaders and line
managers to design and
implement HR systems that HR helps determine principles, conduct, and
support strategic business goals. Values and culture how tasks are done in a business.
HR formulates the structure and formal reporting
Organization design relationships that define a company’s shape.
HR is responsible for employees’ welfare
People and performance and their contribution to business goals.
 HOW COMPANIES WORK
Human resources 78 79

36 %
more profitability is achieved by
ESSENTIAL PEOPLE
SKILLS
As well as recruiting effectively and
ensuring that employees deliver, HR
plays a role in nurturing essential
the most ethnically and culturally people skills across the organization.
Relating to others
diverse companies. ❯ Some people are natural leaders,
but most leaders can benefit
from objective thinking about
the leadership strategy they wish
to follow. See pp.88–89.
❯ Even in flattened, team-based
hierarchies, team leaders need to
develop leadership skills to guide
and support their teams.
See pp.90–91.
❯ Despite the revolution in technology,
people remain vital to organizations,
as skills and knowledge are central
to success. As a result, HR has an
expanding role. One example is
Google, which calls its HR function
People Operations (POPS) and treats
DIVERSITY AND REWARDS AND EMPLOYEE its staff as a valuable asset, offering
INCLUSION BENEFITS ENGAGEMENT a range of attractive perks to “find
See pp.82–83. See pp.86–87. See pp.92–93. them, grow them, and keep them.”
See pp.92–93.
Managing projects
❯ Project management is an essential
skill for managers at all levels, whether
they are running regular day-to-day
activities or special projects. See
pp.94–95.
Negotiating
❯ The ability to negotiate successfully
is an essential skill. Awareness of
strategies and styles is key to success.
See pp.96–97.
 The human
resources cycle
From the moment a company starts to recruit an employee to the
time that person leaves the company, the individual is in a cycle
that is managed by the human resources (HR) department.

How it works people, and I’ll build the business right back again.”
People are a significant cost to any organization and The HR department is there to ensure that the right
of great value—both those who work on the premises people are in the right roles so that the company can
and those who work remotely. Many CEOs talk about deliver the business strategy and maintain its
staff as their most important business asset, and competitive edge. The complexity of the business
industrialist Henry Ford famously said: “You can take influences the stages in the HR cycle, but the basic
my factories, burn up my buildings, but give me my elements are the same.

NATIONAL
CV
EMPLOYMENT LAWS
Employment practice is regulated
by legislation covering everything A business identifies
from gender and racial
Recruit the need to fill a role
discrimination to time-off
and attracts applicants.
entitlement and dismissal.
Résumés are assessed
Laws that once only applied
to full-time staff are being
and interviews held to
increasingly extended to part-time find the best candidate.
workers and those on contracts.

Contract
“Hire people
Once terms are
settled and a
smarter than
Employ contract signed,
the candidate
you and get out
becomes the
company’s
of their way.”
employee. Howard Schultz, former Starbucks CEO
 HOW COMPANIES WORK
Human resources 80 81

$
An orientation program
explains the new role and
Reward introduces the team. HR
gives a briefing on pay, tax,
and benefits, such as leave,
insurance, and pensions.

The company sets targets

and helps individuals Manage
improve performance performance
so they contribute to
business results and get
the most out of their job.

The business has processes

Develop to help people improve their
skills, competencies, and
knowledge through formal
or informal learning, both on
and off the job.

The company Transition …or leave the

helps its employee company, either
move into a new through resignation,
role, which may layoff, retirement,
be in another Exit or firing.
business it owns…
 Recruitment and
selection
Placing the right person in the right job is vital for the success of
the organization—this is the process of recruitment and selection.
Technology is changing traditional hiring pathways.

How it works fits into the organization’s structure.

Human resources and line This information forms the basis BOOSTING DIVERSITY
managers usually work together to of a job description and person
specification. The search can then A diversity and inclusion (D&I)
organize the process of recruitment
strategy is an essential part of any
and selection. Recruitment starts begin. The company’s own website,
HR framework. Recruiting from a
with the company identifying a recruitment agencies, social media, range of backgrounds, regardless of
vacancy—the need for someone to networking sites, commercial job gender, race, culture, and age, and
do a job and pulling together boards, and advertisements in the making all staff feel safe and
information about the exact nature press are traditional ways of included in the workplace helps
of the role and the skills, abilities, attracting the attention of people firms innovate, connect to more
and experience required to do it. outside the organization. Today, customers, and get the most out of
their workforce, ultimately leading
Aspects to consider include the application forms are typically
to higher profits. Casting a wide
job’s purpose, tasks required, and directly submitted online, triggering recruitment net, communicating
the outputs or deliverables of the automatic responses and sorting D&I commitments, assessing
job holder as well as how the role of candidate details. candidates’ competencies over skill
sets and experience, removing bias
in the selection process, and
providing D&I training can all help
boost company diversity.

3
people are
Job description and
person specification
Clear bias-free written
statement of the role,
hired every including job title,
purpose, duties,
minute on responsibilities, scope, and
reporting structure
professional as well as competencies
and qualities required. It Person specification
networking is used in the recruitment
process to provide a clear
Summarizes the necessary
or desired criteria for
website guide for both applicants
and interviewers.
candidate selection using
inclusive language,
LinkedIn. including required skills
and/or competencies for
the role, experience, and
educational qualifications.
 HOW COMPANIES WORK
Human resources 82 83

Internal search Personal

Looking at internal recommendation
resources first creates Some companies External search
opportunities for career encourage existing
Increasingly, companies and
development and employees to introduce
candidates use professional
progression, improving friends as candidates.
networking sites,such as
employee engagement LinkedIn, and social media,
and retention. such as Facebook or Twitter.
External candidates diversify
the workforce but cost more
to attract.

NEED TO KNOW
❯ Psychometric tests Often used
as an initial screening method,
these aim to assess such attributes
Applications as intelligence, aptitude, and type
The résumé is the most important of personality, using verbal and
document, often paired with a nonverbal reasoning tests and
cover letter. Companies may behavior questionnaires.
use an application form
instead.

CONTRACT

Selection Appointment
After HR has drawn Companies may ask for
up a shortlist using references and/or request
nondiscriminatory a medical examination for
criteria, candidates the chosen candidate. The
may be assessed by employment offer is a legally
interviews, group binding contract that sets out the
assessment, and terms and conditions of the job.
psychometric
testing, either
online or in person.
 Evaluating staff
For a business to achieve its goals, it needs to
have a process that measures the contribution and
performance of each individual against those goals.
Individual goals
How it works
The way in which tasks are done is becoming as
important as what tasks are done, as organizations
1 Set personal goals to align
with business strategy

recognize the importance of creating the right

culture to enable workers’ performance. For any
company, effective evaluation of the performance ❯ Business goals drive
of employees should be strategic and aimed at tasks and activity.
ensuring the maximum productivity of individuals, ❯ Culture enables teams
teams, and the organization as a whole. and individuals to deliver.
❯ HR policies give clear
benchmarks.

Traditional performance-
management cycle
Performance management is an ongoing,
continuous process. Many companies use
“360-degree feedback” to collect information
about an employee’s performance anonymously
from a range of people, including their boss,
colleagues, customers, and staff members.

WINNER!
A WIN-WIN SITUATION
Evaluating performance is good for both
the business and the individual.
Business
❯ Aligns individual goals with company goals.
❯ Offers consistent approach, with benchmarks.

5
Rewards
❯ Continuously enables improvement. Promotions and pay
❯ Fosters the right behaviors and relationships. raises in line with
Individual performance
❯ Understands what is expected of them.
❯ Has the skills to deliver on these expectations.
❯ Is supported to fill any gaps in capability.
❯ Is given feedback and allowed to discuss goals.
 HOW COMPANIES WORK
Human resources 84 85

UNCONSCIOUS BIAS
Companies should be aware of the role unconscious bias can
play in performance appraisals. An appraiser’s subconscious
prejudices about employees’ race, gender, age, class, sexuality,
or disability can cause talented individuals to repeatedly be denied
promotion or have their attitude questioned. Conduct
unconscious bias training to make staff more aware of the issue
and require appraisers to use objective criteria to identify job
competencies and to justify their appraisal scores with evidence.

2
Discussion
Ongoing communication on NEED TO KNOW
standards of work and behavior ❯ Balanced scorecard Framework
to improve working relationships to measure performance against
strategic goals, devised by
Kaplan and Norton
❯ Competencies Defined
behaviors and attributes
that individuals must have to
perform effectively at work
❯ Performance appraisal Process
via which individual employee
and their manager can discuss
performance and development

360-degree feedback

3
Coaching
Discussion of performance issues Gives a rounded picture with
and ways to tackle challenges better information about
working relationships

Customer

4 Appraisal
Formal feedback
from the direct Direct
reports Manager
manager, with
an opportunity INPUT FROM
COLLEAGUES
for individuals
to contribute

Colleagues
 Motivation
and rewards
People work for money, but they are also motivated by other factors,
such as doing a good job and being valued. Nonfinancial rewards
drive day-to-day motivation more strongly than pay and benefits.

How it works external to the actual work, and others control the
In the past, tangible pay and benefits were the key amount, distribution, and timing. Employers now
motivational tools for employees. These financial recognize that while extrinsic incentives are clearly
rewards are termed “extrinsic” because they are important, intrinsic (psychological) rewards are crucial.

Understanding motivation in the workplace

Happy staff work well, and job satisfaction comes from subtle feel-good factors
as much as a paycheck. Employees who enjoy their work tend to stay—job
satisfaction makes for lower staff turnover.

Individual
Extrinsic motivation
Policies implemented Employees obtain
by the company: psychological benefits
from doing meaningful
Financial rewards work and performing it
well. Only one in eight
❯ Base pay
workers (about 180
❯ Bonus million employees in
❯ Incentives 142 countries studied)
Benefits is committed to
their job and makes a
❯ Pension contributions
positive contribution
❯ Flexible working to their organization.
❯ Health care
 HOW COMPANIES WORK
Human resources 86 87

15%
Only this
WHY PEOPLE DO TASKS creates positive
motivation.
MOTIVATION

of employees

You are told to do something.

You choose to do something.

I want to do
Do this task this task to make
around the world and get a bonus. a difference.

EXTRINSIC

INTRINSIC
are fully committed Do this task I don’t want
to their jobs. or get in trouble. to do this task—
it is pointless.

DEMOTIVATION

Fostering intrinsic rewards

Businesses that are successful engender trust and
therefore have employees who are passionate
about what they do. All these factors contribute:

Purpose for organization and individual

Intrinsic
❯ Clear vision for organization
Feelings that an individual has:
❯ Understanding of where individual fits to achieve
❯ Purpose A sense of that purpose
being able to accomplish ❯ Clear goals and expectations for individual
something of value Recognition
❯ Choice Clear ownership ❯ Continuous feedback
and feeling responsible
❯ Ongoing engagement
for outcome
❯ Noncash rewards, such as praise
❯ Progress As an individual,
feeling and seeing evidence Career development
of moving things forward ❯ Progression and promotion
❯ Competence Pride and ❯ Mentoring and coaching
satisfaction in own work ❯ Learning opportunities
Culture
❯ Strong teamwork and consistent behaviors
❯ Open communication
❯ Sharing of knowledge and information

INCREASING MOTIVATION
 Leadership strategy
and styles
Top-down leadership, in which managers give orders, is not always
the best way to get results. A number of different leadership styles
have been identified by business experts.

How it works
Every leader is an individual with
In 2007, for example, business
authors Eric Flamholtz and Yvonne
“Outstanding
their own approach. However, over
the years, management gurus have
Randle developed a leadership
matrix based on Lewin’s theories,
leaders go out
identified key leadership styles that which shows the best style to use
in any given situation, ranging from
of their way to
can be used to achieve
different results, depending on the autocratic (one all-powerful leader) boost the self-
environment. Many frameworks are to consensus (decisions reached
based on the ideas of psychologist by general agreement). Truly esteem of their
Kurt Lewin, who developed his
theories in the 1930s with three
inspirational leaders encourage
people to believe in themselves so personnel.”
major styles: autocratic, democratic, that they achieve results beyond Sam Walton, Walmart founder
and laissez-faire (noninterference). even their own expectations.

TRANSFORMATIONAL LEADERSHIP
While different styles can suit different situations, transformational leadership,
in which leaders and their followers raise one another to higher levels of integrity
and motivation, was identified by guru James MacGregor Burns as the most
effective. This has been developed by others, including
industrial psychologist Bernard Bass, who listed
the qualities of a transformational leader.
Inspires people
Stirs the to reach for the
emotions improbable
Encourages of people
others
Sets clear
goals

Has high Gets people

expectations to look beyond
Is a model of Provides their self-interest
integrity and support and
fairness recognition
 HOW COMPANIES WORK
Human resources 88 89

When to use which leadership style

A three-year study of 3,000 managers led psychologist people feel about their work. The most effective leaders
Daniel Goleman to identify six distinctive styles of master a number of styles and use them appropriately,
leadership. Each style has a significant impact on how according to the situation.

Style When to use Drawbacks

Affiliative “People come before task.” Use in times of stress, when Praise and nurturing
Focuses on creating emotional teammates need to recover can foster mediocre
bonds within a team and a from trauma, or when the performance and lack
sense of belonging within team needs to rebuild trust. of direction.
an organization.

Coaching “Try this.” Use to help teammates build Coaching is ineffective

Helps people find their lasting personal strengths when teammates are
strengths and weaknesses, that make them more defiant and/or unwilling
linking these to career successful. to change or learn or if
aspirations and action. a leader lacks ability.

Commanding/ “Do what I tell you.” Only use in times of Insistence should only
coercive Demands immediate crisis or to control be used when essential; it
compliance, without problem employee can alienate people, stifle
discussion or negotiation. when all else fails. inventiveness/flexibility,
and tauten atmosphere.

Democratic “What do you think?” Use when it is necessary for This is not for use in crisis
Aims to build consensus the team to buy into or have or when teammates are
through participation. ownership of a decision, not well enough informed
plan, or goal. to be able to offer suitable
guidance to the leader.

Pace-setting “Do as I do, now.” Only use when the team Style can overwhelm
Expects and models is already motivated and some team members and
excellence, creating competent and when fast adversely affect employee
challenging and exciting results are necessary. commitment; it may stifle
goals for the team. creativity and innovation.

Visionary/ “Come with me.” Use when the team needs This is not effective
authoritative Mobilizes the team toward a new vision because when a leader is working
a common vision and goal, circumstances have changed with a team of experts or
leaving the means up to or when explicit guidance is better-informed group.
the individual. not required.
 Leadership for
team building
Just as generals have to get the best from their troops, so business
leaders must make the most of their teams. The key is ensuring
that individuals work together to achieve a common goal.

How it works
From statesmen, such as former British prime minister of other people. They have a passion that sweeps
Winston Churchill, to Facebook executive Sheryl people along with them; they learn from mistakes
Sandberg, great leaders recognize that to achieve and are prepared to change course to face evolving
a long-term goal, they must not only use their own circumstances. Much academic work has been done
capabilities but also maximize the combined strength to study the traits and strategies of such leaders.

How leaders
inspire their teams Focusing on goal
Academic Carl Larson and organizational ❯ Defines goal in clear and
effectiveness expert Frank LaFasto inspirational way
conducted a three-year study of more ❯ Helps each team member see
than 75 diverse teams. They identified six how they contribute to goal
characteristics of leadership that steer a
❯ Does not play politics
team toward optimum results.

Encouraging
collaboration
“Leadership is ❯ Allows open discussions
❯ Demands and rewards
the art of getting collaboration
❯ Involves and engages people
someone else to
do something you
Building confidence
want done because ❯ Accentuates the positive
he wants to do it.” ❯ Shows trust by assigning
responsibility
Dwight D. Eisenhower,
former US president
❯ Says “thank you”
 HOW COMPANIES WORK
Human resources 90 91

BUILDING AN EFFECTIVE TEAM “Don’t

In their book The Wisdom of Teams (1993), ❯ Select members for skill and potential, find fault—
Jon Katzenbach and Douglas Smith make
a distinction between teams and ordinary
not personality.
❯ Focus on a few immediate tasks and goals find a
groups of people who work together.
They define a team as “a small number
at the beginning to help the team to bond.
❯ Set boundaries and behavioral norms.
remedy”
of people with complementary skills who Henry Ford,
are committed to a common purpose, ❯ Stimulate the team regularly with US industrialist
set of performance goals, and approach new information, encouraging open
for which they hold themselves mutually discussions and active problem solving.
accountable.” They found that leaders who ❯ Ensure that the team spends lots of time
manage to build successful teams tend to: together, both in and outside work.

Providing know-how
❯ Knows own area
❯ Gets expert help for other areas
❯ Shares context with team

Setting priorities 1
2
❯ Demonstrates focus; avoids ambiguity 3
❯ Is clear about what must and must
not happen
❯ Is prepared to change course if
priorities switch

Managing performance
❯ Sets clear objectives
❯ Gives constructive feedback; confronts
and resolves performance issues
❯ Aligns incentives with team goals
 Employee relations
and communications
Thriving organizations recognize the importance of using people’s
ideas and energy to provide a competitive edge, while managers are
eager to gain, retain, and build employee commitment.

How it works send only one-way messages but use interactive media,
Whether managed by human resources (HR) or as a such as video conferencing. In turn, this has paved the
function in their own right, employee relations and way for effective remote working. Workers can use
communications are increasingly sophisticated. Rather intranets and online collaboration tools, such as Slack,
than just relying on face-to-face talks and word of mouth, to share knowledge, but they may still opt to meet in
successful firms use a range of communication tools to formal settings, such as committee meetings and forums.
help people understand the business goals and their
contribution to results. In particular, leaders no longer

Commitment
The art of communication
In this example, a company is establishing weekly
employee forums to facilitate communication and
build trust throughout the business. To strengthen
employee awareness, engagement, and commitment
to the idea, various media are used, from email to
webinars and discussion. Managers increasingly focus
on collaboration rather than just impart information.

Engagement and
involvement
EMPLOYEE FORUMS
In many countries, employee communication used to
focus on structured industrial relations, managed by
HR. Employee relations are now based more on trust
and building strong relationships. Many firms create
formal work committees or employee forums.
Awareness and
DEGREE OF COMMITMENT

At their best, employee forums:

❯ Allow representatives from across the understanding
business to share and generate ideas
for improving performance.
CONTACT
An email is sent to all
@
❯ Encourage discussions on visions, changes, employees with a
and plans for business. short video informing
them that an employee
❯ Recognize the value of employees. forum will be set up.

TIME
 HOW COMPANIES WORK
Human resources 92 93

CASE STUDY
John Lewis £1.5
billion
The John Lewis chain of department ❯ Partnership council Made up of
stores in the UK is famous for its 58 elected partners from across the
unique employee-owned structure, in business, the council meets several
which every worker is a partner times a year. The chair and directors
in the business. It has a number of report to the council, which can
employee-communication policies:
❯ Gazette Employees can send letters
remove the chair.
❯ Forums Elected by employees
spent on basic
directly to management through the
weekly gazette. Managers publish
on a three-year basis, forum
representatives serve to reflect the
pay by John Lewis
their responses in the gazette for all
to read.
views of the partners in a specific
region, community, or business area.
in 2020–2021

REINFORCE AND
INTERNALIZE
Regular face-to-
face updates
ESTABLISH PRACTICE show employees
A company-wide how forums have
off-site day shows made a difference.
employees how
forums have
changed working
practices.

STIMULATE POSITIVE
PERCEPTION
An inspirational seminar
illustrates the benefits
of the new forums.
ADOPT AND SHARE
AID UNDERSTANDING Employees attend forums and
Resources placed on then share their opinions on
the company intranet Twitter and Slack
detail how employee so they feel involved and
forums will work. collaborate with managers.

CREATE
AWARENESS
The purpose of
employee forums
is explained at a
company-wide
video conference.
 Project management
Besides day-to-day activities, a business may have projects—one-off,
specific pieces of work. Projects need to be well managed so they deliver
the benefits that they were designed to achieve, on time and on budget.

How it works involves not only overseeing

The process of project management the people working toward the NEED TO KNOW
takes a complex project from start particular objective but also
to finish. It requires a different managing the risks, schedule,
Project management tools
set of knowledge, experience, and relationships, individual and There are many different project
skills from a mainstream operation team input, range of stakeholders management tools, with each suiting
certain types of project and skill
because the goals set up have to be with a vested interests in the
levels better than others. Specialist
achieved within defined limitations. project, and financial resources. software, such as Wrike and
These constraints include scope, Effective project management is LiquidPlanner, offer powerful
time, quality, and budget. A project increasingly viewed as a strategic feature sets, while more user-friendly
team might include people from competence (see p.85) for any tools, such as Trello, are good for
different organizations, diverse business because it enables the simpler projects.
disciplines, and multiple locations. introduction of new products, new
Successful project management methods, and new technology.

Steps in project management

There are many workable project management systems, using various definitions
for the key stages, all of which are encompassed in five main elements.

Initiation Planning Execution

❯ Project charter, including ❯ Detailed plan of work ❯ Coordinating people and
business case, objective, ❯ Critical path analysis resources
scope, budget, deliverables, ❯ Quality assurance
and schedule ❯ Risks
❯ Communication to team
❯ Roles and responsibilities and stakeholders
❯ Resource allocation
 HOW COMPANIES WORK
Human resources 94 95

HURDLES AND HOW TO OVERCOME THEM

Every project comes up against challenges. These are some of the common ones
and the ways that effective management can keep the project on track.

Obstacle Project managment Options

Project is not ❯ Map out timeline of work and critical paths ❯ Negotiate scope, budget, and
on schedule using tools and techniques. resources of the project.
or is running ❯ Review remaining work and identify risks, ❯ Inform other teams and see if any
short of time barriers, and mitigating strategies. changes can be factored in.

Unclear ❯ Review project charter and revisit vision ❯ Seek clarity from sponsors
vision or lack and objective. and/or senior management.
of clarity ❯ Involve team so everyone understands
direction of work and avoids stalling.

Scope creep ❯ Manage requests for change against ❯ Communicate to identify why
—project business case and project objective. change is important and how to
changes once incorporate or find alternative.
under way

Monitoring and control Closure

97%
of managers
❯ Measuring effort and progress
❯ Managing and mitigating risk
❯ Finalizing all activities
❯ Communication from 38 countries
❯ People management ❯ Learning—project review believe project
management is
critical to success
 Negotiating strategy
Skillful negotiation is vital in business when two or more sides have
different viewpoints, and each one wants to press for their own advantage.
The ideal outcome is a compromise that delivers the best results for both.

How it works talks can end in stalemate, bad feelings, and loss of
Like many aspects of business, negotiation is a process business. Being able to negotiate is vital to building
to find a mutually acceptable solution. Before any strong working relationships; delivering sustainable,
discussion, each party must work to understand the well-considered solutions (rather than a short-term
other’s interests and decide on a strategy; otherwise, fix); and avoiding future conflicts.

Reaching agreement
Any strategy, from a wage negotiation between a trade union and employer to a
sales negotiation between a customer and supplier, depends on the relationship
between the two parties. Good negotiation should leave each party feeling
satisfied with the outcome of the discussion and ready to do business again.

Prepare and plan Define ground Propose, clarify, Bargain to solve

❯ Set objectives and ideal rules and justify problems
outcome (and assess ❯ Agree on logistics— ❯ Ensure both sides have ❯ Offer alternative
those of other party). location, room setup, equal opportunity to proposals and
❯ Rank and value issues agenda, schedule, put forward their case. concessions.
and think of possible number of negotiators. ❯ Clarify any points ❯ Discuss what is
concessions. ❯ Define etiquette, such as of disagreement. acceptable to each side.
❯ Consider ideal agenda no cell phones, one ❯ Focus discussion on ❯ Aim to find win-win
and meeting place. person speaks at understanding rather solutions.
Rehearse. a time, formal breaks. than resolving.
❯ Agree on how
information is to be
presented and recorded.
 HOW COMPANIES WORK
Human resources 96 97

65%
of face-to-face
BODY LANGUAGE IN
DIFFERENT CULTURES
With international negotiations, it
can be hard to read body-language
signals, particularly as the meaning
communication is nonverbal. of gestures can vary.
Eye contact Chinese
people avoid direct eye
contact to show respect,
while American people
see lack of eye contact
as a sign of shiftiness.
Facial expressions
When emotions are high
in the US, it is acceptable
to frown, even to swear,
but not to cry. Japanese
people might smile or
laugh, but never frown
or cry.
Head movements In
much of Europe and the
US, people nod to mean
yes and shake their head
to mean no. But in some
parts of the world, such
as in Bulgaria, it is the
Agree, close, opposite way.
and implement Gestures Western
❯ Conclude with an cultures use a hand
agreement that is extended toward a
mutually acceptable. person to indicate
❯ Clearly articulate and “Come here.” Chinese
note agreement and people would see this
concessions. gesture as offensive.
❯ Formalize agreement in Posture In the US,
writing and follow up. being casual is valued;
people might slouch
when standing or sitting.
In some European
countries, such as
Germany, a slouching
posture is considered
rude. Formality is
also valued in Japan,
particularly the ability to
sit upright and still.
 Flexible working
Businesses are taking a more flexible approach to how and where their
staff work. Faster Internet connections, cloud computing, and better apps
have made it possible for workers to collaborate effectively at a distance,
and many companies are recognizing the benefits of allowing them to
do so. Are shared workspaces becoming a thing of the past?

How it works scrambled to adapt to the new reality of doing what

Advances in communications technology have made they used to do in person over the Internet via video
it easier for businesses to allow employees to work in call, email, instant messaging, and other means. Even
ways that suit their particular needs. As of late 2021, as lockdowns lifted, many employees preferred to keep
21% of workers in the US were working from home, working from home. The result is that businesses now
and that number was rising steadily. The COVID-19 have a clear understanding of the benefits—and
pandemic that began in early 2020 accelerated this drawbacks—that flexible working can create,
process. As countries around the world put and most are unlikely to insist on every
lockdowns into effect to curb the spread of employee working in the same physical
the virus, businesses and employees space all the time as they move forward.

Working remotely: pros and cons

Pros Cons
Fosters a better work/life balance, creating Not suitable for every business—many
happier, more productive employees still need staff to collaborate in person

Gives staff time to focus on their work, More time required to ensure
with fewer distractions clear communication

Frees up room in company workspaces, Workers potentially feel isolated;

allowing businesses to save on rent team culture harder to foster

Gives organizations access to a Business operations completely reliant

global talent pool on technology functioning properly

25% of workers in advanced

economies can work from home three to
five days a week with no loss of productivity.
 HOW COMPANIES WORK
Human resources 98 99

Going remote: what you need

Maximizing the benefits and minimizing the problems of flexible working requires the
right setup. This means not only making sure that the appropriate tools and technology
are in place for all staff members, but also adjusting work practices and developing skills.

Tools Skills
Workspace Communication skills
Wherever they choose to do their job, staff need Working remotely prevents people from picking up
a suitable space to work: somewhere with good on—or displaying—many of the nonverbal cues that
lighting, free from excessive distractions, and we use when communicating, so extra effort is
furnished with a comfortable desk and chair. required to communicate clearly.

Hardware People-management skills

Minimum requirements are a laptop and a reliable For the same reason, interpersonal skills are also
Internet connection. An ergonomic wireless mouse, important. Reaping the benefits of flexible working
good headphones, a webcam, a microphone, a means taking time to understand people’s individual
footrest, and a document holder can be handy extras. circumstances: keep in regular contact, listen carefully,
show empathy, and offer support if needed.
Communication tools
Alongside email, video-call platforms, such as Technology skills
Zoom and Skype, are indispensable for providing People must know how to use the technology that
face-to-face contact, while instant-messaging apps, they need to work remotely to do their jobs
such as Slack, help people ask questions and share properly. Understanding how to protect data
documents. Other collaboration tools, including to prevent security leaks is also key.
online whiteboards and project management
apps, are also useful. Time-management skills
Boundaries between work and home life can blur
File-sharing services when working from home, so maintain a structured
Staff need to be able to read and edit company schedule. Start and finish on time, take regular breaks,
documents and exchange them with colleagues. and organize work hours carefully, keeping meetings
This might be through remote access to the company to a minimum and blocking off enough
server or via online file-sharing services, such as time to get work done.
Microsoft 365 or Google Drive. Such services store
data on remote servers in the “cloud,” allowing Flexibility
workers to share documents, track changes, By its nature, flexible working means adapting to
manage different versions of them, and tag constant change. The key is to stay receptive; take
other users wherever they are. the time to understand new problems, requirements,
and technologies; and adopt fresh approaches.
Specialty software
Workers may also require access to software
specific to their roles or unique to the business.
Cloud-based subscription packages can make
professional software easier to deploy.
$ $ $

$ $
 HOW
FINANCE
WORKS
Financial reporting ❯ Financial accounting
Management accounting ❯ Measuring
performance ❯ Raising financing

$
$
$
 Financial
reporting
Financial reports are everywhere: a bill at a restaurant is a financial report, as
are sales receipts and bank statements. In business, however, financial reporting
refers to the financial statements that make up a company’s annual report and
accounts. Compiled by accountants, they provide investors and lenders with
information to assess a company’s profitability and enable company managers,
the government, tax authorities, and other stakeholders to evaluate the business.

Types of financial reports

Financial reports take many forms and can
contain a vast amount of information about a The annual report
company’s finances, work, core business values, Financial statements usually appear in a company’s
performance, employees, and compliance with annual report and sum up its financial activities in a
local, logistical, domestic, and international standardized way for different audiences to interpret
laws. The most important financial report, quickly and clearly. These statements take diverse forms,
or statement, is usually the annual report— and being able to deconstruct them is a vital skill for
essentially a collection of many other, smaller accountants and businesspeople, making it simple
reports—which sums up how the business has to see how well a business is performing and why.
performed in the last year. There is a multitude
of laws, regulations, and guidelines governing
what should be put into this report.

THE ACCOUNTING CYCLE

The eight steps of the accounting cycle are
used by nearly all accountants. The cycle
50%
of accounting students
helps by standardizing processes and making
sure that accounting jobs are worldwide are women.
performed correctly and in
the same way and order
for every activity. $ $ $
See pp.102–103.
 HOW FINANCE WORKS
Financial reporting 102 103

TYPES OF ACCOUNTING
There are seven widely recognized types of accounting:
❯ Financial Drawn up by accountants; ❯ Forensic Engages in disputes and

$ used by investors, creditors, and

management. See pp.110–129.
litigation and in criminal investigations
of fraud. See pp.152–153.

❯ Management Used by managers ❯ Project Deals with a particular project;

to control cash flow and budgets to
forecast sales. See pp.130–143. $ a useful aid for project management.

❯ Governmental Also called public ❯ Social and environmental Shows how

finance accounting; used by the public a company makes a positive difference
sector for noncommercial accounting. to the community and environment.

❯ Tax Dictates exact rules that companies

$
and individuals must follow when
preparing and submitting tax returns.

statements
ial
nc
a
n

❯ What’s in an annual report? A full record

Fi

of company performance according to various

criteria, plus accounts. See pp.104–105.
❯ What are the statements? The main one is
financial; others include sustainability, directors’
pay, and charitable donations. See pp.106–107.
❯ Who reads which statements? Sections are
relevant to banks, shareholders, government,
auditors, staff, and media. See pp.108–109.
❯ What do the notes mean? Main statements
are annotated in detail. See pp.104–109.
❯ What are the rules? Accounting principles
regulate financial reports. See pp.112–113.
❯ Which are the most important financial
statements? Profit-and-loss statements,
balance sheets, and cash-flow statements
contain key facts. See pp.114–121.
 The accounting cycle
The accounting cycle is a step-by-step process bookkeepers use to
record, organize, and classify a company’s financial transactions.
It helps keep all accounting uniform and eliminate mistakes.

How it works any length of time—this is known as an accounting

The cycle works as a method of organizing workflow period—and usually lasts a month, a quarter, or a year.
into a cyclical chain of steps that are designed to reflect Accounts that deal with revenues and expenses return
the way assets, money, and debts have moved in and to zero at the end of each financial year, while accounts
out of a business. It progresses through eight different showing assets, liabilities, and capital carry over from
steps, in the same order each time, and restarts as soon year to year.
as it has finished. The cycle can be based on

The eight-step cycle

The processes shown here are
repeated in the same way for every Transactions  
accounting period. All businesses Any type of financial transaction,
go through different phases, and the from buying or selling an asset to
accounting cycle works by reflecting paying off a debt, can start the
that. The financial statement, which accounting cycle.
is prepared toward the end of each
cycle, is helpful in showing how
strongly the business has performed
during each period of time.

BOOKKEEPING AND new cycle

ACCOUNTING
❯ Internal controls A method
of deploying, measuring, and
monitoring a business’s resources.
This helps prevent fraud and keep
track of the value of assets.
❯ Double-entry bookkeeping
The process of recording all
transactions twice—as a debit
and as a credit. If a company buys 6,000
a chair for $100, its debit account 15,000
increases by $100 and its credit
account decreases by $100. 21,000
❯ Bad debts Debts that cannot be
or are unlikely to be recovered and Closing the books Financial statements  
so are useless to the creditor A closing entry based on adjusted The corrected balances are then
(lender), who writes them off journal entries is taken, the books used to prepare the company’s
as an expense. are closed, and the cycle restarts. financial statements.
 HOW FINANCE WORKS
Financial reporting 104 105

NEED TO KNOW
❯ Debits An entry where assets and
expenses increase. In double-entry
accounting, debits appear on the
left-hand side of the account.
❯ Credits An entry where revenue,
owners’ equity, and liabilities increase.
In double-entry accounting, credits
appear on the right-hand side.
Journal entries Posting   ❯ Chart of accounts List giving
Accountants then analyze the Journal entries are then the names of all of a company’s
transaction and create a record transferred to the general accounts, used to organize records
of it—a journal entry—in the ledger—a digital record logging ❯ Audit trail Full history of a
company’s accounting system. all the company’s accounts. transaction, allowing auditors to
trace it from its source, through
the general ledger, and note any
adjustments made

72%
$ Trial balance  
A list of all the company’s accounts
$ $ is prepared at the end of the
accounting period, usually a year,

of UK independent
quarter, or month.

contractors do
their own accounts.
10,000
55 230
21,000

Worksheet  
Often, trial balance calculations
don’t accurately balance the
Adjusting journal entries   books (see pp.116–117). In such
cases, changes are made on
Once the accounts are balanced, any a worksheet.
adjustments are noted in journals at
the end of the accounting period.
 Financial statements
The formal records of a business’s financial activities are presented as
financial statements. Most jurisdictions require accurate information
by law, and financial directors and auditors are liable for its contents.

How it works so they need to be detailed but also comprehensible

Financial statements summarize a company’s to the general public. The statements are usually
commercial activities clearly and succinctly, with presented together in the form of an annual report,
details of the business’s performance and changes to with in-depth accounts and footnotes to give detail.
its financial position. They are aimed at several parties, Legal requirements vary, but accounts must be exact.

What’s in an annual report

The contents page shows where to find the big three statements—the balance sheet, cash-flow
statement, and profit-and-loss statement—and softer information, such as stories about staff and
opinions of other stakeholders. The annual report provides an opportunity to impress shareholders
and lenders as well as fulfill legal reporting obligations. It will contain all, or most, of the following.

introduc nvironm
r’s It is common for the chair re These pages contain much of
en
i

Ou

to write an introduction the company’s information on

tio
Cha

focusing on the positives and t its environmental protocols,

n

explaining any negative parts most of which are industry-

of an annual report for the specific. (See also pp.122–123.)
benefit of shareholders.

ers and c mploye

m This section underlines a re A section on employees
Ou
om

company’s social ethos, in discusses such areas as staff

es
r custo

particular its community development and training,

munity

involvement. Different types health and safety, and key

of companies may focus on statistics on staff satisfaction.
Ou

different values.

fnance A brief overview summarizes rastruc The infrastructure pages of

ur the key areas of finance inf t an annual report are a good
O

r
s

ur

for the company, including place to supply more detail

Ou

overall performance, turnover, about the company’s fixed

$ operating costs, capital assets and explain why the
investment, depreciation, company is an attractive
interest charges, taxation, and investment for investors.
dividends. (See also pp.114–121.)
 HOW FINANCE WORKS
Financial reporting 106 107

CONSOLIDATED FINANCIAL STATEMENTS NEED TO KNOW

In an era of globalization, large corporations are now commonly made up of
multiple companies. Companies owned by a parent company are known as ❯ Subsidiary One company that
subsidiaries and continue to maintain their own accounting records, but the is controlled by another, usually
parent company produces a consolidated financial statement that shows the a holding company
financial operations of both companies. Depending on the jurisdiction’s ❯ Holding company A company
reporting requirements, however, if a company owns a minority stake in a set up to buy shares of other
second company, then the latter will not be included in the former’s companies and then control them
consolidated financial statement. ❯ Globalization The process of
businesses developing such large
multinational presences that they
transcend international borders

mance i tors’ rep

or
Performance indicators are In the directors’ report,
common across all industries. ec members of the board
nd
Our perf

or
Di

They measure such areas as of directors give their

icators

t
customer satisfaction and the professional opinions
quality of goods or services on how the business
provided by the company. has performed over the
last year.

me
ntal ac
c nt audito
The environmental
de Auditors are independent
Environ

accounting section contains and check the accuracy of

ou

r’s
Indepen

figures that pertain to the

$ companies’ accounts. This
nting

report

CO2 environment, often those helps eliminate mistakes

stipulated by law—for and track fraud.
example, greenhouse
gas emissions.

The board of directors, Notes to the accounts

of direc o the acc
rd governance report, and st are a key part of financial
a

ou
to

statement of directors’ statements. They provide

e
Bo

Not
rs

nts

responsibilities sections extra detail, insight, and

indicate who is leading the explanation of the bare-
company, showcases their bones figures supplied in
credentials and roles, and earlier pages of the report.
reveals their pay.
FINANCIAL STATEMENTS

Deconstructing a
financial statement TAXES
The profit and loss account shows
The percentage of business taxes taken by governments varies from country
revenues, costs, and expenses—
to country, but the generic types remain similar:
how much money the business
makes—over an accounting period. ❯ Direct taxes are levied directly on profits or income and
The balance sheet shows what include income taxes and taxes relating to sales or purchases
of property and other capital assets.
a business is worth at the time
it is published and is relevant
to investors, as it reveals assets, ❯ Indirect taxes are paid on goods or services, such as sales
liabilities, and shareholders’ taxes. Indirect taxes are often targeted to reduce consumption
equity—all useful for gauging of harmful goods, a factor relevant to companies working in the
business health. The cash-flow alcohol and tobacco industries.
statement shows the movement ❯ Green taxes are increasingly common and are often indirect.
of cash within a business—its They are generally used as a way of prohibitively increasing
liquidity. However, along with the the price of goods or services harmful to the environment,
big three financial statements, an such as air travel, landfill sites, or fuel, to diminish their use.
annual review contains a wealth
❯ Corporation tax is only paid by companies, not by sole
of information about a company’s
proprietors or partnerships. It is levied as a percentage of the
performance, of interest to its company’s total profit.
stakeholder groups. It is often the
notes that bring statements to life.

Case study: the details Sustainable investment

Financial statements are presented as part of the The utility company’s investment in
annual report, which also publishes case studies, sustainability includes mandatory expenditure
quotations, statistics, and profiles of customers, and extra discretionary expenditure.
suppliers, employees, and directors. The notes,
often running to 20 pages or so, contain tables and 2013 2012
text that flesh out the financial information. This $m $m
example shows the sustainable investment figures
in the annual report of a fictional utility company.
CUSTOMERS AND
COMMUNITIES
130 110

Our finance
$ This section contains the
headline financial figures of ENVIRONMENT 115 102
the business, such as profits,
taxes paid, assets owned,
liabilities, and dividends
paid out, as well as some EMPLOYEES 91 88
more detailed explanation
of the figures.
TOTAL 336 300
 HOW FINANCE WORKS
Financial reporting 108 109

NEED TO KNOW BOARD OF DIRECTORS

Much of what might be considered personal information about directors of public
❯ Monopoly Situation in which companies is in the public domain. It is usually a legal obligation to disclose:
there is just one supplier of a
particular product or service; ❯ Names of executive directors ❯ Dates of directors’ terms of office
without government control, ❯ Names of non-executive directors ❯ Remuneration, including bonus, share
a company with a monopoly and whether they are independent options, pension plans, and benefits
could make prices high and or shareholders ❯ Notice period
quality low, as consumers would ❯ Shareholding
have no alternative. ❯ Termination payment
❯ Board attendance record ❯ Potential conflicts of interest
❯ Oligopoly Industries that have
a small number of suppliers. The
competition is not as intense as in
the free market, so governments
often impose regulations on
companies to ensure quality
and fair prices.
❯ Remuneration Money paid
for work or a service provided—the
financial term for pay; may include
bonuses or share options.

Charitable donations
Companies boast of their philanthropy
in the annual report, detailing how
$

71%
much they have given away and how
it has helped. They may support
charities relevant to the nature of
their business or let employees vote
on recipients.

of CEOs feel
personally responsible
Customer satisfaction
Overall, this section shows how the
for ensuring that their
company works with customers to
improve service and support. In
organization’s
monopoly and oligopoly industries,
customer satisfaction is particularly
sustainability policies
important, as governments often set
high targets.
reflect their
customers’ values.
FINANCIAL STATEMENTS

Financial statements for users operations and policies. For this reason, financial
The many financial statements included in the annual statements are useful to a wide range of stakeholders,
report are a gold mine of information for those who from the company’s employees, customers, and
know how to read them. They provide headline profit shareholders to potential investors, governments,
figures, explanations of issues from directors, detailed tax authorities, journalists, credit-rating agencies,
financial data, and information about companies’ banks, and the general public.

Who reads what

Different stakeholders are interested in different parts of the
annual review. Customers of a service provider, for instance,
may look at the section on customers and community, while
potential lenders go to the financial statements.

Stakeholder Important parts Why?

REHOLDER ❯ Profit-and-loss
HA ❯ To see how much money the
account
S

company is making
S

❯ Balance sheet ❯ To assess the long-term strength of

❯ Dividends the company
❯ To see how much will be paid
out to them

PLOYEES ❯ To check the health of the

EM ❯ Our employees company in order to assess
❯ Governance report their job security
❯ Performance ❯ To see how much executive and
indicators non-executive directors are paid
❯ To see how well the company is
performing and if it can improve

DITORS ❯ The whole statement ❯ To assess whether the accounts are

AU
❯ Independent error-free

$
auditor’s report ❯ To ensure that the company has
(written by the complied with Generally Accepted
auditor) Accounting Principles (GAAP)
(See pp.112–113.)
 HOW FINANCE WORKS
Financial reporting 110 111

UNDERSTANDING REVIEW JARGON

An annual review includes essential information about the financial health of the business, such as:

Post-tax ❯ A percentage figure estimated by dividing income after tax by the amount of investment. It is
return on capital useful for showing shareholders the kind of returns they can expect on their investments.

Gearing ❯ Gearing is a company’s debt compared to its equity and is expressed as a percentage.
The higher the gearing, the more risk a company is taking. See pp.174–175.

Credit rating ❯ Credit ratings assess the likelihood that loans will be repaid. Credit rating agencies often
give ratings in the form of letter grades, with AAA being the highest, indicating that a company
has a strong capacity to meet financial commitments. C and D grades are the lowest.

Stakeholder Important parts Why important?

T/TAX AU ❯ Taxation ❯ To check that the figures are
EN T
M ❯ Independent correct and the correct amount
HO
GOVERN

auditor’s report of tax has been paid

RITIES

❯ Environment section ❯ To check the audit and that they

and environment- are satisfied with the accounts
related notes ❯ To check that environmental laws
have been adhered to

❯ Balance sheet ❯ To see the company’s assets and

NSTITUTION
LI liabilities and assess its strength
IA

S/
FINANC

❯ To decide whether it is wise to

BANKS

$ lend to the company

❯ Chair’s introduction ❯ To find elements to quote

URNALISTS
JO ❯ To see how strongly the
❯ Accounts and notes
company has performed
❯ To analyze why a company
has been performing well or
poorly and see whether
there is a story to write
 Financial
accounting
A company’s financial accounts classify, quantify, and record its transactions.
They are extremely useful for people outside the business, such as creditors and
potential investors, as well as those currently involved with making investment
decisions. For this reason, the accounts should be concise and clearly present the
timing and certainty of future cash flows, so that people looking at the company
can decide whether or not to invest in, lend money to, or do business with it.

Key elements
The profit-and-loss account,
balance sheet, and cash-
flow statements are the
most important financial
statements in an annual Accounting Profit-and-loss Balance sheet
review, supplemented standards statement Gives a snapshot of
by the report’s notes. Generally accepted Shows how much how much a business
To understand these principles standardize money a company is worth at a certain
statements, a knowledge practice worldwide to is making and is time and is a good
of accounting principles, ensure accuracy and especially useful for indication of its
depreciation, amortization, prevent fraud. potential investors long-term health.
and depletion is vital. See pp.112–113. and stakeholders. See pp.116–119.
Accountants also need ❯ International See pp.114–115. ❯ Balances company’s
to understand the legal standards simplify ❯ Outlines revenues assets against its
requirements that the account reporting. and gains minus equity and liabilities.
statements must satisfy ❯ Companies must expenses and losses ❯ Lists different types
and how environmental meet environmental or operating costs. of assets, including
laws can affect a business accounting rules ❯ Informs a company tangible fixed assets
and its accounts. and regulations. whether a profit and current assets.
See pp.122–123. warning is needed.

$
 HOW FINANCE WORKS
Financial accounting 112 113

$74 AUDITING
The accounts of public companies are
given unbiased scrutiny by external

billion
accountants to verify that they are
accurate and clear. This is a legal
requirement in most countries,
designed to ensure market
confidence in the business
the total value lost by world and transparency
in corporate finance. A
shareholders in the 2001 company may also have
an internal audit process,
Enron accounting scandal which means that its
accounts are checked
before being submitted
to an external auditor.

Cash-flow Environmental Depreciation Amortization

statement accounting Accounts for the and depletion
Reveals a company’s Accounts for myriad decrease in value Account for the
liquidity by tracking environmental rules over time of tangible decrease in value
the flow of cash— and regulations that fixed assets in order over time of a range
money or short-term oblige companies to to spread the cost of intangible assets,
investments—in and mitigate the impact of of assets over their loans, and natural
out of the company. business activities. economic life. resources.
See pp.120–121. See pp.122–123. See pp.124–127. See pp.128–129.
❯ Shows whether a ❯ Showcases green ❯ Can be calculated ❯ Intangible assets
company can sustain credentials in with a number of include patents,
itself, grow, and pay financial statements. different methods. trademarks, logos,
debts. ❯ Reveals compliance ❯ Tangible fixed and copyrights.
❯ Details cash flow with environmental, assets include ❯ Natural resources
from operating, social, and buildings, plants, include minerals
investing, and governance criteria. and machinery. and forests.
financing activities.
 Profit-and-loss
statement
A profit-and-loss statement is a financial statement that shows all
revenues, costs, and expenses during an accounting period. It is also
known as an income statement or an income and expense statement.

How it works profitable the company is. The statement usually

The purpose of the profit-and-loss statement is to show works by showing revenues and gains, minus expenses
the profitability of a business during a given period. and losses from business activities, as well as the
Along with the cash-flow statement and the balance sale and purchase of assets. Businesses that are sole
sheet, it is the most important financial statement that proprietorships or partnerships are generally not
a business produces, as it shows investors how required to submit profit-and-loss statements.

How to read a profit-and-loss statement

Profit-and-loss statements commonly illustrate the financial performance of a business
over a particular month, quarter, or year. The key pieces of information are the figures for
turnover (or revenue) and operating profit. If profits are going to be lower than expected,
the company may put out a profit warning ahead of releasing the statement.

$
Case study: profit-and-loss statement
This example of a profit-and-loss statement for a fictional
utility company shows that it is making a profit.

Year 2021 Year 2020

Amount of money taken by the $m $m
business over a certain time; in this case,
there was a 5.5 percent increase in Turnover 607.5 575.9
turnover from the previous year.
Operating costs –372.7 –354.2

Profit earned from the business’s core Operating profit 234.8 221.7
operations after expenses have been
Financial income 0.6 0.2
taken off, but before taxes have been
deducted; it does not include money Financial expenses –98.1 –100.3
made on investments.
Net financing expense –97.5 –100.1
Profit before tax after all
income and expenses have been Profit before tax 137.3 121.6
taken into account, excluding Taxation 61.2 20.8
extraordinary payments.
Profit after tax 76.1 100.8
Level of profit that can
be paid out in dividends to the
company’s shareholders.
 HOW FINANCE WORKS
Financial Accounting 114 115

TYPICAL EXPENSES
Payroll IT and office supplies
$
Salaries and wages paid to staff, temporary IT equipment and software used by employees;
contractors, and indirect labor stationery, printer supplies, furniture, lighting
Utilities Legal fees and professional services
Water, electricity, and gas; postage and Accounting and legal fees, payable to
shipping; transportation accountants, auditors, and legal advisers
Insurance Interest on loans
Insurance on fixed assets and personal liability
insurance for employees
% Interest paid on money borrowed, which counts
as a business expense
Phone/internet bills $ Tax
Cost of telephone, broadband Internet, Varying among jurisdictions, this may
and mobile devices used by employees include payroll tax and corporation tax
Advertising Entertainment
Sales and marketing of the company and Legitimate costs of business entertaining
its products

$
Case study: operating costs
This table shows the utility company’s operating costs in more detail. It is important to
read any notes about depreciation and ordinary and extraordinary costs and gains.

Employee costs, including basic pay, Year 2021 Year 2020

pensions, Social Security contributions, $m $m
and directors’ remuneration
Employee costs 133.3 125.5
Term given to the gradual decline in an Utility costs 36.3 35.1
asset’s value, caused by such factors as
Raw materials and consumables 17.1 16.1
wear and tear and market conditions
Insurance 25.5 26.1
Decrease in value over time of Depreciation 117.9 116.9
intangible assets or loans
Amortization of intangible assets 8.1 5.1
Profit or loss on the sale of fixed assets Loss/[gain] on disposals of fixed assets [0.3] [4.9]
Leasing costs for buildings Operating leases for plant and machinery 5.3 4.8
and equipment Research and development 1.9 0.3
Research and development carried Other operating costs 142.0 132.0
out to improve the reliability and
effectiveness of services
Funds spent by the company to create
Own work capitalized [111.2] [100.1]
capital assets that have a life greater 375.9 356.9
than one year
Fees paid to the auditor 0.3 0.3

Figures in brackets represent negative numbers.

 Balance sheet
A balance sheet is a financial statement that shows what a business
is worth at a specific point in time. Its primary purpose is to show
assets, liabilities, and equity (capital) rather than financial results.

How it works assets, liabilities, and the business’s

The balance sheet essentially shows capital—what the company owns NEED TO KNOW
what the company owns, what it (assets) is purchased either through
❯ Deferred income Income a
owes, and how much is invested in debt (liability) or investment
company receives for goods
it. It is based on the accounting (capital). The equation always or services that have not yet
formula, sometimes called the balances, as everything a company been delivered or provided. Until
balance-sheet equation, which is the owns has to have been bought income is received, it is recorded
basis of double-entry bookkeeping. with the business’s funds or on a balance sheet as a liability.
This shows the relationship between through borrowing.

The balance-sheet equation

As the name suggests, the balance sheet must always balance. This is
because everything the business owns (its assets) must be offset against
the equivalent capital (or equity) and liabilities (debt).

Company has no liabilities

For example, a young business may
have assets of $1,000. It currently has
no liabilities, so its capital is equal to ASSETS LIABILITY CAPITAL
its assets—that is, it is the amount of
$1,000 $0 $1,000
equity the owners or shareholders
have invested in the business. Using
the accounting formula, the equation
would look like this:

Company incurs $400

in liabilities
After spending $400 on, for example,
an illuminated sign for the storefront,
the owner incurs $400 in liabilities, and ASSETS LIABILITY CAPITAL
so the formula changes. However, $1,000 $400 $600
because the sign is worth $400, and
the owner has $600 remaining, the
equation remains balanced—as it
always does.
 HOW FINANCE WORKS
Financial accounting 116 117

£
Case study: balance sheet
This example from a fictional transportation infrastructure
company shows how a balance sheet works in practice.

Fixed assets (or noncurrent assets) ASSETS, LIABILITIES, AND CAPITAL Year 2021 Year 2020
are not easily converted into cash $m $m
and usually last longer than one year.
They are either tangible, such as Fixed assets
land, or intangible, such as a logo. Tangible assets 3,872.4 3,699.5
Intangible assets 60.1 44.6
Investments – –
Current assets are assets that last 3,932.5 3,744.1
one year or less and can be easily
converted into cash. Cash, cash
Current assets
equivalents, and inventory are
the most common current assets. Inventories 4.2 6.1
Trade and other receivables 185.1 189.6
Current liabilities are the amounts that Cash and cash equivalents 46.5 -22.4
the company owes to individuals 235.8 173.3
or organizations. Here, the money must
be repaid in the current financial year.
Current liabilities—amounts falling due within one year –182.2 –274.4
Net current assets equal current
assets after current liabilities have Net current assets 53.6 –101.1
been deducted.
Total assets less current liabilities 3,986.1 3,643
Total assets less current liabilities is Noncurrent liabilities—amounts falling due after more than one year
the sum of fixed and net current
assets minus liabilities due within the Other interest-bearing loans and borrowings –2,226.6 –2000.4
current financial year. Contract liabilities –6.9 –6.9
Employee benefits –89.9 –121.1
Deferred grants and contributions –299.2 –265.6
Liabilities due in more than one Provisions –0.5 –0.9
year are amounts due to creditors,
which are deducted from total fixed Deferred tax liabilities –444.3 –355.5
and net current assets. –3,067.4 –2,750.4
Net assets 918.7 892.6
Net assets are what is left once
liabilities have been deducted from
Equity
the company’s fixed and net current Share capital 10 10
assets to give the overall net assets.
Retained earnings 908.7 882.6

Shareholders’ funds 918.7 892.6

Shareholders’ funds, or owner’s
equity, is the remaining capital;
this money can be reinvested
into the business or paid out as SYMBOLS FOR DEBITS AND CREDITS
an annual dividend. Accountants use a number of different terms and symbols to
indicate debits and credits. Some use “Dr” for debits and “Cr”
for credits; others use brackets to show negative numbers.
BALANCE SHEET

Understanding the notes after the summary, the detailed section of the balance
The balance sheet is a useful indication of the health sheet explains the specific financial workings of the
of a business, and it is important that investors know business in a number of notes. It shows exactly where
how to analyze it. It can be read in two ways—“at money has been gained or lost, in numbers, and it often
a glance,” as on the previous page, where general includes a written commentary about potential
information is summarized, or in depth, with more developments that may affect the company, such as
detailed information about each element. Provided court cases, staffing, or availability of resources.

Balance-sheet notes
Investors may want to know more about the figures in the summary section,
so additional notes and tables give detailed breakdowns of the numbers.

$
Case study: tangible fixed assets
This table presents details of the transportation company’s tangible fixed assets (long-term
assets that cannot easily be converted into cash).

Tangible fixed assets

include land and machinery. LAND AND INFRASTRUCTURE PLANT, OFFICE AND IT
BUILDINGS ASSETS MACHINERY, EQUIPMENT
Additions are new tangible AND
fixed assets the business has VEHICLES
acquired this year.
$m $m $m $m
Cost
Disposals are any tangible At April 1, 2020 901.1 2,300.7 1,908.2 44.1
fixed assets the business has Additions 57.1 110.6 71.5 4.1
disposed of or sold this year.
Disposals –1.5 –0.1 –32.2 –5.3
Total value of the company’s
fixed assets is listed by category At March 31, 2021 956.7 2,411.2 1,947.5 42.9
and in total.

Depreciation is the decrease Depreciation

in value of assets over time. At April 1, 2020 –322.6 –107.8 –999.2 –25
Charge for the period –15.1 –20.4 –22.3 –3.7
Value of depreciation of assets
is listed by category and in total. Disposals 0.9 – 24.5 4.8
At March 31, 2021 –336.8 –128.2 –997.0 –23.9
Net book value of an asset is
its initial cost minus all its
depreciation to date.
Net book value

Combined value of the

At March 31, 2021 619.9 2,283.0 950.5 19
company’s tangible fixed
assets in each category,
and also in total, is listed. At April 1, 2020 578.5 2,192.9 909.0 19.1
 HOW FINANCE WORKS
Financial accounting 118 119

Case study: debtors

$
Debtors are individuals or entities that owe the business money.
The transportation company has various categories of debtor.

2021 2020
$m $m
Amounts receivable from customers 123.0 134.2
Owed by immediate holding company 22.1 23.2
Owed by fellow subsidiary companies 20.1 20.6
Owed by other group companies 0.2 –
Owed by associate companies 1.8 1.6
Prepayments for services Prepayments 6.1 3.9
that will be received in the Contract assets 2.1 –
future that the business has
already been paid for Other debtors 9.7 6.1

=
185.1 189.6

TOTAL

Case study: creditors

$
Creditors are individuals or entities that the business owes
$m money to. They are in credit to the transportation company.

5,154.1 Individuals or entities that are 2021 2020

owed money for supplying raw $m $m
243.3
materials or components
–39.1 Trade creditors 12.0 19.1
Amounts owed to subsidiary 20.4 18.3
5,358.3 company
Money owed to related
companies that are owned
Amounts owed to other group 0.5 0.5
by the same group companies
–1,454.6 Dividends 24.0 24.0
–61.5 Payment to Other creditors 4.2 3.2
shareholders
30.2 Corporation tax 2.6 99
Tax and Social Security 2.9 2.7
–1,485.9
Accrued expenses 55.1 49.1
Tax and employee benefit Contract liabilities 60.5 58.5
payments 182.2 274.4
3,872.4

3,699.5
 Cash-flow statement
The cash-flow statement shows the movement of cash during the last
accounting period. It is important because it reveals a company’s
liquidity—whether it has more money coming in than going out.

How to read a cash-flow statement

The statement of cash flows, to state its official title, answers the key question of whether a
business is making enough money to sustain itself and provide surplus capital to grow in the
future, pay any debts, and give out dividends.

$
Case study: cash-flow statement
By analyzing this fictional manufacturing company’s statement, which includes a comparison to the
previous year, decision makers can base future plans on past cash flows.

Using profit before tax as a starting Year to Year to

point, noncash income and expenses March 31, March
are deducted to reach net cash inflow 2021 31, 2020
from operating activities. $m $m
Net cash inflow from operating activities 340.7 349.4
Returns on investment in this case
are total interest received minus total
interest paid, as well as interest paid Net cash from investing activities –255.3 –245.6
on finance lease rentals.

Taxation is the sum of all taxes paid Taxation paid –28.4 –23.7
and tax credits received.

Net cash flow before financing activities 57 80.1

This is the sum of the figures above.
Net cash flow from financing activities 12 –141.8
Includes changes in borrowings,
loans, and dividends paid.

This is the change in cash flow,

calculated by adding the two figures
above—net cash flow before financing
activities and net cash flow from Increase/decrease in cash and cash equivalents 69 –61.7
financing activities—and must equal
the difference between opening and Opening cash and cash equivalents –22.4 39.3
closing cash flow for the year.

Closing cash and cash equivalents 46.6 –22.4

This is the change in cash flow

over the year, calculated from the
closing cash position minus the opening
cash position.
Increase/decrease in cash and cash equivalents 69 –61.7
 HOW FINANCE WORKS
Financial accounting 120 121

How it works are performing. The profit-and-loss statement, for

The cash-flow statement is often more useful for example, obscures this by adding in noncash factors,
investors assessing a business’s health than other key such as depreciation. Similarly, the balance sheet is
statements because it shows how the core activities more concerned with assets than liquidity.

Three types of cash flow

Cash refers to actual money as well as cash equivalents, including cash in the bank; bank lines
of credit; and short-term, highly liquid investments for which there is little risk of a change in
value. Cash does not include interest, depreciation, or bad debts (debts written off).
Cash flow from operating activities
The bulk of cash flow usually comes from operations and is worked out with a
formula. The change in working capital (current assets minus current liabilities)
can be a negative figure.

ANY CHANGE CASH FLOW

REVENUE – – REPAIR +
TAXES + IN WORKING = FROM OPERATING
COST OF SALES COSTS
CAPITAL ACTIVITIES

Cash flow from operating activities in practice

In this example, a juice company sells $100 worth of orange of $20 over the period which is another cash outlay. There
juice after spending $20 on oranges. It pays 25 percent of its is no change in working capital (short-term assets to cover
$80 earnings in tax. Its juicing machine incurs a repair expense short-term debt).

A JUICE
25%
TAX GS

COMPANY SELLS

$100
IN RNIN
EA

WORTH OF
OF PAYS

ORANGE JUICE ITS JUICING

ITS

MACHINE INCURS

- - + + = $80
IT

A REPAIR NO
EXPENSE OF CHANGE

AND SPENDS $20 IN WORKING

CAPITAL CASH FLOW
$20
ON ORANGES
OVER THE
PERIOD $0 FROM
OPERATING
ACTIVITIES

=
Cash flow from Cash flow from Total cash flow
investing activities financing activities Adding all three cash flows
Buying or selling assets This includes buying or gives the total. Separating
or investments is in this category. selling stock and paying out debt out the three types shows decision
This figure is usually a cash outflow or dividends. Money made from makers the health of core activities
(negative figure) due to buying more selling something is called cash as opposed to financing and
than selling, but it can be positive if inflow; money lost through paying investing, which bear little relation
there are significant sales. out is cash outflow. to day-to-day operations.
 Environmental
accounting
Environmental regulations force companies to consider the impact of
their activities and to adopt corporate social responsibility (CSR) as
they grapple with legislation, climate change, and public opinion.

How it works
Globally, there are reams of different environment
acts spread across multiple jurisdictions that affect
Environmental credentials
the companies operating within their borders in Most companies include a section on environmental
different ways. Areas protected by environment acts accounting in their financial statement. Some details are
include the atmosphere, fresh water, the marine required by law, but the statement also gives an opportunity
environment, nature conservation, nuclear safety, and
to showcase environmental credentials to stakeholders.
noise pollution. International acts are usually ratified
by each country individually before taking effect there.
An example of a common global means of reducing
greenhouse gas emissions is emissions trading (“cap
and trade”), by which companies must buy a permit
for each ton of CO2 that they emit over a certain level. Society
Those emitting under the agreed level can sell their
❯ Programs and practices
permits to other companies. that assess and manage
the impact of operations
on communities
❯ Fines and sanctions for
noncompliance with
CASE STUDY regulations

The Tata Group

The Indian multinational conglomerate prides itself
on being a values-driven organization and seeks to Product
protect the environment through its various businesses responsibility
and the support of environmental NGOs via its
philanthropic Tata Trusts. Projects include: ❯ Life-cycle stages in which the
health-and-safety impact
❯ Tata Chemicals has established a 150-acre botanical of products and services are
reserve on the site of a factory in Mithapur, Gujarat, assessed for improvement
protecting indigenous and other plant species.
❯ Adherence to laws, standards,
❯ Tata Motors has created 245 acres of urban wetlands and voluntary codes relating to
within its plant in Pune, western India, attracting marketing communications
150 bird species and 60 types of butterfly.
❯ In the last 30 years, Tata Power has planted more
than 18 million trees around the Walwan Dam and
its hydroelectric facilities in Maharashtra state.
❯ Other initiatives include efforts to protect turtles
and whale sharks as well as flood relief in Kerala.
 HOW FINANCE WORKS
Financial accounting 122 123

GREENHOUSE GAS EMISSIONS

In some countries, companies are Appointed Direct fuel Grid Third Total Total
required by law to provide details business use electricity parties 2020–21 2019–20
of their greenhouse gas emissions.
This is usually presented as a table Gas, diesel, 7 0 2 9 7
in the environmental accounting other fuels
section of the annual report. Grid electricity 0 120 0 120 115
It includes direct and indirect
emissions—by the company itself and Transportation 11 0 2 13 12
by third parties—of gas, diesel, and
Methane 20 0 3 23 23
other fuels; sulfur oxides and nitrous
oxides; methane; and other ozone- Nitrous oxide 12 0 5 17 18
depleting substances. In this table,
from a fictional utility company, Exported 0 –6 0 –6 –5
emissions are shown as ktCO2 renewable
equivalents.
TOTAL (net 50 114 12 176 170
emissions)

Economic
❯ Financial implications, risks,
and opportunities for the Human rights
organization’s activities ❯ Investment agreements
due to climate change that include human rights
❯ Financial assistance received clauses or that have undergone Labor practices
from the government human rights screening ❯ Workforce by employment
❯ Suppliers and contractors that type, contract, and region
have undergone screening on ❯ Average hours of training
human rights; actions taken to per year, per employee, by
address any issues employee category
❯ Ratio of basic salary
of men to women, by
employment category

Environmental
❯ Direct and indirect energy
consumption
❯ Waste by type and disposal method
❯ Water withdrawal by source;
discharge by destination and quality
❯ Fines and sanctions for
noncompliance with regulations
 Depreciation
When a company buys an asset, its cost can be deducted from income
for accounting and tax purposes. Depreciation allows the company to
spread the cost, by calculating the asset’s decline in value over time.

How it works typically a year. Secondly, they

If a business buys a long-lived match that loss in value to the NEED TO KNOW
asset, such as a building, factory amount of income earned in that
equipment, or computer, to help it period, so depreciation becomes ❯ Fixed/tangible assets Items that
enable a business to operate but are
earn income, this expenditure can a deduction from taxable income.
not a part of trade; assets lasting a
be offset as a cost against income There are several different year or more qualify for depreciation.
earned. However, not all this ways to calculate depreciation.
❯ Useful/economic life Length of
income will be generated in the The method a company uses may time an asset is fit for its purpose
year of purchase and, over time, depend on the kind of business, the and has monetary value
the asset will age and become less type of asset, tax rules, or personal ❯ Salvage/scrap/residual value
beneficial to the business, until preference. In the United States, Worth of an asset once it has
it becomes outdated or unusable. per IRS guidelines, companies outlived its useful life—often set
Accountants do two things to turn must use MACRS (Modified by the tax authority
the declining value into a Accelerated Cost Recovery System), ❯ Book value An asset’s worth on
tax advantage. Firstly, they work a combination of straight-line and paper at any point between its initial
out how much the asset’s value double declining balance methods purchase and salvage
decreases over a period of time— (see below and p.126).

Calculating depreciation VALUE ($)

0
,00
The straight-line method is the simplest way of working out $25,000 $21
depreciation and can be applied to most assets. Depreciation is
calculated along a timeline, with value loss spread evenly over $20,000
the asset’s economic life. Scrap value is deducted from purchase
value, and the remainder is split into equal portions over time. $15,000

$10,000
PURCHASE SCRAP ANNUAL
– VALUE
VALUE DEPRECIATION ($) $5,000
= $
USEFUL ECONOMIC
LIFE (YEARS) $ 0 1

Year 1 After a year, the van’s

Example value has depreciated by $4,000
A landscaping business buys a $25,000 – $5,000 (its purchase value minus its scrap
new van for $25,000. The IRS = $4,000 value, divided by its useful economic
5 life). Its value is now $21,000.
sets its scrap value at $5,000
after five years of use.
 HOW FINANCE WORKS
Financial accounting 124 125

TYPICAL LIFE OF FIXED ASSETS

Tax authorities often specify the typical useful (economic) life of a particular asset.
This helps standardize depreciation and eliminate uncertainty about value and the

60%
number of years over which an asset can be depreciated.

OFFICE the value the

average car
RACEHORSES FURNITURE FENCES
3 years 7 years 15 years Time
10 20+
(years)
loses after
5
FRUIT-
15
OFFICE three years
BUILDINGS
BEARING TREES 39 years
COMPUTERS 10 years
5 years

0
,00
$17
0
,00
$13
000
$9,
000
$5,

2 3 4 5
TIME (YEARS)

Year 2 After the second year, the value Year 3 At the end of the third Year 4 The van has Year 5 By the
has depreciated by another $4,000. The year, the van has depreciated depreciated by end of year five,
van will lose an equal amount of value by another $4,000, and its book $4,000, to $9,000, the van is valued
each year for the next three years of its value is $13,000, although its at the end of four at only $5,000—
useful economic life. actual value may be more or less. years of life. its scrap value.
DEPRECIATION

Applying depreciation categories of assets. For example,

When calculating depreciation, the “accelerated” methods that WARNING
there are a number of different chart rapid depreciation at the
factors to consider. For instance, beginning of an asset’s life are more Misusing depreciation
a business needs to be able to suitable for technology, ❯ The wrong method A company
predict the number of years an while the “activity” methods that must choose a method that is
asset will last. Helpfully, tax link depreciation to actual hours permissible for an asset type.
authorities in most countries issue of use or number of units produced ❯ Frontloading Opting for an
guidelines to accountants and are best suited to transportation accelerated method can result in a
businesses with estimates of and production lines. taxable gain if an asset is sold early,
the useful economic life of many Again, tax authorities in most for more than its book value.
common business assets. countries offer guidelines on which ❯ Claiming beyond useful life
Finance staff are trained to method to use. Although it is Depreciation cannot be claimed
after an asset’s useful life.
choose between the many methods technically possible for a company
of calculating depreciation to use to use two different methods for ❯ Ignoring depreciation If a
company fails to claim depreciation,
for a given asset. Each method their own accounting and for tax
it has to report a gain from the sale,
reflects a different pattern of purposes, this is best avoided. despite the loss on deduction.
depreciation, with some being
more suitable for particular

Other depreciation methods

There are many different methods of calculating depreciation. Some are favored by
particular tax codes, while others are specifically applicable to certain industries and
types of assets, and their patterns of value loss.

Double declining balance method

( )
A method used to claim more depreciation in PURCHASE VALUE – SCRAP VALUE ANNUAL
the first years after purchase, which is useful for X 2 = DEPRECIATION
assets that lose most of their value early on. It reduces a USEFUL ECONOMIC
LIFE (YEARS) (%)
company’s net income in the early years of an asset’s life,
but generates initial tax savings.
When to use it This accelerated method can be used for assets that
lose most value early, such as computers or a delivery truck.

Sum of the years’ digits

method (SYD) (PURCHASE VALUE – SCRAP VALUE)
X ANNUAL

( )
Depreciation is calculated by dividing each year = DEPRECIATION
REMAINING USEFUL LIFE
of the asset’s life by the sum of the total years to give a (%)
percentage of the depreciable value. If the asset’s useful SUM OF THE YEARS’ DIGITS
life is 5 years, then the sum of the years as digits
is 15 (5 + 4 + 3 + 2 + 1). In year 1, it loses 33 percent When to use it This is another accelerated method that can also
(5 ÷ 15), in year 2, 27 percent (4 ÷ 15), and so on. be used for vehicles that lose most of their value early.
 HOW FINANCE WORKS
Financial accounting 126 127

DEPRECIATION ON THE BALANCE SHEET

A company’s accounts have to list all assets held by the
company, including all fixed assets, such as property and COMPANY NAME BALANCE SHEET
equipment. The accumulated depreciation of these fixed
Assets
assets over the year is deducted from their value at the
Current assets: 2020 2021
start of the year to give the year-end total. Without a Cash 17,467.00 8,023.00
depreciation figure, the accounts would give a false Investments 4,853.00 3,367.00
reflection of the finances of the business. The assets would Inventories 1,056.00 2,138.00
appear as their original cost value, which could exceed Accounts receivable 2,165.00 3,600.00
their current value. Prepaid expenses 3,000.00 3,000.00
Other 860.00 976.00
Fixed assets are separated Total current assets 29,401.00 21,104.00
from current assets.
Fixed assets: 2020 2021
Property and equipment 64,553.00 58,219.00
Depreciation of fixed Building/site improvements 4,780.00 2,679.00
assets is deducted. Equity and other investments 3,789.00 4,587.00
Less accumulated depreciation 5,625.00 4,171.00
Total fixed assets 67,497.00 61,314.00
Total assets are calculated after
depreciation has been Other assets: 2020 2021
deducted. Goodwill 1,577.00 1,650.00
Total other assets 1,577.00 1,650.00
Previous year’s total Total assets 98,475.00 84,068.00
assets can be compared.

Units of production method

When a company uses an asset to produce (PURCHASE VALUE – SCRAP VALUE)
X

( )
quantifiable units, such as pages printed DEPRECIATION
by a copier, it can claim depreciation with this method, UNITS PRODUCED PER YEAR = (PER UNIT)
which calculates depreciation according to the number LIFETIME PRODUCTION
of units an asset produces in a year.
When to use it This method is typically used by factories to
calculate depreciation on machines that produce units of goods.

Hours of service method

The asset’s decline in value is measured according (PURCHASE VALUE – SCRAP VALUE)
X DEPRECIATION

( )
to the number of actual hours it is in use. To =
calculate depreciation with this method, the company HOURS USED PER YEAR (PER HOUR)
measures the hours of use per year as a percentage of the LIFETIME HOURS
estimated total lifetime hours. It is particularly useful for
transportation industries. When to use it This method may be used to match an airplane’s
flying hours with the revenue generated from those hours.
 Amortization
and depletion
Similar in concept to depreciation, amortization and depletion are
used by accountants to show how intangible assets and natural
resources, respectively, are used.

How it works asset on the balance sheet and an expense on the

Amortization is how the cost of purchasing an income statement. In lending, amortization can also
intangible asset, such as copyright of an artwork, is mean the paying off of debts over time. Depletion
spread over a period of time, usually its useful lifetime. shows the exhaustion of natural resources, such as
It is shown as a reduction in the value of the intangible coal mines, forests, or natural gas.

Amortization in practice
There are two types of amortization: one for spreading the cost of an
intangible asset and the other for loan repayment. Both are calculated
in similar ways, but loan repayments are worked out as a percentage.

Intangible assets
INITIAL COST YEARLY
In this example, a VALUE ($) =
USEFUL LIFE AMORTIZATION
company buys an
intangible asset— $20,000
a patent for a new, $20,000
= $2,000
revolutionary type $16,000
10 YEARS
of tennis racket—for
$20,000. The patent $12,000
will be useful for 10
years, so its cost is
recorded as a $2,000 $8,000
amortization (expense)
each year rather than as a $4,000
one-time cost. Unlike
tangible assets, a patent
does not have a salvage 0 1 2 3 4 5 6 7 8 9 10
value (see p.124). TIME (YEARS)

Loan percentage
COST OF LOAN YEARS TO REPAY
If a company has an outstanding loan worth = = %
$150,000 and pays off $3,000 of this loan YEARLY REPAYMENT 100
each year, then $3,000 of the loan has been
amortized. It can also be said that 2 percent 150,000 50
of the loan has been amortized, as it will = = 2%
3,000 100
take 50 years to repay the loan at this rate.
 HOW FINANCE WORKS
Financial accounting

GOODWILL NEED TO KNOW

In business, goodwill describes an total sum of its assets and liabilities is ❯ Intangible assets Nonphysical
intangible asset based on a company’s $9 million, the goodwill is worth $1 assets, such as patents, trademarks,
reputation, including loyal customers million. According to International brand recognition, and copyright;
and suppliers, brand name, and public Financial Reporting Standards since their valuation is sometimes
profile. Goodwill arises when one 2001, goodwill does not amortize, subjective.
company buys another for more than so it does not appear as amortization
❯ Patent A license granted by a
the fair market value of its net assets in financial statements. However, if
government or authority giving
(total assets minus total liabilities). the value of goodwill falls (through
the owner exclusive rights for
For example, if Company A buys negative publicity, for example), it
making or owning an invention
Company B for $10 million, but the can be recorded as an impairment.

How to calculate depletion

Like amortization, depletion is calculated by using the straight-line
method (see pp.124–125), unless there is a particular reason to use
another method.

In this example, a logging company buys

a forest with an estimated 60,000 trees for COST – SALVAGE VALUE UNITS DEPLETION
X =
$10 million. The original salvage value is TOTAL UNITS EXTRACTED EXPENSE
$1.5 million, but the company spends $500,000
on building roads in the forest, bringing it down 10,000,000 - 1,000,000
to $1 million. The company cuts down 6,000 trees X 6,000 = $900,000
during each accounting period. 60,000
N

NUMBER
M $10
IO

OF TREES
ILL

N
M $9.1
IO
ILL

N
M $8.2
IO

ON

60,000
MI $7.3
ILL

LLI

ON
MI $6.4

50,000
LLI

ON
MI $5.5

ON
LLI

MI $4.6

40,000
LLI

ON
MI $3.7

30,000
ON
LLI

MI $2.8

ON
LLI

MI $1.9

N
LLI

20,000
IO
MI $1
LL

10,000

0
1 2 3 4 5 6 7 8 9 10
TIME (YEARS)
 Management
accounting
For a company’s management to anticipate profit and loss, plan cash flow, and set
effective goals for the business, the coming year’s incomings and outgoings need
to be documented in detail. Unlike financial accounting, which is primarily for
external users, such as investors, lenders, or regulators, management or cost
accounting takes place within a business to project expected sales revenue and
expenses so that the business can decide how to best use its available resources.

Department budgets
Management
Managers estimate what funds will be needed accounting process
for expected expenses. See pp.136–137. Planning is done for the financial (fiscal)
year that lies ahead—this is also called
Purchase orders (POs) the accounting year and is made up of
POs tell the finance department exactly how 12 consecutive months. Start and end
much money to reserve for payments. dates differ from country to country.

Timesheets
Staff employed on an hourly or daily basis fill in timesheets;
these help managers calculate overall staff costs. See pp.140–141.

Invoices
Invoices submitted by contractors and suppliers have to be
matched against purchase orders and paid. See pp.134–135.

Goods received
Employees log receipt of merchandise, describing
the goods or services and the quantity received.

Management
Information
Managers create budgets and document business costs is passed to
to monitor business performance and plan for the short finance
and medium term. The information they collect sheds department.
light on the financial implications of ongoing projects.
 HOW FINANCE WORKS
Management accounting 130 131

$157 COST ACCOUNTING PRINCIPLES

The Chartered Institute of Management Accounting (CIMA)

billion
in the UK and the American Institute of Certified Public
Accountants (AICPA), with members in 177 countries, have
established Global Management Accounting Principles.
❯ Communication provides insight that is influential.
Facilitate good decision making through discussion.

combined revenue of ❯ Information is relevant. Source best material.

❯ Stewardship builds trust. Protect financial and
the Big Four accounting nonfinancial assets, reputation, and value of organization.
❯ Impact on value is analyzed. Develop models to
firms* in 2020 demonstrate outcomes in different scenarios.

* Deloitte, PwC, Ernst & Young, and KPMG

Cost of production report (CPR)

CPR shows all the costs that can be charged
to a particular department. See pp.140–143.
$
Budget reports
Reports help management determine the accuracy of
budgets and analyze business performance. See pp.136–137.

Cash-flow statement $
This shows how well the business will be able to meet its financial
obligations and generate cash in the future. See pp.120–121.

Balance sheet
Financial The balance sheet estimates the value of assets and inventory held $ $
analysis is so that management can reduce it, if necessary. See pp.116–117.
passed to
managers. Profit-and-loss statement
$
Also called an income statement, the P&L statement tells
management how much money the business made or $

lost over a particular time period. See pp.114–115.

Finance department
Accountants in the finance department (or contracted
from outside the business) receive information about
the costs from managers. They then use these figures to
generate reports and statements for the managers, who use
this information to make decisions for the next financial year.
 Cash flow
The money coming in and going out of a business is its cash flow; the
balance of inflow and outflow is key to survival. Inflows arise from
financing, operations, and investment, while outflows are expenses.

Sales revenue

Cash for goods and

services sold
❯ Revenue generated by core
operations
❯ Basis of profit—does not have to Capital
be repaid, unlike loans or capital
Investment and lump sums
❯ Company must be able to turn CASH
revenue into cash (get paid) to ❯ Main source of cash inflow for IN
maintain cash flow start-ups
❯ Also known as cash flow from ❯ Additional cash injection after
operating activities initial start-up or at key stages
in a company’s growth
❯ Revenue from flotation of private
CASH
IN $
“The three most companies (going public) and
shares issued by public companies
dreaded words $
in the English
❯ Also known as cash flow from
investing activities $
language are CASH OUT

‘negative Ca
sh
cash flow.’” in
han
David Tang, entrepreneur, 2011 d

Salaries and wages Overheads Loan repayments

Payments to employees Payment of bills Debt servicing and

❯ Money paid to employees who ❯ Day-to-day running costs shareholder profit
are directly involved in the ❯ Rental cost of commercial property; ❯ Interest on long-term loans for
creation of goods or provision utility bills—water, electricity, gas, asset purchases and on short-term
of services telephone, and Internet; office loans for working capital
❯ Salaries paid to staff as a fixed supplies and stationery ❯ Repayments on capital loans
amount monthly or weekly (based ❯ Salaries and wages of employees ❯ Commission paid to factoring
on an annual rate) not directly involved in creating companies
❯ Wages paid to contractors for goods and services (known as ❯ Cash distribution to shareholders
hours, days, or weeks worked indirect labor) via share repurchases and
dividend payments
 HOW FINANCE WORKS
Management accounting 132 133

How it works and other sources. Cash flows out to pay employees,
Cash flow is the movement of cash in and out of a rent and utilities, suppliers, and interest on loans.
business over a set period of time. Cash flows in from Timing is key—having enough cash coming in to
sales of goods and services, loans, capital investment, pay bills on time keeps the company solvent.

Other revenue

Grants, donations,
and windfalls
❯ Grants from the government or
other institutions, usually one-time
Loans sums for research and development
❯ Donations and gifts (applicable to
Bank loans and overdrafts nonprofit organizations)
CASH
IN ❯ Working capital loans to meet ❯ Sales of assets and investments
shortfalls, with anticipated inflows ❯ Repayment of loans made to
as collateral other organizations
❯ Advances on sales invoices ❯ Tax refunds

$ CASH
IN
from factoring companies
❯ Short-term overdrafts
❯ Also known as cash flow from
financing activities
$
$
CASH OUT

k
toc
or s

Suppliers Tax Equipment

Payments for materials Payments to tax authorities Purchase of fixed assets

and services ❯ Corporation tax based on annual ❯ Cost of buildings and equipment,
❯ Cost of raw materials needed financial statements such as computers and phones,
to manufacture goods for sale ❯ Payroll tax paid by employers on office furniture, vehicles, plants,
❯ Cost of stock, imported or local behalf of employees and machinery
❯ Fees for services, such as ❯ Sales tax on goods or services ❯ Offset by depreciation
consulting or advertising, (see pp.124–127)
❯ Vary from country to country,
to generate revenue depending on tax law
❯ Payments to contractors involved
in goods and services creation
 CASH FLOW

Cash-flow management manage cash flow, it is essential for

The handling of cash flow companies to forecast cash inflows WARNING
determines the survival of any and outflows. Sales predictions and
business. Equally important is cash conversion rates are important. Top five cash-flow problems
a company’s ability to convert A schedule of when payments are ❯ Slow payment of invoices
its earnings into cash, which is due from customers, and when a ❯ Credit terms on sales invoices
known as liquidity. No matter how business has to pay its own salaries, set at 60 or 120 days, while credit
profitable a business is, it may bills, suppliers, debts, and other terms on outgoings are 30 days
become insolvent if it cannot pay costs, can help predict shortfalls. ❯ Decline in sales due to change in
its bills on time. New businesses If cash flow is mismanaged, a economic climate or competition
may become victims of their business may have to pay out or product becoming outdated
own success and fail through before receiving payment, leading to ❯ Underpriced product, especially
“insolvency by overtrading” if, for cash shortages. Some businesses, in start-ups trying to compete
example, they spend too much on such as supermarkets, receive stock ❯ Excessive outlay on payroll and
expansion before payments start on credit but are paid in cash, overhead costs; buying rather than
coming in and run out of cash to generating a cash surplus. renting assets
pay debts and liabilities. In order to

Positive and negative cash flow

CASH
IN
CASH
IN
$
CASH IN HAND INCREASES

$
CASH CASH IN HAND STABLE
OUT

Positive cash flow Stable cash flow

Cash flowing into the business is Cash flows into the business at
greater than cash flowing out. Cash the same rate as it flows out. Cash CASH
in the tank—stock—increases. A stock remains stable—a sign that a OUT
business in this position is thriving. business is healthy.

$
 HOW FINANCE WORKS
Management accounting 134 135

NEED TO KNOW
❯ Factoring Transaction in which a
business passes its invoices to a third
party (factor), which collects payment
from the customer for a commission
Cash conversion
Successful businesses convert their
product or service into cash inflows
76%
of global small
before their bills are due. To make the
❯ Accounts payable Payments a
business has to make to others
conversion process more efficient, a business owners
business may speed up:
❯ Accounts receivable Payments ❯ Customer purchase ordering are concerned
a business is due to receive
❯ Aging schedule A table charting
❯ Order fulfillment and shipping
❯ Customer invoicing
about cash flow
accounts payable and accounts
receivable according to their dates ❯ Accounts receivable collection
period
affecting their
❯ Cash-flow gap Interval between
payments made and received ❯ Payment and deposit growth.

HANDLING THE FLOW

Managing a surplus
❯ Move excess cash into a bank
account where it will earn interest
or make profitable investments.
❯ Use cash to upgrade equipment
CASH NO CASH to improve production efficiency.
IN IN/OUT ❯ Expand the business by taking on
new staff, developing products, or
CASH IN HAND DECREASES buying other companies.
❯ Pay creditors early to improve
credit ratings or pay down debt
before it is due.
CASH DRIES UP Managing a shortage
❯ Increase sales by lowering prices
CASH NO CASH
OUT or profit margins by raising them.
IN/OUT
❯ Issue invoices promptly and
pursue overdue payments.
❯ Ask suppliers to extend credit.
Negative cash flow $ Bankruptcy ❯ Offer discounts on sales invoices
in return for faster payment.
Less cash is flowing into the If cash flowing out continues
business than is flowing out. Over to exceed cash flowing in, cash ❯ Use an overdraft or short-term
time, the stock of cash will decrease, stock levels will drop so low that loan to pay off pressing expenses.
and the business will face difficulties. the business becomes insolvent. ❯ Continue to forecast cash flow
and plan to avert future problems.
 Budgets
Setting the budget for a business involves planning the income and
expenditures for the accounting year. This is usually broken down by
month so the planned budget and actual figures can be compared.

How it works manager in the business, along with expected cash-

Every business needs to budget for anticipated flow projections for the business, to create a master
revenue and operating costs within the financial year. budget. The master budget can also include figures for
Unlike capital budgeting, in which senior management any financing that the company is expected to need
allocates what will be spent on specific projects or over the coming year. As the year progresses, the
assets, revenue budgeting focuses on the overall projected budget and the actual money coming in and
projections for money coming in and money going out going out are monitored on a daily, weekly, or monthly
for each month of the coming financial, or accounting, basis so that any deviations from the original budget
year. Accountants compile operating budgets from each can be identified, and, if necessary, remedied.

Setting and
controlling budgets
Budget setting is a process that

$
takes place between the department
managers, senior management, and
finance department in a company to
establish and control the cost of each
department or project.

46%
of global firms
say their revenue
forecasts are
accurate to Consultation
Senior management sets out
Prepare the budget
The budget is usually based on the
within 5%. the company’s objectives to the
departmental managers. Each
accounting year but broken down
into shorter periods. Departmental
manager is then responsible for managers submit their budgets to
working out the budget required senior management for approval.
by their individual department These may cover such areas as
in order to meet those objectives operating costs (salaries and supplies)
for the coming year. and administration (office expenses).
 HOW FINANCE WORKS
Management accounting 136 137

INCREMENTAL AND ZERO-BASED NEED TO KNOW

There are two main approaches to setting budgets: ❯ Planning, Programming, and Budgeting
Incremental budget The Zero-base budget The coming Systems (PPBS) A budgeting system used in
budget for the year ahead is year’s budget starts afresh, with public service organizations, such as city
based on the previous year’s no reference to previous years. councils and hospitals
budget. This budget takes This means that each item ❯ Virement An amount saved under one cost
into account any changes, entered into the budget is heading in a budget is transferred to another
such as inflation, that could carefully scrutinized and has to cost heading to compensate for overspending
have an impact on the new be justified by the department
❯ Budget slack Deliberately underestimating
calculations. The downside managers. This method makes
sales or overestimating expenses in a budget
is that previous inaccuracies it easier to see the full cost of all
may be carried forward. planned changes.

$
$ $

Master budget Measure performance Take action

Once approved, the budgets from After each month (or equivalent time If necessary, the budget is revised
each department are combined into period set in the budget), the actual to take into account any unforeseen
a master budget for the year, which figures achieved by the company are and continued expenditures or any
includes a budgeted profit-and-loss compared with the original budget savings that were not anticipated. If
account, a projected balance sheet, projections. Variations are examined income is less than expected, action
and a budgeted cash-flow statement closely to identify whether they are may be taken to alter departmental
that typically shows a month-by- significantly different from the figures processes or campaigns in order to
month breakdown. in the original budget. reach the targets set in the budget.
 Assets and inventory
A company’s possessions, or assets, are divided into two categories:
fixed (or long-term) assets and current (or short-term) assets. Current
assets consist of cash in the bank and inventory.

How it works Current assets are held for the short

Fixed assets are items that enable term and used mainly for trading. NEED TO KNOW
a business to operate. They tend The most important category in
to be long-term holdings and terms of generating revenue is ❯ Asset valuation A method of
assessing the value of a company’s
cannot be easily converted current assets. The key component
holdings. Asset valuations may
into cash. Fixed assets can be of these is inventory. Inventory can take place prior to a merger or
categorized as either tangible or be finished goods ready for sale, the sale of the business or for
intangible: tangible assets are but it can also be the raw materials insurance purposes.
material objects, while intangible that will be used for producing
assets have no physical form. the goods.

Assets and inventory in practice

The partial balance sheets below show the current assets of a branch of Super Sports Inc.,
a fictional sportswear and sports accessories company. These assets include cash in the
bank and inventory held by the company. The inventory in this case consists of all the
items in the shop that are ready for sale.

Super Sports Inc. Super Sports Inc.

May 31 June 15

Assets $ Assets $

Cash in bank 12,000 Cash in bank 54,000

Inventory 22,000 Inventory 0

Total assets 34,000 Total assets 54,000

Balance sheet as of May 31 Balance sheet as of June 15

The “Assets” section of the balance sheet shows that the Two weeks later, the company sells all of its inventory for
company holds $22,000 worth of inventory (or goods) at $42,000 and receives payment for this sale on the same day.
this point in time as well as $12,000 cash in the bank. This means that total assets have risen by $20,000—the
profit made on the sale of the inventory—and increases
the amount of cash in the bank by $42,000.
 HOW FINANCE WORKS
Management accounting 138 139

TYPES OF INVENTORY
Inventory can include three types of stock, depending on the kind of business being
carried out: raw materials, unfinished goods, and finished goods. See pp.316–317.

Raw materials Work in progress Finished goods

Materials and components scheduled Materials and components that have The stock of completed products or
for use in making a product. For begun their transformation into goods ready for sale to customers.
example, a chocolate factory will have: finished goods; these may be referred A bookstore, for example, will have:
❯ Ingredients in the form of sugar, to as “unfinished goods.” For instance, ❯ Hardback and paperback books of
cocoa mass, cocoa butter, additives, a graphic designer will have: various genres and formats supplied
flavorings, and perhaps milk or nuts ❯ Layouts and designs that are by publishing houses
❯ Foil, plastic, and paper for the being developed and are awaiting ❯ Gift items, such as greeting cards
wrappers and packaging client approval and notebooks

Types of fixed assets

Super Sports Inc. owns a range of tangible and intangible fixed
assets. Compared to tangible fixed assets, the worth of intangible
fixed assets can sometimes be harder to evaluate.

Tangible fixed assets

ND PROP NITURE IP VEHICLES D MACH
DA E FUR EQU MENT AN
N IT LS I

N
RT

O
LA

ER
TO
Y

Y
Retail outlets plus Store displays and Computers and other IT Trucks and branded Warehouse and
company headquarters back office furniture devices and components company cars distribution equipment

Intangible fixed assets

ECT
UAL PR
OP ADEMARKS BRANDS PU
TER SOFTW
GH
T AND RO
LL TR M RI
Y
E

AR

AL
ER

Y
CO
INT

COP

TIE
E
TY

©
S

Brands and designs, Legally protected words Brands, including value Internet portal for online Licensing revenue
creative innovation and symbols and luxury lines sales streams
 Costs
Costs are the direct or indirect expenses that a business incurs
in order to carry out activities that earn revenue, such as
manufacturing goods or providing a service.

How it works
There are two main ways of classifying costs:
variable costs, which increase as output increases,
Variable costs
and fixed costs, which remain constant; direct and
indirect costs, which contribute directly or indirectly
to the overall running of the business, can either vary The head chef orders
with the level of production or stay fixed. There are the ingredients that will
three main costs that businesses need to account for. be required each day.
The first is labor—wages paid to people employed to For peak evenings, the
carry out a particular task. Labor can be regarded as a cost of the food order
direct cost or overhead or as variable or fixed. The is higher; for quieter
second is the raw materials used in production and nights, the food order
other materials used in service industries—these costs is lower. LARGE
FOOD ORDER
are variable. The third is expenses, which are other
costs incurred in the course of the business’s activities.

Fixed and Fixed costs

variable costs
One way of looking at costs is to split them
into two categories: fixed costs, which do not
change with the level of business activity, and
variable costs, which do change with the level RENT AND
of business activity. This helps accountants INSURANCE
determine how changes in business activity COSTS
(for example, cutting or increasing
production) will affect costs. In reality, some
fixed costs will increase once business activity
reaches a certain level—these are called
stepped fixed costs.

LAUNDRY
SERVICES

STAFF SALARIES CLEANING BILL

A restaurant rents a building to serve 40 diners. The

fixed costs are the same whether the restaurant serves
30 or 40 diners a night.
 HOW FINANCE WORKS
Management accounting 140 141

NEED TO KNOW
❯ Break-even point (BEP) The
point at which total sales revenue
is equal to total costs
❯ Questionable costs Costs that
can be treated as fixed or variable
❯ Sunk costs Costs incurred in the
past that cannot be recovered
❯ Prospective costs Costs that may
be incurred in the future,
depending on the business
decisions made
QUIETER
PEAK EVENINGS
EVENINGS

SMALL
FOOD ORDER

Stepped fixed costs €28.5

the average
hourly labour
HIGHER
RENT AND cost in the EU
INSURANCE
COSTS in 2020

EXTRA
LAUNDRY
SERVICES

HIGHER STAFF COSTS HIGHER CLEANING BILL

The restaurant becomes popular, so the owner rents the space

next door to serve an additional 40 diners each night. The costs
that were fixed at a certain level have now doubled.
 Product costing
and pricing
Knowing the full cost of creating each product that a business
sells is vital because it helps a company price its products
appropriately and assess the performance of the business.

How it works the cost of a product, it is treated

Both direct and indirect costs as one unit of production. The NEED TO KNOW
contribute to the production direct and indirect costs involved
❯ Absorption costing Allocation
cost of a product, whether it is a in creating that single unit are then
of all production costs to product
manufactured good or a service assessed and added together to
❯ Differential costing Difference
being provided. In order to calculate create the full cost.
between the costs of two options

25%
❯ Incremental (marginal) costing
The change in total costs incurred
when one additional unit is made
❯ Throughput costing Treating all
costs except for direct materials
the average net profit margin as period expenses
❯ Cost-plus pricing Product price
in the banking sector. In food is based on direct and indirect
costs, plus markup percentage.
retail, the average is 2%.
Full cost pricing Direct costs Share of indirect costs
Direct costs can be measured in terms ❯ Materials ❯ Production and service
of how materials and labor are used ❯ Direct labor overheads
to produce each unit. Indirect costs ❯ Administrative
❯ Direct expenses
(overheads) are harder to assess but also and management
need to be factored in so that the full cost of ❯ All used exclusively to
overheads
each product can be calculated. Managers create a product or
service for sale ❯ Sales and distribution
and accountants must apportion indirect overheads
costs to reflect their contribution to the cost
of creating a single product. Once this is
ascertained, the full cost of that product can
be determined. In general terms, the price is
worked out by adding the direct and indirect
costs of production with a
profit margin that gives an
appropriate selling price.
 HOW FINANCE WORKS
Management accounting 142 143

OTHER COSTING METHODS

There are several different approaches to costing and pricing, depending on the
industry, the type and size of the business, and the method of production.
$

JOB COSTING
Used for a
customized order
made to a client’s BATCH COSTING
$ CONTRACT COSTING
Used for a large one-time job,
specifications—for Used when a batch of identical often the result of a tender process
example, a printing products is made—for example, (when a company bids for work)
company that an electrical goods company and carried out at the client’s site—
prints brochures manufacturing television sets for example, a construction
for a client company building homes in a
new residential development
$

PROCESS COSTING SERVICE COSTING

Used for an ongoing job that often Used when the product being sold
involves several manufacturing is a standard service offered to
processes, making it difficult to isolate customers—for example, a nail salon
individual unit costs—for example, offering an express manicure and
an oil refinery that processes pedicure within a set period of time
crude oil into diesel oil and for a fixed price

$
Profit margin Selling price
❯ Must be able to generate profit ❯ Low: in order to gain market

$
for the company share or to match competitors
❯ Must be in line with how the ❯ Cost-based: recover
product has been direct and indirect
marketed costs and profit
ME
❯ Must be Y HO margin that the
R E
pitched
LUXU R SAL market will accept
realistically FO ❯ Service-based:
so that flexible because no
customers manufacturing or
will buy distribution cost
 Measuring
performance
There are two main ways of measuring a company’s performance: financial
and nonfinancial. To assess financial performance, a company calculates
financial ratios. To assess other areas of the business, a company examines its
key performance indicators (KPIs), which help management and staff evaluate
performance and how it can improve. KPIs also help interested outsiders, such
as investors, lenders, or analysts, decide whether to invest in the business.

Financial and non-

financial categories
Any company that publishes a financial report
will be required to set out key figures on the
revenue generated and the expenses incurred
during the course of its activities. These figures
can be compared by using mathematical
calculations called financial ratios.
However, financial ratios alone may
not give an accurate vision of the
company’s future prospects.
Nonfinancial ratios, or key
performance indicators,
do not measure financial
performance, but they do reveal Tracking and forecasting
other important characteristics Comp
of a company that will
Financial and nonfinancial measures can be any
used to forecast company performance and
ultimately affect its profitability, track fraud. See pp.152–153.
such as customer loyalty and
research and development
(R and D) productivity.
 HOW FINANCE WORKS
Measuring performance 144 145

TREND ANALYSIS USING PERFORMANCE MEASUREMENTS

A comparison of CURRENT RATIO COMPARISON OVER TIME
either financial Fast-food chain A is shown to be a consistently better performer over time
ratios or KPIs CURRENT and therefore has the most solid financial standing of the three companies.
RATIO
between companies
in the same industry 0.9
and across time 0.8
is often used to FAST-FOOD CHAIN A
0.7
track a company’s
performance. Current 0.6
ratios are calculated 0.5 FAST-FOOD CHAIN B
by dividing current 0.4
assets by current FAST-FOOD CHAIN C
0.3
liabilities: the
higher the ratio, 0.2
the more liquidity 0.1
a company has.
1 2 3 4 5 6 7
YEAR
Fi eas
na u
m

n- cial s
nc res

o THE BIGGER PICTURE

N an ure
ia

fin eas
l

Some professional bodies

$ m and services companies, such
$

as the UK’s CBI and multinational

PwC, conduct regular surveys,
interviewing senior executives to
find out how optimistic they are
about their sector and the wider
Financial ratios Key performance economy. Such surveys help
indicators companies measure their own
❯ Used by investors and
performances objectively.
lenders to gauge financial ❯ Used internally and by
health of an organization: investors, as they appear
whether it’s likely to survive in financial statement
economic slump and its ❯ May be calculated daily or
prospects for future growth even more frequently for
❯ Standard set of ratios used by internal use

4–10
the financial industry ❯ Companies can set diverse
❯ Calculated based on figures KPIs to reflect future goals.
provided in financial reports ❯ Unique to each company
See pp.148–149. See pp.146–147.

KPIs are likely

to be crucial for
most companies.
 Key performance
indicators (KPIs)
Key performance indicators (KPIs), or key success indicators (KSIs),
are based on a company’s goals and vary depending on the company
and industry. KPIs are usually stated in a company’s annual report.

How it works determine the department’s efficiency. This is an

KPIs are the non-financial measures of a company’s example of a lagging indicator—it is an outcome and
performance—they do not have a monetary value therefore easy to measure, but not straightforward to
but they do contribute to the company’s profitability. influence. Companies also look for leading indicators,
Any company department can adopt KPIs to gauge its which are focused on inputs and easier to change.
performance. A KPI for an accounts department might A leading KPI for the accounts department might be
be the percentage of overdue invoices, as this will help the percentage of purchase orders raised in advance.

Corporate KPIs
KPIs can be set up as dashboards on computers
so that they can be checked frequently. These
dashboards show examples of KPIs specific Accounts
to departments in a company. Having
set their KPIs, the departments are
subject to managerial review,
which could result in
action if KPIs are
sub-standard. $
Number of retrospectively raised
d market purchase orders; finance report
es an ing Cus
tomer service
Sal
error rate (measures the quality
of report); average cycle time
of workflow; number of
duplicate payments

Net promoter score (NPS—how many Number of customer complaints;

customers would recommend company); customer satisfaction (measured over
customer retention rate; customer time); average email response
lifetime value (total amount of time; number of products
money generated by sold compared to total
one customer) sales calls made
 HOW FINANCE WORKS
Measuring performance 146 147

93%
of companies
BALANCED SCORECARD SYSTEM
This strategic system offers a different
way of monitoring a company’s
performance, presenting a more
balanced view rather than one solely
❯ Learning and growth
Employee training and
corporate culture
❯ Business
say their focused on financial results. It was
proposed by Robert Kaplan and
processes
Includes specific
Balanced David Norton at the Harvard Business
School in the 1990s, and over 50
measurements for
monitoring daily performance
Scorecard is percent of large companies in the
US, Europe, and Asia use the
❯ Customer perspective
Customer satisfaction
extremely or approach. The Balanced Scorecard
consists of four ways to view an ❯ Financial perspective
Traditional financial data
organization’s performance:
very helpful

Operations

Cost variance (difference between

budgeted cost and actual cost of work);
an resource nt and sustain
Hum
time taken to get a product to market;
s nme ab
optimally running operations ro ili
vi
En

ty

Economic value of an employee’s Waste recycling rate; size of carbon

skill set; employee satisfaction levels; footprint; size of water footprint
revenue per employee; rate of (amount of water usage);
employee turnover energy consumption
 Financial ratios
Lenders, investors, analysts, internal management, and other
interested parties calculate financial ratios to decipher what
financial statements are really saying about the state of a business.

How it works purpose—for example, whether the purpose is to

Financial ratios are used to assess the financial measure the company’s ability to provide a good
standing of a business and identify any problem areas return to shareholders, its capacity to handle debt,
that might affect its future prospects. The process or the efficiency with which it operates. The ratios
involves comparing two related items in the financial can also be used to compare a business with its
statement, such as net sales to net worth or net income competitors or in comparison to specific benchmarks
to net sales, and using those ratios to measure the within the company to determine how consistent its
relative performance of the company. There are many financial results are.
different ratios to choose from, depending on the

Top financial ratios Profitability ratios Efficiency ratios

These are used to see how These show how efficiently
These are some of the ratios most effective a company is at the company uses its assets
commonly used by people involved generating profit. Profitability ratios and resources to maximize profits. An
with assessing businesses. They are may mirror investment valuation example is the sales revenue to capital
best considered comparatively and ratios. One example is the operating employed ratio, which indicates a
in the context of the economic climate. profit margin ratio. A high ratio is good, company’s ability to generate sales
The ratios are for analyzing established as it indicates a high proportion of revenue by using its assets. Similar
companies, usually public ones with revenue (gross income) converted into ratios can examine how quickly the
shares traded on the stock exchange— operating income (profit minus costs). company settles its bills and invoices.
start-ups and small-to-medium
enterprises generally do not have a full
enough range of figures to provide any SALES
kind of reliable guide. OPERATING OPERATING REVENUE TO NET SALES
PROFIT = INCOME CAPITAL = CAPITAL
MARGIN REVENUE EMPLOYED EMPLOYED
RATIO

$$$ Other profitability ratios

❯ Return on equity (ROE) is measured
Other efficiency ratios
❯ Accounts receivable turnover ratio is
as net income after tax / shareholders’ measured as net credit sales / average
equity. The higher the ratio, the greater accounts receivable. It shows how
x
6 the profitability, but not if a company is efficiently a company turns sales into
relying too heavily on borrowing. cash. The higher the ratio, the more
+
2 3 ❯ EBITDA to sales ratio is measured frequently money is collected.
1 – as EBITDA (earnings before interest, ❯ Inventory turnover ratio is measured
=
0 . taxes, depreciation, and amortization) / as the cost of goods sold / average
revenue. It gauges the profitability of inventory. It shows how efficiently a
core business operations. The higher the company manages its inventory level. A
margin, the greater the profits. low ratio usually equates to poor sales.
 HOW FINANCE WORKS
Measuring performance 148 149

WARNING

10–14%
Investors beware
Ratio analysis must be used over
time—at least four years—to
understand how a company
has reached its current position, not
just what the position is. For
the minimum return on
instance, if debt has suddenly
gone up, it could be because the investment (ROI) needed
company is branching out into new
areas of potential profit or to limit to fund a company’s future
the damage of a poor past decision.

Liquidity ratios Solvency ratios Investment

This group of ratios reveals While liquidity ratios look at a valuation ratios
whether a company has company’s short-term ability These ratios are typically used
enough cash or equivalent assets to to meet loan repayments, solvency by investors to gauge the returns they
meet its debt repayments. An example ratios indicate the likelihood of a are likely to get if they buy shares in a
is the working capital ratio (also a company being able to continue company. An example is the dividend
measure of efficiency), which indicates indefinitely with enough cash or payout ratio. It indicates how well
whether a company has enough current assets to pay its debts in the earnings support the dividend
short-term assets to cover long run. An example is the debt to payments—more mature companies
its short-term debt. equity ratio. tend to have a higher payout ratio.

TOTAL YEARLY
CURRENT SHAREHOLDERS’ DIVIDEND
ASSETS DEBT TO DIVIDEND
WORKING = = EQUITY = PER SHARE
EQUITY PAYOUT
CAPITAL CURRENT RATIO TOTAL RATIO EARNINGS
LIABILITIES ASSETS PER SHARE

Other liquidity ratios Other solvency ratios Other investment valuation ratios
❯ Cash ratio is measured as total cash ❯ Interest coverage ratio is measured ❯ Net profit margin ratio is measured
(and equivalents) / current liabilities. as EBIT (earnings before interest and as profit after tax / revenue. Another
It shows whether a company’s short- tax) / interest expense. It indicates measure of a company’s profitability, it
term assets could repay its debts. A high how easily a company can pay the is also useful for comparing a company
ratio is seen as favorable. interest on its debts. The higher the with competitors. The higher the ratio,
❯ Quick ratio (acid-test ratio) is ratio, the more easily it can pay. the more profitable the company.
measured as current assets minus ❯ Debt ratio is measured as total ❯ Price to earnings ratio is measured
inventories / current liabilities. It shows liabilities / total assets. It indicates as market value per share / earnings per
how easily a company can repay short- the percentage of the company’s share. It indicates the value of the
term debt from cash. The higher the assets that are financed by debt. A company’s shares. A high ratio
ratio, the more easily it can pay. low ratio is considered favorable. demonstrates good growth potential.
 Forecasting
Predicting future business performance is necessary to estimate
probable sales, income, costs, and profitability and thus gain
investment and maintain confidence in the company.

How it works and can be tracked over time. The tracked and
Forecasting success or failure relies on historical monitored data can provide an early warning system for
data—financial statements, financial ratios, and Key potential problems. For small businesses and start-ups,
Performance Indicators—that reflect business operation accurate forecasts provide a basis for raising external

Forecasting with Z-score models

Realizing that traditional financial ratios, such as the ratio of
costs to revenue, created only a partial picture of a business’s Working capital / total assets
financial performance, Altman devised a set formula that A measure of liquidity: the
combined four or five key ratios to give a Z score. The model more working capital in a company,
has proven to be 90 percent accurate in predicting business the more it is able to pay its bills.
failure over one year and 80 percent accurate over two years.

Market value of equity / Retained earnings /

book value of total liabilities total assets
A measure of the market confidence A measure of leverage: a high ratio
in the company: a ratio of less than indicates profits are funding growth;
one means the firm is worth less a low ratio indicates growth is
than it owes—it is insolvent. financed by debt.

Corporate success Earnings before interest Sales / total assets

and taxes / total assets A measure of efficiency: the
Efficiently run companies with a
A measure of return on assets: sales generated by the assets.
healthy balance between assets
it gauges operating income
and liabilities and profit and debt
generated by assets.
inspire confidence in investors.

SS Success
Finding the Z score
Each of the above ratios is multiplied by
a specific value to weight them; results are
added together to give a Z score.
❯ A score of 0.2 or lower means the
company is highly likely to fail.
❯ A score of 0.3 or higher means the
company is unlikely to fail.
 HOW FINANCE WORKS
Measuring performance 150 151

financing, while for larger companies, this information

provides an indication of financial strength for investors NEED TO KNOW
and markets. There are many different prediction
❯ Ohlson O score ❯ Undertrading When
methods and models—the ones you choose will depend
Alternative to Z score for a company trades at
on exactly what you want to forecast. One of the most predicting failure low levels compared
frequently used to predict the chances of a business to its finance levels
❯ Overtrading When a
going bankrupt is the Z-score model, devised by company’s sales grow ❯ Zeta analysis Second-
Edward Altman, a New York University finance faster than its finance generation Z-score model
professor, in 1968.

Signs of corporate failure

There are many signs that a company is doing badly
and perhaps sliding into insolvency. These signs make
investors nervous, which is likely to lower share prices
if they start selling their stock. However, most
companies that fail are profitable but run out of cash.
59%
of organizations say they
are now using advanced
and predictive analytics.

Cuts to employee
Sales of assets benefits
s
to pay off debt
SS F
ailur Repea
e to shar n
te
divide d
dc
eholde uts
rs
Bankruptcy
occurs if the
company cannot Top management
pay its debts. resigning and taking
jobs elsewhere

High borrowing,
high interest paym lity, seen in
continue
d ents, Low profitabi
, seen in and dwindling reve nslide in profit
Low c ash flo w
in cash ho lding s nue consistent dow from
eclin e e ars loss statements
f d
pattern o t over consecutiv
e y on profit-and-
ars
ce she e consecutive ye
on balan
 Tracking fraud
For keen observers of financial statements, warning signs that
indicate fraudulent business activities may be detected in overly
optimistic statements and evasive attitudes of senior management.

How it works uncovered. It is the auditor’s job to

Public companies are required ensure that business records and NEED TO KNOW
to have their annual financial statements are accurate and have
statements audited (checked) been honestly reported. Auditors ❯ Asset stripping Selling off the
assets of a company for a profit
by an independent auditor. It carry out a systematic examination
to raise funds, often resulting in
is typically during this process of the company’s records and may the closure of the business
that any financial shenanigans— identify any irregularities that may
❯ Tunneling A particular type
creative accounting tricks used to indicate fraud. If evidence of fraud of fraud in which assets and
manipulate the figures and improve is found, the next step is to involve funds are illicitly transferred to
the performance of a company in forensic accountants and criminal management or shareholders
its financial statements—and investigators, who may prosecute
outright fraudulent activity are the perpetrators.

Red flags Suspicious figures on financial statements

indicating fraud ❯ Cash flows that are negative ❯ Sales recorded before
for three quarters and then they have been made
Auditors may be alerted to fraud by a
suddenly and dramatically ❯ Made-up, nonexistent
number of recognized warning signs or become positive
“red flags”; these may have directly sources of revenue
to do with the behavior of the CEO or ❯ Sudden increase in gross ❯ Expenses moved from one
margin, at odds with company to another or
other top executives or be in the form of
industry average and classified as assets
irregularities within the financial statements.
company’s previous
❯ Ongoing, long-term growth
performance pattern
of earnings per share
❯ Large sales to companies

6
❯ High payments to executives
with dubious track records
compared to base salary

the average
number of
fraud incidents How to detect fraud
Applying ratio
reported per Procedures should be in place to
hold accountable anyone who handles
analysis to
reveal key
company in the expenses. When these fall short,
internal and external auditors need
long-term
trends (see
last two years to take more drastic measures. pp.148–149)
 HOW FINANCE WORKS
Measuring performance 152 153

LINE-UP: TOP FIVE NOTORIOUS FRAUDS

Some of the worst frauds stem from the most prestigious companies.
Enron was one of the top seven U.S. companies, while JPMorgan Chase
& Co. was the largest American bank when measured by assets.

SECURITIES ENRON WORLDCOM JPMORGAN CHASE WIRECARD

EXCHANGE CO. Energy company U.S. communications & CO. The top German
In 1919, Charles Ponzi Enron declared company WorldCom For 10 years from fintech firm filed for
began a pyramid bankruptcy in 2001, declared bankruptcy 2002, the company insolvency in June
scheme in Boston, although it had in 2002 after it approved thousands 2020 after revealing
selling postal reply never shown a loss improperly accounted of home loans to it was “missing” $2.24
coupons. He pledged in its financial for $3.8 billion in ineligible recipients. billion. Its collapse
investors 50 percent statements. External expenses. Auditor The employee who sparked questions
return within 45 days, auditors were accused Arthur Andersen blew the whistle was over regulators’ and
which he paid from of failing to properly was held liable awarded $64 million. auditors’ failure to
new investors’ funds. review accounts. for not noticing. spot the disaster.

CEO behavior Technicalities
❯ Evasive behavior by executives ❯ Late entry of sales or earnings
over important financial details adjustments
❯ Attempts by CEO to steer auditors ❯ Missing approvals or signatures
away from certain documents

Setting up confidential Using the element of Conducting a Data mining with

hotline for current and surprise, such as surprise cash count auditing software
past employees or others undertaking an aggressive to determine whether to detect any mismatch
with knowledge of the internal audit without current cash flow between past patterns
company prior warning matches statements and current statements
 Raising
financing
When a company needs additional funds, it can use internal or external sources,
or both, depending on whether it seeks large amounts of funding for long-term
growth, such as an expansion, or smaller amounts for short-term expenses, such
as operating costs. In addition, the number of external sources available depends
on whether the business is well established or whether it is relatively new and
without much of a track record.

Sources of financing and capital

When considering the prospect of raising financing, the financial directors will
first evaluate the financial health of the company. They will then decide what
proportion of the company will be funded by equity (the company’s own
reserves of cash and money raised from issuing shares) and what proportion
will be funded by borrowing money from an outside source, such as a bank,
so that the company takes on debt.

59%
of U.S. financial
Debt and loans

managers say FUNDS IN THE

FORM OF A
LOAN FROM
financial flexibility $ $ AN OUTSIDE
SOURCE

is the most
important factor INTEREST
PAYMENTS
Institutional lenders
in deciding how Large financial bodies that lend money,
much debt the such as banks. See pp.158–159.

company takes on.

 HOW FINANCE WORKS
Raising financing 154 155

EVALUATING CAPITAL STRUCTURE

When investors consider buying shares in a ❯ A company with significantly more debt than
company, they look at its capital structure to equity has a high debt-to-equity ratio and is
assess the future prospects of the business. more risky as an investment.
The capital structure refers to the percentage ❯ Debt is not always bad. If interest rates are low,
of a company’s finances made up of funds from a company could take on more debt to fund
shares and earnings, called equity, and the expansion, as long as the revenue it makes
percentage made up from borrowed funds, from the borrowed funds is

$
or debt. When evaluating capital structure, greater than the interest
investors consider the following: payable. So, although this

$
❯ As a general rule, companies with more equity company may be more
than debt are considered less risky to invest in risky, it may also have
because their assets outweigh their liabilities. So, greater potential for
a company with significantly more equity than growth—this is known as
debt has a low debt-to-equity ratio and “gearing.” See pp.174–175.
is generally seen to be a low-risk investment.

Equity
FUNDS FROM
SHARE ISSUES
AND RETAINED
PROFIT $ $ $ $

Profit from business Shareholders’ stake

activities in company
Proceeds of the core business. Payment received for shares in
See pp.156–157. the company. See pp.164–169.

DIVIDENDS—PAID ONLY WHEN A COMPANY

MAKES ENOUGH PROFIT

Company
Bonds
Investor
lenders
FUNDS FROM Bondholders
BONDS BOUGHT $ who lend money.
See pp.170–173.

INTEREST AND CAPITAL

SUM ON MATURITY
 Internal financing
Most companies prefer to secure funding from their own internal
resources rather than take on debt through borrowing or give up a
stake in the company by issuing shares, both of which cost more.

How it works
When a business needs funds, or capital, to pay for
expansion or investment in order to maintain its current Raising internal financing
operations, it is faced with two choices: either find the
Whether a company’s need for additional funds is
money from outside sources or find the money from
long or short term, steps can be taken to increase
within the organization itself. Because there are costs
the level of funds within the company.
attached to bringing in funds from external sources,
such as interest that has to be paid on a bank loan, the
business managers must weigh the opportunity cost of
using the company’s own funds—the profit it could
Short-term financing
earn by investing those funds—against the cost of For businesses wishing to raise funds without
financing. resorting to external sources, there are three main
strategies they can implement to maximize the
amount of cash available for day-to-day operations
and capital expenditure.

THE RECENCY BIAS

When a company receives timely payments for its invoices, this Tighten credit control
helps maintain its levels of funds. Interestingly, invoices issued
Actions include chasing
right after completion of work tend to get paid sooner than
debtors so that invoices are
those invoices that are sent later. A theory called recency bias
paid on time; ensuring that
explains this phenomenon: the brain prioritizes recent events
new customers are
over those that occurred longer ago.
creditworthy by conducting
strict credit checks; and
setting a 30-day payment
term.

10

8
DAYS IT Delay payment
TAKES
CLIENT 6 Large suppliers may offer a
TO PAY discount for early payment,

$
4 but they may also allow a
company longer terms for
2 payment, boosting that
company’s cash levels in
the short term.
0 1 2
WEEKS IT TAKES TO SEND INVOICE
 HOW FINANCE WORKS
Raising financing 156 157

USING PROFITS TO
Company FUND EXPANSION
A company seeking to grow may
choose to fund the expansion with
its profits. This option offers both
advantages and disadvantages.
Pros
❯ The use of profits means that no
interest payment has to be made,
Long-term financing unlike on money that is borrowed.
For a business needing long-term ❯ Existing owners and directors are
financial help, its own resources able to retain full control over the
should act as the primary support. business rather than sharing it with
new investors.
❯ The company is able to keep a low
debt profile, which will appeal to
Reduce inventory $ future investors and lenders.
$
It is expensive for a business Cons
to retain a large inventory ❯ Profits can take time to build up
of unsold goods. Cutting Retained profits sufficiently to fund expansion.
the inventory back reduces ❯ Withholding dividends may upset
storage costs, the cost of A portion of profits may be
some shareholders, who prefer to
production, and replacement pumped back into the business.
receive the profit as dividends.
of goods that go out of date A company may also decide to
or become obsolete. sell assets to raise cash. ❯ There is a lost opportunity to earn
funds from investing profit rather
than spending it.

al fin
ancing fo
r
56.7
is the average
th
Total intern

eb

number of days
usiness

it takes a US
company to pay
a supplier invoice.
 External financing
When business growth or unforeseen expenses cannot be met by
using internal sources of financing, such as retained profit,
organizations must rely on finding funds from lenders or investors.

How it works larger sums for an expansion is more

External financial support comes in challenging. A company that is NEED TO KNOW
various forms, including getting either already listed on a stock
bank loans and issuing shares. The exchange or is preparing to enlist ❯ Term loan A bank debt repaid
over a set period of time
available sources of outside will be able to raise the capital
financing depend on the amount a through the sale of shares. However, ❯ Loan note A form promising
payment to the holder at an
company requires and whether the an unlisted company may struggle
agreed future date
money is needed to resolve a to raise a comparable amount. A
❯ Eurobond A bond issued in a
short-term issue, such as cash flow, company with a large amount of
currency other than the currency
or for the long-term growth of the debt will also find it hard to raise of the country in which it is issued
business. While short-term funds because lenders or investors
financing is easier to secure, finding will see the business as risky.

Raising external Short-term financing

financing A range of financial agreements that help provide a
Generating funds from external company with immediate funds can be made with outside
sources can be a challenge, especially parties as a way of raising cash in the short term.
when securing investors. However,
the funds do not necessarily need Bank line of credit
to take the form of a loan. There are $
Borrow from business checking
a number of strategies that can be account up to an agreed limit, with
implemented through working with interest typically at a high rate.
external parties in order to provide a
company with good working capital.

43%
Asset financing
Borrow against assets owned by
$ the business, including inventory,
equipment, and property. These can
be seized by the lender if firm defaults.
of U.S. small
businesses Invoice discounting
applied for Borrow money against sales invoices
customers have yet to pay (again, often
new financing at a disadvantageous rate).

in 2019.
 HOW FINANCE WORKS
Raising financing 158 159

DEBT FACTORING
Debt factoring is another means by which businesses can raise short-term cash. A company sells
unpaid invoices (accounts receivable) to a third party, known as a “factor.” The factor advances the
company a major portion of the total, holds the rest until the account is paid, and then charges a fee.

$ $
Company negotiates Company sends invoices Factor pays company Customer pays Factor pays remaining
an agreement in which out to customers and an agreed percentage factor the invoice invoice amount to
its unpaid receivables copies them to factor. of the invoices (typically amount after 30 days company, minus a fee
(invoices) are sold at a Customer now owes 80–90 percent) within (or more, if terms of (usually 2–5 percent of
discount to a “factor.” payment to factor. a few days of receipt. payment are longer). the invoice amount).

Company Long-term fnancing

Putting effective measures in place to provide ongoing
funds is essential for a company’s long-term growth.

Shares
Raise capital by issuing shares to finance
growth. The company then retains less
profit, as it pays dividends to shareholders,
who also benefit from any capital gains in
the company’s value (see pp.164–165).
Borrowing
$
Secure long-term loans from banks and
other financial institutions, usually with
nancing for better terms than a bank line of credit.
lf
a

th

Finance leases
rn

eb
l exte

Sell expensive assets, such as computers, to

usiness

finance companies to release capital and

Tota

then lease them back.

Rent-to-own agreements
$ $ Pay for expensive assets, such as vehicles, in
$ installments. Overall costs may be higher,
but capital is not tied up.
 Going public
When a company changes from private to public, it offers shares for
sale to members of the public. This process is known as going public
and enables the company to raise money for growth.

How it works
The process by which an
Ways to list on a stock exchange
organization goes public (also
known as flotation) marks the end There are three primary ways to take a company public,
of its life as a private company, after each of which has different associated costs. The type of public
which it is no longer owned by a
offering that a company chooses will be determined by
its size and how much capital it needs to raise.
small number of shareholders or
company members. A company
may choose to go public when it
tion A company joins a new stock exchange
needs capital to finance growth. uc without raising capital but by trading its
od

Going public usually happens over existing shares. To do this, a significant

Intr

several months; the company proportion of the shares must already

makes legal and financial be in public hands (on other stock
preparations before the final stage, exchanges), and no one shareholder
when it releases company shares can own a majority of shares.
for sale to selected investors, the
general public, or a combination of
both. Each share represents a
“stake” in the company, and the
money that the company receives Select groups of institutional investors
from the sale of shares becomes
g are invited to buy shares. This involves
in

capital, or wealth, that it now owns. fewer costs than undertaking a full
Plac

public share offering (see below),

but the amount of capital that can
potentially be raised is limited
because there are fewer shareholders.
WARNING
❯ Underestimation If the
initial valuation of shares by
the underwriters is too cautious, g (IPO)
then the company will fail to erin Institutional and private investors are
realize the true value of its stock. f invited to subscribe to or buy from
of

the first round of shares that the

tial public

❯ Overestimation If underwriters
overestimate the value of shares company issues. This is the most
newly on the market (new issue), expensive way to go public, but it
it may flop due to lack of demand. allows a company to raise large
amounts of capital.
❯ Volatility Share prices in the first
Ini

few days of an IPO may fluctuate

dramatically due to political or
economic events.
 HOW FINANCE WORKS
Raising financing 160 161

1,415 the number of IPOs that took

place around the world in 2020

10 LARGEST IPOS IN HISTORY

When a well-known private company undertakes an IPO, there is fierce competition between
investors to buy its shares, and record-breaking activity can ensue. This graph shows the largest
IPOs until 2014, based on proceeds from shares sold on the first day they went public.
INITIAL PUBLIC OFFERING (IPO)

Saudi Aramco 2019, Saudi Stock Exchange

$25.6BN
(Saudi Arabian oil company)

Alibaba Group 2014,

New York Stock Exchange $25BN
(Chinese e-commerce group)

Agricultural Bank of China 2010,

Shanghai Stock Exchange $22.1BN
(Chinese bank)
Stock exchange
A financial market Industrial and Commercial
Bank of China 2006, Hong Kong Stock $21.9BN
in which company Exchange (Chinese bank)
securities (stocks and
shares) are bought SoftBank Corp. 2018,
and sold according to Tokyo Stock Exchange $21.3BN
( Japanese tech conglomerate)
current market rates.
See pp.170–171. AIA Group 2010,
Hong Kong Stock Exchange $20.5BN
(Hong Kong insurance corp.)

Visa 2008, New York Stock

Exchange (American financial $19.7BN
services corp.)

NTT Docomo 1998,

Tokyo Stock Exchange $18.4BN
( Japanese telecoms group)

General Motors 2010,

New York Stock Exchange $18.1BN
(American car manufacturer)

Enel SpA 1999, New York and

Milan Stock Exchanges $17.4BN
(Italian utility company)

$0 $10 BILLION (BN) $20 BILLION (BN)

VALUE (USD)
GOING PUBLIC

A closer look at IPOs WORLD’S TOP 10 STOCK EXCHANGES

An Initial Public Offering (IPO)
is the first time that shares in The largest exchanges manage shares exchanges are listed in order of the size
the company are offered for public belonging to some of the world’s most of market capitalization—in other
sale. It is the most common way for lucrative businesses and, as a result, words, by the total monetary value of
a private company to go public if substantial sums of money flow shares issued by the companies listed
it needs a large injection of capital through them. The following on each exchange.
to fund major expansion. There are 1. New York Stock Exchange 6. Euronext (Pan-European)
other reasons for going public—for 2. NASDAQ OMX, New York 7. Shenzhen Stock Exchange
example, if a government wants to
3. Hong Kong Stock Exchange 8. London Stock Exchange
privatize a state-owned company,
4. Shanghai Stock Exchange 9. Bombay Stock Exchange
such as a national railroad, or if the
members of a large family-owned 5. Japan Exchange Group 10. National Stock Exchange
enterprise want to sell their stake.

The IPO process

Before a company can issue shares, it has to 3
be listed on a stock exchange where trading
(the buying and selling of shares) can take
place. The company must then fulfill the
criteria necessary to secure investors. This
process is lengthy, subject to strict financial
regulations, and extremely expensive to File a prospectus
undertake. Only once all stages of the process This document contains information
are complete can the share offering be about the offering, the business, its
officially declared on a stock exchange. financial history, and proposed plans.
Details are still subject to change.

1 Pretax earnings
above a certain
2
Meet the level
qualifications
Three years of
The specific audited financial
requirements are set statements
by the stock exchange
where the company Ability to pay the
annual listing fee
plans to list. Listing Appoint underwriters
conditions vary
between exchanges, These financial professionals will be
but typically demand: responsible for buying and selling
the shares to the public.
 HOW FINANCE WORKS
Raising financing 162 163

$7.63 NEED TO KNOW

❯ Large cap Listed company with

trillion
market capitalization of more than
$10 billion
❯ Mid cap Listed company with
market capitalization of between
$2 billion and $10 billion

the total market capitalization ❯ Small cap Listed company with

market capitalization of between

of companies listed on the $250 million and $2 billion

Shanghai Stock Exchange* * as of May 2021

4 6
Promote the share offering
Company representatives as well as $
the underwriters visit national and
international destinations to pitch $
to potential investors.
$
$
$
$
Sell on the stock market
The IPO is officially declared a few days
after potential investors receive the final
prospectus. The declaration is made on
5 a set day after the exchange has closed,
Set the final offer price and the shares are available for trading
the following day.
After ascertaining market conditions
and the anticipated demand, the
company decides the price and the
number of shares to issue. It is then
ready to launch the offering.

7 8 9 +
–
 Shares and dividends
When a company goes public, it sells shares to investors, who become
part-owners in return for capital investment. The number and type of
shares bought by each investor determine the size of their ownership.

How it works be offered on the exchange. Upon

any shares
Before floating on a stock exchange, going public, a company issues
mp
Co
a company undergoes a valuation ordinary shares to investors as the
process to set the initial price of its basic unit of ownership, commonly
shares. This process involves the referred to as a stake in the
directors, prospective investors, and business. A company may also
an investment bank, which is issue shares privately rather
appointed to assess the company’s than publicly to investors
value. Together, they reach a via the stock exchange
decision on the most financially to retain greater
viable price for the shares that will management control.

A share of the pie

Ordinary shares, issued by all companies when they go
public, are the most common type of shares. There are also
other share types, which give the company more flexibility to
control rights available to different shareholder groups. Most
shares are sold on the stock exchange, but nonvoting and
management shares are issued directly to holders. Different
types of shares entitle the holder to different rights.

Management shares
Issued (usually given, not sold) to
owners and members of company
management, who have:
✓ Extra voting rights, so control
of company stays in the same
hands Iss
ue
dd
ire
ctly
Nonvoting shares

Issued to employees, who:

✓ Receive a part of remuneration
in the form of dividends
✗ Have no voting rights
✗ Receive no invitation to attend
annual general meeting (AGM)
 HOW FINANCE WORKS
Raising financing 164 165

Common stock NEED TO KNOW

Shareholders: ❯ Flipping Buying and quickly reselling IPOs
✓ Share in the company dividends for a large profit
✓ Share in the company’s assets ❯ Redeemable shares Shares that may be
✓ Have the right to attend AGM later bought back by the issuing company
for a cash sum
✓ Have the right to vote on
important company matters, such
as appointment of directors
✓ Receive the company’s annual

$
report and financial statements
So
ld
via

67,564
sto
ck e
xcha

what $100 invested in

nge

Preferred stock
Apple’s 1980 IPO was
Shareholders:
✓ Receive fixed dividend, paid
worth 40 years later
ahead of any dividends paid
to ordinary shareholders
✓ Take priority in receiving a share RAISING MORE SHARE
of any assets left after debts are CAPITAL
paid if the company is insolvent
✗ Have fewer, if any, voting rights After the initial sale of shares, when a company
goes from private to public, the business can
raise additional funds by issuing more shares.
There are three main ways to do this:
❯ Rights issue entitles existing shareholders
to buy additional shares from the company
within a set time frame, before they are
offered to other buyers.
❯ Public issue is a process by which the
company issues a new allotment of shares
to sell to the public on the stock market.
Deferred stock
❯ Private placement is a practice by which the
✓ Shareholders receive company company sells its shares (or other securities)
dividends and share of assets, but directly to private investors, usually large
only after all other shareholders. institutions, bypassing the stock exchange
all together.
SHARES AND DIVIDENDS

25%
Establishing share value
The forces of supply and demand SPLITTING SHARES
set the price of shares. Companies
issue only a limited number of A company occasionally carries
out a “share split” to its existing
shares to the public, which can
then be bought and sold on the the drop in shares. This increases the total
number of shares, although the
stock exchange. Demand for those
shares is determined by whether share value over combined value of shares stays
the same. A share split allows a
investors think the company has
good future economic prospects.
four days during company to lower the price of its
shares to bring them in line with the
If investors believe that the
company is primed for substantial
the Wall Street price of competitor shares. The
share split is usually a two-for-one
growth, they will want to buy Crash of 1929 or three-for-one increase, whereby
the shareholder sees the number
shares in it, which consequently of their shares double or triple.
drives up the share price.

Rising value of
VALUE
shares (INDEX
POINT)
Financial market observers believe
that the emphasis on optimizing
the value of shares for shareholders 4,500
began in 1976, when the idea of
maximizing profit for shareholders
4,000
became a priority. Since then, the
market has experienced a general 198
upward trend with occasional deep 3,500 OC 7
MO TOBE
dips. The graph tracks the average ND R 19
AY :
value of all shares on London’s FTSE CR BLAC
3,000 ASH K
from 1964 to 2021.

2,500

NEED TO KNOW
2,000 197
❯ Bear market Market that has STO 2–1
974 6
197 IMIZINLGDER OVASED
seen decline of 20 percent over CR CK M LUE
1,500 ASH A
a period of 2 months or more RK
ET
X O P
❯ Bull market Market where MA AREH PRO
share prices are rising and 1,000 SH EORY
TH
investor confidence is high
❯ Market correction Short-term
500
decline in share prices to adjust
for an overvaluation
0
1970 1980
 HOW FINANCE WORKS
Raising financing 166 167

1,000
$ 3
$3

$1.5
0 2,000 $1.5
0

SHARE PRICE TOO HIGH SHARES SPLIT SHARE CERTIFICATES ISSUED SHARE VALUE ALIGNED
A company listed on the stock The company decides on a share It issues new share certificates to The value of shares is now
exchange has seen its share price split. It halves the price of each holders, doubling shares held: a similar to that of competitors.
increase so that its shares now existing $3 share, so each share shareholder with 1,000 shares at The price encourages new
cost more than its competitors’. is now worth $1.50. $3 each now has 2,000 at $1.50 investors to make a purchase.
The high price puts off investors. each. Total worth is still $3,000.

19
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1990 2000 2010 2020 YEAR

SHARES AND DIVIDENDS

What is a dividend? pay out dividends. In a good

Shareholders in a company are economic climate, they win twice— NEED TO KNOW
usually entitled to a payment of the dividend provides income, and
cash from its profits. The company the capital value of the ❯ Dividend yield ratio Measure
pays a dividend sum on every share shareholding increases. However, of how much a company pays in
it has issued, but it is up to the there is always a risk that the dividends relative to the price of
each share
company’s board to decide how value of shares will go down,
❯ Dividend per share Sum paid
much profit to reinvest and pay out. and companies only pay dividends
on each share after retained profits
Investors may look at a company’s if they have made a profit. have been calculated
rate of dividend payout, along with Paying dividends is a good way
❯ Dividend payout ratio
its capital growth, to gauge its for a company to attract investors. It Percentage of a company’s net
financial health and decide whether is essentially a reward for putting income that is paid in the form
to invest in it. Investors who rely money into a company so that it can of dividends
on shares for income are likely to fund its existing output and develop
invest in companies that reliably and expand the business.

How it works
Shareholders usually receive a dividend if the company in which they hold
shares has retained enough profit in that financial year to make the payment.
The decision to make a payment is made by the board of directors. The dividend
might be paid every quarter (four times a year) or in two parts—an interim dividend
may be made partway through the year, with the final dividend paid just after the
end of the financial year.

Announcing retained profits Making the decision for dividends

At the end of the financial year, the company The board of directors makes a decision on whether
announces its retained profits: the sum it intends there is enough to warrant a dividend payment and,
to keep for reinvesting or paying off debts rather if so, how much. It records details of each payment
than pay as dividends. in dividend vouchers.

$
$
$
$ $
$
 HOW FINANCE WORKS
Raising financing 168 169

INTEREST RATES AND DIVIDENDS

Investors are Investors are
When interest rates are low, shares with high dividend attracted to attracted to
payouts become extremely attractive to investors pay into buy shares, as
because they provide a better return than investments fixed-income dividends give
that yield an interest payment. This economic climate assets, such as a good return
deposit accounts. for their money.
encourages companies to pay top-rate dividends and HIGH LOW
therefore attract as many investors as possible, which in INTEREST INTEREST
turn increases the share value. RATES $ $ RATES
Conversely, when interest rates are rising, investors
may prefer to put their money into fixed-income assets,
which will pay high rates as a result of the hike without
the risk attached to buying shares.

$
$
$
1602 the year the Dutch East
Keeping funds for growth
India Company became
The company keeps some of its profit to put back into the first business to
the business. It needs to strike a balance between
pleasing investors and expanding its operation. issue stocks and bonds

Paying taxes
Shareholders must
$ declare dividends on $
their tax return and
pay taxes on them.

Making the payment

Most dividends are cash dividends. Sometimes,
companies distribute stock dividends, issuing
more shares instead of cash to shareholders.
 The capital market
The capital market is a global marketplace for trading long-term
securities—bonds with a maturity of at least a year and shares. It is where
governments and businesses raise funds and investors make money.

How it works to users of capital, such as businesses and government,

There are two types of products sold on the capital and capital is what enables goods and services to be
market: shares (equity) and bonds (debt investments). produced. The original issuers of the shares and bonds
Shares and bonds are sold first on the primary market, do not gain from trading activity in the secondary
where they are originally issued, and later traded on market, which is purely for investors. However, share
the secondary market. The capital market is crucial value and bond trading levels reflect confidence in a
to a functioning economy because it channels funds company or institution, reinforcing its financial position.

The structure
The capital market encompasses the debt capital market,
ital mar
where bonds are sold, and the stock exchange, where shares p

ke
are sold. Both have a primary and a secondary market.

Ca

t
Primary market
The market issues new bonds and shares, with
investment banks overseeing the trading. It is
also known as the new issue market (NIM).
$

COMPANIES
GOVERNMENTS SELL BONDS SELL BONDS
AND SHARES

BONDS SHARES
Sold on debt capital Sold on stock
market (bond exchange (equity
market) capital market)

INVESTORS
 HOW FINANCE WORKS
Raising finance and capital 170 171

WHAT IS A BOND?
A bond is a debt security that
a company issues to investors.
interest is paid to the investor
annually. When the bond
US$119
trillion
By buying bonds, an investor matures, the issuer repays the
is effectively loaning money to original sum of the loan to the
the issuers, who in return agree investor. Companies or
to pay interest to the investor. A governments issue bonds to
bond has a set term of maturity raise money that can then be
(a limited number of years of
validity), and until that time, the
put back into the business or
used to fund government.
the estimated value
of global bond markets
Bonds or shares: pros and cons

Bonds (debt investments)

✓ Sellers are contractually obliged to pay interest.
Secondary market
✓ Bonds are less risky: debt capital markets are
Investors buy bonds and shares from other investors, less volatile than stock exchanges. If the issuing
not from issuing companies. The cash proceeds go to company has trouble, bondholders are paid
an investor, not to the underlying company or entity. before other expenses and before
compensation to shareholders.
✗ Buyers of bonds have no stake in
the company.
✗ Buyers cannot access the principal
sum until bonds mature.

Shares (equity)
✓ Buyers of shares gain a stake in the company.
✓ Sellers of shares have to pay dividends,
BONDS SHARES although these can be reduced or suspended
if the company believes it is necessary.
✗ Shares are more risky: changes in company
profits and in the economy as a whole can cause
share prices to rise and fall. If the company fails,
the shares become worthless.

Individual investors buy and sell shares

and bonds previously issued on the
primary market.
THE CAPITAL MARKET

How do bonds work? and sold. It attracts investors

Bondholders effectively buy a slice because bonds provide more NEED TO KNOW
of a larger loan with each bond, for protection from risk than shares.
which they receive interest, along There are various types of bonds, ❯ Debt instrument Official term
for bond or other long-term debt
with the original sum on maturity. some safer than others—the risk
Issuing, buying, and selling lies in whether the issuer will be ❯ Convertible bond Bond that
can be converted into shares of
bonds take place in the debt capital able to pay the interest and repay
the issuing company or cash
market. The marketplace has the principal sum on maturity. A
❯ Warrant Security that allows the
several functions: it offers bonds secured bond is backed by an asset,
holder to buy stock in a company
and other types of loans to such as property; an unsecured at a fixed price
investors; it operates as a fixed- bond is not and so carries more risk.
❯ Callable bond Bond that
income market, because the issuer Both bonds and shares may be gives the issuer the right to
is required to pay regular interest; referred to as securities. The term redeem it before maturity
and it enables companies and describes the share or bond itself ❯ Noncallable bond Bond
governments to raise long-term and the certificate of ownership or that has no maturity and cannot
funds. Overall, the debt capital creditorship that gives the holder be redeemed or sold back to
market is much larger than the the right to receive a dividend, the issuer but continues to
stock exchange (equity capital in the case of shares, or interest provide interest
market), where shares are bought payments, in the case of bonds.

Investing in the debt capital market

A company wants to raise $100 million to finance growth but does not wish
to issue further shares. Instead, it raises the money by issuing bonds on the
debt capital market.

BOND
$100

BOND
$100
10 YEARS
$100

7%
interest

Company issues bonds Investors buy bonds

The company issues 1 million bonds at $100 each. Each bond has a set maturity date of 10 years and
Each bond effectively acts as a loan between the a 7 percent interest rate, with a face value of $100.
investor and the company. During the 10 years, the company can use the
money as capital.
 HOW FINANCE WORKS
Raising finance and capital 172 173

TYPES OF BONDS
Government bonds Corporate bonds

GOVERNMENT SECURED BONDS UNSECURED BONDS

BONDS

red red
cu cu
Se Se
Unsecured
Government bonds are the safest Secured bonds are secured by the Unsecured bonds are not
type of bond because governments assets of a company, making them backed by pledged collateral and are
in developed capitalist economies a less risky investment than shares. a riskier investment—if the company
are unlikely to default on interest Examples include equipment, trust fails, investors are paid only after
payments on the loan or on the certificates, and mortgage bonds. secured bonds have been paid
principal sum. out. Because they are more risky,
investors expect a higher return
(interest) on their investment.

100
INTEREST PAID (%)

90
80
70
60
$70
over 10
50 years
10 YEARS
40
30
20
10

0 1 2 3 4 5 6 7 8 9 10
YEARS $100
$7
Investors receive annual interest Mature bond is repaid
Each year, the company pays an investor $7 Once the bond reaches its date of maturity, in this
(7 percent of $100) for each bond bought, in case 10 years, the original sum of money, $100, is
return for using the principal sum as capital to repaid to the investor. So, the investor receives a
fund its business. After 10 years, the investor has total of $170, including interest, over the full term,
received a total of $70 interest per bond. in return for the original $100 investment.
 Gearing ratio and
financial risk
Capital gearing is the balance between the capital a
company owns and its funding by short- or long-term
loans. Investors and lenders use it to assess risk.
Low
How it works
Most businesses operate on some
Equity finance (shares) gearing
form of capital gearing (also called
Pros
financial leverage). They partly fund
❯ Does not have to be repaid Company has
their operations by borrowing
❯ Shareholders absorb loss.
less debt
money, via loans and bonds, on the
condition that they make regular ❯ Good for start-ups, which may
repayments of a fixed amount to the take a while to become profitable
Company has
lender. If the level of gearing is high ❯ Angel investors share expertise.
more equity
(in other words, the business has ❯ Low gearing is seen as a measure
Low proportion of
taken on large debt), some investors of financial strength.
debt to equity, also
will be concerned about its ability ❯ Low risk attracts more investors described as a low
to repay and see this as an and boosts credit rating. degree of financial
insolvency risk. However, if the Cons leverage. Equity
amount of operating profit is more comes from:
❯ Shared ownership, so company
than enough to repay interest, high has limited control of decisions ❯ Reserves (retained
gearing can provide better returns profits)
❯ Shared profit in return for
to shareholders. The optimum investors risking their funds ❯ Share capital
level of gearing for a company also ❯ Legal obligation to act in the
depends on how risky its business interests of shareholders
sector is, how heavily geared its ❯ Heavy administrative load
competitors are, and its current life ❯ Complex to set up
cycle stage.

Gearing ratio calculation Low gearing

Analysts and potential investors assess A software company is going public. Its ratio of 21.2 percent tells
the financial risk of a company with this investors that it has relatively low gearing and is well positioned
calculation, presented as a percentage. to weather economic downturns.

LONG-TERM DEBT
× 100 $1.2 MILLION
SHARE CAPITAL + × 100 = 21.2%
$2 MILLION + $2.455 MILLION +
RESERVES +
$1.2 MILLION
LONG-TERM DEBT
 HOW FINANCE WORKS
Raising financing 174 175

Debt finance (loans) NEED TO KNOW

Pros ❯ Interest cover ratio An
alternative method of calculating
❯ If the company makes a profit, gearing—operating profit divided
it can reap a larger proportion. by interest payable
❯ Paying interest is tax deductible.
High
❯ Overleveraged A situation in
❯ Does not dilute ownership which a business has too much

gearing ❯ Company retains control

of decisions.
debt to meet interest payments on
loans
❯ Repayment is a known amount ❯ Deleverage Immediate payment
that can be planned for. of any existing debt in order to
Company has ❯ Quicker and simpler to set up reduce gearing
more debt ❯ Small business loans at favorable
High proportion of debt rates may be available to start-ups.
to equity, also described
as a high degree of
Cons
financial leverage. ❯ Loan must be repaid.
Typical examples of ❯ Interest must be paid, even
debt are: if operating profit shrinks.
❯ Loans ❯ Debt may be secured on fixed
❯ Bonds assets of company.
❯ Unpaid lender can seize assets and
force bankruptcy.
❯ Lenders are first to be paid in the
event of insolvency.
❯ High gearing is considered a
Company has measure of financial weakness.
less equity ❯ High risk may put off investors and

25%
adversely affect credit rating.

High gearing the ratio at

A water utility is the only water provider in the area, with several
million customers. The ratio of 64 percent is acceptable for a utility
or below which
company with a regional monopoly and a good reputation.
a company is
traditionally
$360 MILLION
$82 MILLION + $120 MILLION +
× 100 = 64% said to have
$360 MILLION low gearing
$
HOW
SALES AND
MARKETING
WORKS
Marketing mix ❯ Marketing approaches
Outbound marketing ❯ Inbound marketing
Business development ❯ Information management
 Marketing
mix
The successful marketing of a product or service depends on the consideration of
four key elements—the product itself, its price, how it is promoted, and where it
is sold. This combination is called the marketing mix, and it is used as a tool for
planning product launches and campaigns. Before focusing on the marketing mix,
marketers need to define the target market for their product by determining
which groups of customers are most likely to purchase it.

The 4Ps and 4Cs of

Commodity Product
the marketing mix ❯ Has the product been specifically ❯ Is the product the right
First proposed in 1960, the classic engineered and designed to meet design, size, and color
marketing mix tool contains the 4Ps: and exceed customer expectations? to appeal to customers?
product, price, promotion, and place. ❯ What are its unique
In the 1990s, these were recast as the features? How does it
4Cs, which emphasized the customer- compare with competitors?
oriented dimension of the tool.

The 7Ps of the marketing mix

Some marketers use a more detailed
model of the marketing mix, which
has three additional elements.
❯ Product See pp.180–183.
❯ Price See pp.186–187. Communication Promotion
❯ Place See pp.188–189. ❯ What is the most meaningful way ❯ What combination
to get marketing messages to of marketing and
❯ Promotion See pp.190–191.
customers and provide them media channels will
❯ People Does the business with useful information? be most effective?
employ the right people to deliver
optimum service to customers? ❯ When is the best time
to run promotions?
❯ Process Are effective systems
in place for handling orders and
dealing with customer questions
and complaints?
❯ Physical environment Does the
design and layout of the business
premises appeal to customers?
 HOW SALES AND MARKETING WORKS
Marketing mix 178 179

DEFINING THE MARKET

“Product, In order to establish a marketing strategy for the product they are introducing
promotion, to the marketplace, businesses have to define the customers they aim to sell to
by researching and segmenting the market.

and place Market research Market segmentation

create value. ? See pp.192–193. See pp.194–195.

But price ❯ Identifies gaps in the market for the

launch of new products
❯ Breaks down the market into smaller
customer groups with similar needs
harvests ❯ Measures customer reactions to new
offers and campaign messages
❯ Allows more focused campaigns with
a greater chance of success
value.”

Price Cost
❯ What is the value of the product ❯ How much will the product cost
to prospective customers? the customer, and will it be
perceived as a good buy?
❯ What is the usual price point
for this type of product?

The 7Cs of the marketing mix

This model offers a customer-
focused variation of the 7Ps, adding
three more elements to the 4Cs.
❯ Commodity
Place Convenience ❯ Cost
❯ Where should the product be ❯ How easy is it for busy customers ❯ Convenience (or Channel)
sold—stores, online, or catalogs? to find and buy the product?
❯ Communication
❯ Where do competitors sell, and ❯ Corporation How do company
is there a way to stand out in the structure, stakeholders, and other
same place? competitors affect marketing?
❯ Consumer What are the
customer’s needs and wants?
Is the product safe? What product
information is available?
❯ Circumstances Can the business
deal with external factors, such as
laws, weather, economy, culture?
 Product
The goods and services a company sells are its product. A product can
be defined in terms of features, design, size, packaging, service type,
return policies, and warranties, all intended to meet the customer’s needs.

How it works Marketers identify the goods and services they sell in
Consumers can be said to buy benefits rather than three or five product levels, with the benefit at the core.
products. For the marketer, the product itself is that The marketer’s job is to translate and communicate
benefit to the consumer, as packaged and presented. each product level as an offer to the consumer.

Total product concept:

three product levels Core product
Product’s basic function and its
From a marketer’s perspective, a product core benefit to consumer
is more than the end commodity bought
by a customer. It is a total product concept
with several layers of benefit, and these
must be conveyed to the consumer.

Actual product
Packaging, brand name,
quality level, design, and
additional features that set
it apart from rival products
ec

s
high-tech tire
o-fr
free delivery •

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Takes rider
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Additional benefits, such

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 HOW SALES AND MARKETING WORKS
Marketing mix 180 181

40%
of new products are
NEED TO KNOW
❯ Personal branding Promoting oneself
as a product with a distinct brand personality
❯ Fast-moving consumer goods (FMCGs)
Sold quickly and at relatively low unit cost,
still on the shelves such as food and household products

three years later.

Variation: five product levels

This variation on the total product concept is more detailed.
It introduces two more levels by breaking down the actual
product level into a generic and an expected product and also
includes an extra level of benefit—the potential product.

Core product Product’s

core benefit to consumer

Generic product Basic

functional benefits

Expected
product
Additional
desirable
benefits

Takes Augmented
rider from product
A to B Extra features
kes

and benefits
2w

ra

ee
•b
h

ls •
3 gears
ur id
st

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ligh

dy
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hr
tio

• re ot Potential
liable • smo
ter

ec

sig
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an
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product
ot

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fra

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prevent theft • bui
 Product positioning
A vital step in the process of deciding how to market a product is
defining how it is distinct from the competition—what is unique
about it and what are the qualities that make it better than rivals.

How it works of the product or brand and clarify how it is different

Before a company launches a product, the marketing from similar types of products offered by competitors.
department has to decide how to position it in the They also need to identify the criteria that customers
marketplace compared to competitors’ products. To are most likely to use when choosing a particular
determine the positioning of a product, marketers product or brand. With this information, the marketers
must define the most important features and values can then create a product positioning matrix or map.

Product positioning maps HIGH QUALITY Ideal brand position

Marketers commonly create a perceptual “map”
using a product’s two most important attributes,
presented as variables on an x and y axis, to
determine where to position it. Attributes may
include price, quality, status, features, safety, and
reliability. Once the map is labeled, existing
Competitor
products are placed on it to reveal the best brand
position or gap for the proposed launch. Competitor
Competitor brand
Gap in the
brand
FOUR POSITIONING market
Competitor
STRATEGIES

HIGH PRICE
LOW PRICE

Competitor Competitor
brand brand
brand
❯ Value positioning A product
plotted on the map so that it has
Brand’s
an attractive price while delivering current
good functional qualities. position
❯ Quality positioning A product
that is located on the map on
the basis of its perceived quality or
superiority.
❯ Demographic positioning
A product mapped according to its
appeal to a specific population
segment, such as consumers with
a particular occupation. LOW QUALITY
❯ Competitive positioning Product positioning template
A product that is very similar to
those of competitors, relying on The map shows how marketers position competing products
correct pricing to find a viable in the marketplace according to the price/quality variables (the
position in the marketplace. most commonly used) to identify a gap for the new product.
 HOW SALES AND MARKETING WORKS
Marketing mix 182 183

EXPENSIVE

ant
oiss
r

C
nd bacon An expensive
gsa
g A breakfast dish breakfast food
E

aimed at those ideal for busy

with ample professionals in
leisure time a hurry.
and money.

ereal
ldc
o

C
Centrally
positioned,
cereal is the
most popular
breakfast food.

QUICK
SLOW

es
ncak With a slow cook time,
a pancakes occupy a
P

niche gap in the

market.

reakfast
ant b
eal t
cer s
ot
In
H

Students make
the ideal target
Older people market for
and children instant breakfast
provide strong products.
demand for
hot cereals.

INEXPENSIVE
Breakfast positioning map
The positioning of the various breakfast foods
“Positioning is not what you do
has been determined by the speed at which
the food is prepared, measured from slowest to
to a product. [It] is what you do
fastest, and the price of each food type, from the
least expensive to the most expensive.
to the mind of the prospect.”
Al Ries and Jack Trout, marketing strategists
 Product life cycle
Every successful product launched on the market experiences growth
followed by decline. To maximize profitability, business managers
must recognize and manage each stage of the product’s life-span.

How it works different stages in the cycle is crucial to maintaining

There are typically six identifiable stages in a product business growth. The life of older products may be
life cycle, with the product’s rate of growth measured prolonged by extension strategies, but if they are no
by time and revenue. Most businesses have more than longer grabbing new market share, the business must
one product on the market at any time, and strategic consider launching new products in order to continue
manipulation of the portfolio of products at their generating revenue.

Growth Saturation

Sales increase, and the cost per Sales peak, and the cost per
customer falls as profits rise. customer is at its lowest.
There are more customers and Profits are now high, and
more competitors. competition is intense.

Launch

Business outlay is high due to

product development costs
and marketing budget.
There is no return on
investment.

Decline

Profits fall as sales fall, and the

customer base contracts. The cost
Introduction
per customer remains low.
Marketing spend is now kept
Sales are typically low and
at a minimum.
cost per customer is high
$
as the market takes time to
accept the new product.

SALES

TIME
 HOW SALES AND MARKETING WORK
Marketing mix 184 185

Diffusion of innovation NEED TO KNOW

(consumer uptake) %
Marketers identify five distinct ❯ Extension strategy Revival

6
customer types according to of a product by rebranding,
how quickly they pick up on repackaging, or repricing it or
a new product. finding new markets
❯ Portfolio analysis Each of

months
a company’s products measured

EARLY ADOPTERS

EARLY MAJORITY

LATE MAJORITY
by growth rate and market share

INNOVATORS
to determine marketing spend

LAGGARDS
❯ Product life cycle management
(PLM) Management of a product

the length of time from inception to withdrawal

a product can be
PORTFOLIO ANALYSIS
labeled as “new”
34% 34% Rising stars
Products with a high
market share in a
high-growth market;
Withdrawal they require a big
marketing spend to
The product is phased out keep them growing.
as sales stall or continue to
fall. The business introduces
a replacement product before Cash cows
the old one is withdrawn. Products with a high
market share in a
low-growth market;
they generate money
to support rising stars.

16%
Problem children
Products with a low
market share in a
13.5%
high-growth market;
they need a big
marketing spend.

Dogs
Products with low
market share and low
growth; they may stay
in portfolio to keep
2.5% customers happy.
 Price
Price is a crucial variable of the marketing mix: it generates revenue,
while product, promotion, and place yield costs. Pricing may also be the
marketer’s most potent tool because even minor tweaks affect returns.

How it works the product is low, they will

To set the price of a product, look for the cheapest price among NEED TO KNOW
marketers adopt a pricing strategy competing products.
based not only on the actual cost A business must also take into ❯ Price, value, and cost
Price refers to the amount a
of production but also on the account the price charged by rival
product sells for; value refers to it’s
perceived attractiveness of the organizations, particularly in perceived value to the buyer; cost
product to consumers. If consumers competitive markets. Setting is the amount that has been spent
think a product has a high value, a price above that charged by to manufacture the product
they will be prepared to pay more competitors can only work if the
for it, but if they believe the value of product is superior to others.

Pricing strategies
Low quality
A number of different strategies can be
used to determine the price of a product.
Economy
Low price

Cost-plus pricing is a retail markup used

by many companies to ensure a profit is ❯ High prevalence Manufacture $
made. For example, adding a markup of 50 a product that is very similar
percent to a product that costs $2 to make to others in the same category.
means that every unit will sell for ❯ Low price Undercut competitors’
$3, generating a $1 profit. pricing and gain a larger share
of the market.
Pricing matrix: price vs. quality ❯ Minimal marketing Keep the
A product’s quality affects its price tag—the marketing and branding spend
higher the quality, the more money as low as possible.
consumers will pay for it—but marketers
use strategies that play on the interaction
between price and perceived quality.

Skimming
❯ High launch price Charge more $$$$
than usual in the short term while a
product is seen as unique.
❯ Correct timing Set a higher price
when the business has a temporary
“Price is what advantage in the marketplace,
High price

before competing products appear.

you pay. Value ❯ Price adjustment Reduce the
price once competitors enter the
is what you get.” market or to draw more customers.
Warren Buffett, investor
 HOW SALES AND MARKETING WORKS
Marketing mix 186 187

PRICING MARKUP COMPARISON

Different industries adopt 600%
different approaches to COCKTAILS
markups. A markup of 500% WINE DRAFT BEER 300–500%
two to five times the cost 250–300% 250–300% of cost
is typically applied to 400%
of cost of cost
drinks served in bars and
restaurants. The highest LIQUOR
300% 650%
markup is usually applied
of cost
to the second-cheapest
200%
bottle of wine on the
wine list, as people tend
(100%)
COST

to avoid the cheapest item.

High quality Other pricing strategies

Psychological
Market pricing
$ penetration $ Manipulate a
customer’s emotions,
❯ Low price Charge the lowest price appealing to their thrifty
possible in order to lure customers side or desire for prestige.
away from competitors.
❯ Price adjustment Increase the Bundle pricing
price to a normal level once the
product has a loyal following. Offer several products for
❯ Pricing flexibility Reassess pricing;
initial high-volume sales lower cost
$$$$ an overall price,
providing better value
than buying separately.
of production, allowing price tweaks.

Premium $
Geographic pricing
$$$$ ❯ High price Charge as much as
Charge different prices
for the same product
the market will pay for an item. in different locations.
❯ Unique value Apply premium
prices to products that have no
comparable substitute, such as
famous brand-name goods.

?
Nonpricing
❯ High production cost Charge strategies
a premium price because a product
is customized and offers no savings Avoid adjusting the price
through volume manufacturing. to attract sales,
promoting superiority of
product instead.
 Place
Knowing where customers shop, where a product is sold, and how
efficiently goods can be delivered to the consumer—called “place”
in marketing terms—is essential to sales success.

38%
How it works A sales outlet is the place where a
Whether a company sells goods product or service is sold, such as
or services, customers must be physical outlets or e-commerce
able to find and buy those products
as easily as possible. Businesses
websites. Sales channels are the
merchants, agents, distributors, and
revenue growth
have to decide on the best sales platforms that take a product from globally at online
outlet and sales channel to get
their products to customers in a
the seller and bring it to the
consumer, such as Amazon or TV
retailer Amazon
way that benefits both parties. shopping channels like QVC. in 2020

Main distribution channels Selling direct to consumers

A product reaches the marketplace through one of four main types of Product is sold directly by the
distribution channels. The most suitable distribution channel is usually producer, usually online, and
dictated by where customers prefer to buy the product. delivered to customer without
intermediary.

Selling through retailers

Goods are delivered by producer
directly to retail outlets; retailer
adds a markup onto the price it
pays to producer.

Selling through
wholesalers and retailers
Products are distributed in two
stages: by producer to wholesaler
and then wholesaler to retailer.

Selling through an agent

Products are distributed in three
Producer
stages: from producer to agent,
A producer chooses the distribution channel, or a combination from agent to wholesaler, and then
of channels, that will maximize the number of customers it can on to retailer.
reach while keeping costs as low as possible.
 HOW SALES AND MARKETING WORKS
Marketing mix 188 189

PROS AND CONS OF USING INTERMEDIARIES NEED TO KNOW

Pros Cons ❯ Channel margin The cost
❯ Allows wider market coverage so ❯ Raises difficulty of making direct intermediary adds to producer’s
producer can reach more customers, communication with customers selling price, which is added to
especially those in distant areas. to learn about their preferences. price paid by customer
❯ Minimizes distribution cost for ❯ Increases the risk of slow, inefficient ❯ Push strategy Method in which
producer, as intermediaries are delivery, especially if several producer promotes products
responsible for this service. intermediaries are involved. to wholesalers, wholesalers to
❯ Provides producer with specialized ❯ Takes away control over how retailers, and retailers to customer
knowledge of customer buying products are handled and displayed ❯ Pull strategy Use of advertising
habits as well as delivery logistics. at point of sale. and promotion to sell to customer

Example
E-commerce site selling
vitamins; they are sent
to customer by mail
or delivery service.
Consumer

Example
Electronics company
distributes its television
sets to a chain of
retail stores.
Retailer Consumer

Example
Farmer sells apples to
wholesaler, who sells
them to supermarkets.

Wholesaler Retailer Consumer

Example
Chocolatier in France
uses import agent in
Japan to sell its products
to wholesalers and
to retailers. Agent Wholesaler Retailer Consumer
 Promotion
Promotion is necessary for generating interest in and sales of a product
or service. A complex and expensive part of the marketing mix, it involves
communicating to customers and influencers, such as peer groups.

How it works
The primary purpose of promotion
is to boost sales by attracting new
customers while enticing existing
ones to try out something new. Personal
Most companies use a number of selling
communication activities to inform Interact with customers face
and remind their target audience of to face and tailor
a product’s benefits (see pp.196–231).
Co sales messages to
nsu
One of the long-term benefits of mer bee their needs.
communicating with customers is
that it helps build brand loyalty, but
be aware that rules apply to the use
of personal data.

NEED TO KNOW
Customer
❯ Integrated Marketing service
Communication (IMC) Provides customers with
Promotion of the same brand information about the
message across all media channels product; offers updates
❯ MarCom (Marketing and special deals.
Communication) Full range
of promotional activities used
to reach out to the market

73%
of marketers
Below the line (BTL)
Describes promotional
activities a business carries
out in-house, such as social
media marketing and sales
promotions, to reach
say social media customers directly.

marketing has
been effective
for their business.
 HOW SALES AND MARKETING WORKS
Marketing mix 190 191

Advertising Direct
Run ad campaigns marketing
through media channels
Send product offers and
most likely to reach target
information directly to
market and stick to Interactive
the potential consumer
budget appropriate marketing
via social media
for the product.
or email. Build long-term
relationships with
customers using two-
way communication,
especially online.

Sales
promotion
Entice customer with
offers, free samples, gifts, Public
competitions, packaging, relations
and point-of-sale Generate positive
displays. interest by pitching
content to media or getting
endorsements from
influencers.

Above the line (ATL)

Refers to online and
offline advertising
a business pays for
to target customers.
 Market research
Asking customers what they think about a product or service is a vital
part of the decision-making process for marketers. Research offers
insights into how a product might sell and lowers the risk of marketing.

How it works quantitative and qualitative. Quantitative is numbers-

Market research is used to make decisions throughout focused and often involves asking fixed questions to
the entire business planning cycle, from generating large groups. Qualitative is more exploratory and is
ideas to evaluating solutions. Researchers use a variety about understanding topics in depth among smaller
of data sources, including internal business information, groups. Marketing departments use both types of
primary (new) research, and external sources, such as research, depending on the specific business
social media. Primary research is broken down into questions they want answered.

Primary data
collection
New research to answer
specific question

Observations Quantitative surveys Qualitative surveys

❯ Researchers may watch ❯ Researchers question many ❯ Researchers probe small
from a distance as customer people for a broad view, groups or individuals for
interacts with product, or they generating numerical data. their in-depth view.
may identify identify themselves ❯ They carry out surveys, usually ❯ They conduct focus
and talk to customer. online, to obtain a quick result groups and other types of
❯ They observe customer by using from a large sample. interpersonal discussions.
equipment, such as eye-tracking
analysis and checkout scanners.
❯ They study credit card records or
computer history to observe past
consumer behavior.
 HOW SALES AND MARKETING WORKS
Marketing mix 192 193

CASE STUDY

?
Marketer Marketer
Helping Hummel
When Danish sportswear brand Hummel wanted to expand into
leisurewear, it turned to market research firm Ipsos to help it better
understand its consumers and market position. Ipsos conducted
16 qualitative focus group studies and 6,500 quantitative interviews
has a reaches a in Denmark and Germany, enabling it to identify five unique market
segments, and areas with development potential. It also created
question decision animations and infographics, and ran workshops to communicate the
DATA RETURNED
DATA REQUESTED

findings to Hummel staff. “This gives us a strong foundation for making

both strategic and operational decisions,” said Lene Christensen Heinz,
leader of Hummel’s business intelligence team.

Secondary data
collection
Published material
on a subject

Agency
Carries out original research
and organizes research data
into meaningful results

Internal sources External sources

❯ Web usage data (for example ❯ Industry reports by trade

$73.4
browser logs and online bodies, institutions, and private
sales records) research companies
❯ Customer profiles with buying ❯ Reports by broadcast, print,
history and demographic data and Internet media

billion
❯ Accounting records, such as ❯ Academic papers, university
financial statements think-tank reports, and research
❯ Original data from past library holdings
market research reports ❯ Government surveys,
the value of the reports, and statistics
❯ Social media and
global market search-engine data

research sector
 Market segmentation
In order to make decisions about who to sell their product to,
marketers try to identify distinct groups of consumers with similar
wants and habits who together form a “segment” of the market.

How it works narrows down a potentially huge

Marketing departments use market into segments, allowing
a strategy of market segmentation marketers to identify the ones more
to find the potential customers who inclined to buy a given product.
are most likely to buy a particular For example, after applying this
product, thereby increasing the strategy, a company trying to launch
chances of a successful product premium-price organic baby food
launch. They divide a broad group realizes that instead of marketing to
of consumers into subgroups based all women who have young children,
on many factors, including age, it should aim its product at working
lifestyle preferences, location, mothers with children under six
family structure, household income, months, above-average incomes,
and occupation. This process and an interest in healthy eating.
Behavioral
Focuses on behavioral
patterns when it comes to
NEED TO KNOW Defining market groups shopping. Understanding this
helps marketers adapt
❯ Baby Boomers Section of To establish different consumer groups, campaigns to target
population born between marketers create five segments and focus specific groups. Potential
1946 and 1964 on each individually. Besides identifying focus areas include:
❯ Generation X People born groups by geography and demographics, ❯ Brand loyalty
between 1966 and 1980 marketers also explore psychology to
ascertain how consumers behave, so that ❯ Regularity of purchases
❯ Millennials Section of
population born between they gain a better idea of which products ❯ Credit card usage
1980 and mid-1990s might appeal to which consumer groups. ❯ Typical expenditure
❯ Generation Z People born See also pp.258–261. ❯ On- or offline shopping
between the mid-1990s and ❯ Heavy product use
the early 2010s

“Market segmentation
is a natural result of
the vast differences
among people.”
Don Norman, cognitive science researcher and professor
 194 195
Sociographic Psychographic
Identifies individuals’ connections on Focuses on consumer’s interests, values,
social media or membership in political and opinions to help marketers develop
and other groups, helping marketers relevant messages and find the right
learn about consumers’ passions and media channels to target a segment.
interests. Potential focus areas include: Potential focus areas include:
❯ Group memberships ❯ Risk taker
❯ Number of friends on social media ❯ Charitable
❯ High achiever
❯ A tendency toward
expensive tastes
❯ A preference for
email contact

Geographic
Concentrates on a
customer’s place of
residence, so that any
product launched is made
relevant to their
environment. Potential
focus areas include:
❯ Zip code
❯ Continent
❯ City
❯ Neighborhood
Demographic
❯ Population density
Uses basic consumer
data, such as gender or ❯ Climate
age, to accurately categorize
needs and target products
appropriately. Potential
focus areas include:
❯ Income
❯ Nationality
❯ Family size and age
❯ Ethnic background
❯ Occupation
❯ Religion
 Marketing
approaches
Every product launch requires strategic planning to make sure messages about
a new product reach the right types of consumers, are communicated through
the most effective combination of channels, and have the most relevant content
and style. Once marketers have researched the market and defined their target
audience, they face several key decisions on how to make their approach.

Types of approaches
Whom to target and how to go about it are crucial to Rather than sending the same message via different media,
success. Marketers may use several complementary they usually adjust the tone and style of the marketing pitch
approaches to different groups of potential consumers. to suit the channel as well as the target consumer.

Niche marketing Mass marketing

“I only have eyes for you.” “I love you all.”

The big choice

The first decision is whether to go for a narrow, specialized market or to
appeal to as large an audience as possible. See pp.198–199.
 HOW SALES AND MARKETING WORKS
Marketing approaches 196 197

89%
of women worldwide
say they control or
share the shopping Engagement
marketing

for daily needs. “Come dance

with me.”
It entices the
customer to
collude in
product sales.
See pp.204–205.

Sensory marketing
“Wake up and smell
the roses.”
Traditional It seduces the
channel allied with customer with sights,
a dominating style. sounds, and smells.
“Let me tell you,” it See pp.206–207.
blares.
See pp.200–201.

Relationship marketing
“Let’s be friends.” It builds a rapport with its
audience of consumers. See pp.208–209.
Digital channel allied with a
soft approach. “Let me woo you,”
it gently whispers.
See pp.202–203.

How to tell the customer Making a move

Marketers often get the best of both worlds by using Turning the buying transaction into an experience
traditional and online channels in varying styles. the consumer enjoys can help sell a product.
 Niche vs. mass
marketing
Two fundamental choices traditionally face marketers: whether to
try to sell a product with broad appeal to as many people as possible
or to focus on selling a tailored product to a defined group.

How it works use Internet channels to promote

Both niche and mass-marketing the same product to different
strategies offer businesses the groups of customers within a
potential to make a high return mass audience.
on investment. A niche approach

20%
generally works on the basis of low-
volume sales at a premium price to
a specific group of consumers, while
a mass approach tends to use heavy
promotion to a wider audience and
aims to achieve high-volume sales.
In reality, businesses tend to mix
of sales can
up both approaches, launching a
niche product and then expanding
make up to
it to a mass market. Marketers also 80% of profit.

NEED TO KNOW
Long-tail marketing
Coined by Wired magazine editor Chris Anderson, the term “long-tail
marketing” takes its name from a demand curve (see below) depicting
products with low demand or sales volume—niche products—that
continue to sell and make profit over time.

Head Popular products with

POPULARITY

high demand and sales volume

Withdraw The point at Long tail Products
which retailers typically with low demand
stop selling a product that sell steadily

PRODUCTS
 HOW SALES AND MARKETING WORKS
Marketing approaches 198 199

Niche market

Who and how

❯ Business targets a select group of consumers
with specific needs and wants.
❯ Customers are often prepared to pay a
premium price for an uncommon product.
❯ Sales volume of niche product is low and so
does not benefit from production economies of
scale (manufacturing large quantity to
reduce the unit cost of production).

HYBRID APPROACHES
Using social media to identify and reach
more than one target market, marketers have
developed hybrid approaches that are more
flexible than conventional niche or mass-
market positioning of products.

Mass market
An unfocused strategy that aims at the
broadest customer base.
Large segment
Mass market Channels marketing resources to one
large segment of the mass market.
Who and how Adjacent segment
❯ Business targets a large group of consumers Once large segment is fully penetrated,
with generalized wants and needs. product expands into related segment.
❯ Requires high marketing spend to promote Multi segment
products, which must be widely distributed. Markets to several segments at once,
❯ Marketplace is often crowded with other with a customized strategy for each.
competitors selling a similar product.
Small segment
Markets to a small segment with few
competitors, if resources are limited.
Niche segment
Focuses marketing resources on a
specific group of customers.
Mass customization
Customizes a strategy for each
subsegment within the mass market.
 Traditional marketing
Before the digital age, marketers relied exclusively on nondigital
channels, such as TV, radio, and print media, as well as direct mail,
events, and cold-calling, to convey their message to the consumer.

How it works
Traditional marketing encompasses
a number of tried-and-tested ways of
building a brand and pushing
a product to sell more. It remains a
key facet of marketing. Nowadays,
however, most businesses use Events
a mix of traditional and digital Staging sports activities,
marketing methods. One of the themed displays, parades,
advantages of traditional marketing or exhibits to promote a
is that companies have face-to-face product, cause, or brand
contact with customers through TV
person-to-person selling, special Promoting sales through TV
events, and event sponsorship. ads, program sponsorship,
or product placement

Traditional
marketing process
Small and large businesses use
a range of conventional marketing
channels and often integrate them
with digital marketing strategies.

Direct mail
Mailing catalogs or ads
to targeted consumers, often
promoting offers (in compliance
with data protection rules)

Face-to-face Telemarketing
Approaching customers directly Calling potential customers who
to create brand awareness or have an identifiable need for a
persuade them to buy a product product with a sales pitch (in
compliance with cold-calling rules)
 HOW SALES AND MARKETING WORKS
Marketing approaches 200 201

Product samples
Offering free samples of a product to customers, giving them the
opportunity to try it before making a purchase—an effective way to Billboards
launch new products and build a customer base Renting large outdoor advertising
spaces to market products; cost
depends on the size of the space,
its visibility, and the amount of
traffic that passes the location

Radio
Using commercial slots on radio
to promote products either
locally or nationally, depending 25%
on the station’s reach Newspapers and
magazines Traditional
marketing
Buying space in print media to Digital
run advertisements or creating marketing
advertorials to market products 75%
or services

70%
higher brand
recall by
people
exposed to
Brochures and flyers Networking
Promoting through mailing or Interacting with other people
direct mail ads
locally hand-distributing printed
materials to promote businesses
at special events to develop
professional contacts
rather than
digital ones
 Digital marketing
Using the Internet, marketers can connect directly and instantly
with current and potential customers to build brand recognition,
collect data, and encourage word-of-mouth recommendations.

How it works
Unlike traditional offline
r experienc
marketing, digital marketing
gives a business direct, two-way e e

m
communication with customers.
Digital marketing employs some Consu
conventional approaches, such Customer blogs
about the gym
as “pop-up” or “banner” ads
on web pages, but it also relies

Q
R
CUSTOMER VISITS THE GYM

co on
heavily on the power of social

de ce

Bl we

er s
to
media for raising awareness of

is ll p

om ct
og b
ta ho

st re
lin site
ke n

cu Di
a product or brand. This makes

n e

ks
to

to
it harder to measure return on

gy
m
investment. Digital marketing
Customer takes coupon to gym

is often used in conjunction

with traditional marketing

Cu
techniques, a hybrid known
st
om
as “tradigital” marketing.
er
sc on
he w
du eb
le sit
sa e
fr
ee
POSTER WITH
Tradigital w
QR CODE FOR
or
ko
g

TRIAL
in practice ut
tin

QR code is
A new health club is launched PRINTED AD scanned with
nal marke

using a tradigital approach to WITH TRIAL cell phone

marketing. TV ads are aired with COUPON to

a call to action to visit the gym’s

er

$
m
to

website and schedule a free POSTER IN GYM

us
sc

workout with a fitness trainer. ADVERTISING

ct
re

Print ads feature a coupon or FREE WI-FI

Di

a QR (quick response) code to

scan and present at the health
club for a free trial. At the club,
o

members get free Wi-Fi access.

ti

The Wi-Fi landing page has a

TV ADS AIRED Directs viewer to
i

link to the gym’s free app. The

d

DURING TENNIS
club may also use pop-up ads, TOURNAMENT
ra

podcasts, email, and text messages

to attract or retain members. T
 HOW SALES AND MARKETING WORKS
Marketing approaches 202 203

% SHARE OF GLOBAL
Digi AD SPEND BY MEDIUM
tal
ma The Internet is expected to account for

rk more than half of global ad spending in

et
FREE 2021 as the expenditure on print and TV
APP ads continues to fall.
i

ng
6%
6%
5%
Fe ia
ed so
v

33%
ba cia
Directs Wi-Fi user to

7% 2019
ck l m
is ed
gi ia

$
ve
n

43%

Feedback is given
I LANDING PA
I-F GE via social media
W
3% 6%
6%

Wi-Fi landing page links to 5% 30%

a workout clip on
2021
Directs Wi-Fi

video-sharing site
$
user to

@
50%
p
re ice m slet ail s u

KEY
n
ew em r sig

s es g

TV Radio
m eiv in
gy ec ch
r
fo me

te

GYM WEBSITE Internet Out of home

or r ar
o
r

s f lin ese

Newspapers
st
Cu

ad n r

Magazines
d o er
e
n

eb
m aw
ilo dv sto
ta a u

gy es
ss l c

he do
ne tia

of advertising
rt r
fit ten

fo e m

70%
Po

ch to
ar us

spending in
se al c
i
nt
te

China is set
Po

to go on digital
ads in 2021.
 Engagement marketing
By involving customers directly in the development of a brand,
marketers hope to build a strong two-way relationship with
customers and win long-term loyalty.

How it works
Engagement marketing harnesses
several online and offline strategies Start with a “wow”
to draw a customer’s interest and experience
get them talking about products
Provide interesting, informative, or
and services. This contrasts with the
entertaining content to draw potential
more traditional style of marketing customers to a web page.
in which a brand concept and
product proposal are presented to
the customer as fixed, to be either
accepted or rejected. Engagement
marketing, on the other hand,
encourages customer input so that
they feel closer to the brand. The
goal is to lure potential customers
to the website with an initial
experience and then work hard Sale
to keep them there.
Once customer makes purchase, $

follow up with after-sale call, full $

of feel-good reinforcement.
$

PURCHASE

NEED TO KNOW
❯ “Sticky” customers Consumers New prospects
who are loyal to a company and Offer incentives to existing
return to make more purchases customers for recommending
❯ Decision simplicity Ease product or sharing content.
with which consumers can
find trustworthy information
about a product
❯ Churn rate Percentage of
customers who cut ties with the
company in any given time period Social visibility
❯ WOM Word-of-mouth Post interesting and relevant
marketing, which relies
COMMENTS
content on social media and
on satisfied customers
AND SHARES encourage dialogue.
recommending products
to others
 HOW SALES AND MARKETING WORKS
Marketing approaches 204 205

72% of people are more likely to be loyal

to a brand if it offers a personalized experience.
Entice to stay
in touch
Offer incentives to visitors
ATTRACT when they sign up for email
updates and newsletters.

EMAIL

Virtual engagement
Design every aspect of a
website to maintain visitor
interest so people return for
new content.

IN-STORE PROMOTION

SOCIAL MEDIA

Actual engagement
Events
Encourage customers in the real
Use previous customer world to use product, meet and
feedback to decide on best speak with sales staff, and
content for publicity events. interact with other customers.
 Sensory marketing
Sensory marketing targets multiple senses to sway purchasing
decisions. Based on research showing how the brain responds to
sensory input, this type of marketing acts covertly on the customer.

How it works
Sensory marketing is most obviously
used by the food and drinks industries, Sight
but its use extends to diverse products Technology is making
and services: computers designed advances with this, the most
with tactile materials, hotels scented stimulated sense in marketing,
to relax customers, and even fireworks by using optical illusions,
displays featuring edible confetti. digital effects, 3-D, and
360-degree photography.
Typical channels for sensory
marketing include field marketing, such
as in-store events, samples, person-to-
person sales, direct mail, and product
delivery. For online businesses,
however, finding a way to use
it remains a challenge.

Touch Smell
Marketers use 2-D and 3-D Customers are willing to
textural print techniques for pay more for a product
promotional materials and sold in an environment
packaging as well as to sell that is scented appealingly.
products with tactile appeal.

72%
of consumers
born from 1980 Taste
to 1996 value Taste sensations
can be enhanced or
experiences over subtly altered by
combining them with
material items. touch, sight, and especially the
closely linked sense of smell.
 HOW SALES AND MARKETING WORKS
Marketing approaches 206 207

NEED TO KNOW Attitude, memory,

behavior, and mood
❯ Sensory testing Assessment of The sensory input results in a short- or long-
products by panel members with term effect on attitude, memory, behavior,
exceptional sensory perception and mood. This can be influenced by the
❯ Haptic technology Invention intensity of sensory data and by using it to
that simulates touch through stimulate more than one sense at
vibrations on computers the same time.
❯ 3-D marketing
An immersive form of
consumer marketing
Perception
The brain receives
stimuli from one
or more senses.
Emotion
Sensory stimuli tap
into the store of
emotional memories, as
both are processed by the
Cognition same area of the brain.
After processing
sensory stimuli, the brain
embeds memory,
regulates emotion, and
makes decisions.

Hearing
Sound is more
effective than sight
in triggering the
brain areas that
process emotions.
 Relationship
marketing
The strategy of relationship marketing is to develop and
manage a trusting, long-term association with customers
and other stakeholders who have links with the company.

How it works
Relationship marketing aims to corporations have now changed
replicate the type of interaction their focus from making the
that village stores once had with sale to relationships and from
their customers, offering a high level short-term reward to long-term
of personalized service gain. The marketer can extend Supplier markets
to win them over for a lifetime. the network beyond the engaged Building a relationship
While small, local businesses customer to include employees, of collaboration with
naturally work this way, large suppliers, and others. suppliers makes good
commercial sense.

Six markets model

Relationship marketing has established a strategy for communicating with the
customer. This strategy defines six markets—not just traditional customer markets—
where companies should direct their marketing efforts.

CASE STUDY
Starbucks
The strategy of coffee-shop chain Marketing internally
Starbucks exemplifies effective ❯ Barista training
relationship marketing. Centered on
❯ Tech development opportunities
core customer and internal markets, it
also involves suppliers, referrals, and Marketing via referrals
recruitment (employee) markets. ❯ Word of mouth
❯ Social media shares
Marketing to customers Marketing to employees
❯ Social media ❯ Stock options Influence markets
To maintain good public
❯ Business crowdsourcing ❯ Medical insurance
relations, the company works
❯ Familiarity with customers ❯ Partnership with regulators and consumer
❯ Loyalty program Marketing to suppliers or environmental groups.
❯ Reward card app ❯ Fair-trade programs
❯ Mobile payments ❯ Quality control
 HOW SALES AND MARKETING WORKS
Marketing approaches 208 209

“Advertising brings
Referral markets
in customers, but
Customers can be word-of- word of mouth brings
mouth advocates for a company.
Related businesses may also in the best customers.”
refer trade. Jonah Berger, marketing professor

Customer markets Internal markets

The main marketing focus is on A company’s employees are its
customers, but activities are based internal customers, working together
more on building long-term to represent its goals, mission, and
customer relationships than strategy.
on acquiring new customers.

NEED TO KNOW
❯ Key account management (KAM)
Marketing strategy that coordinates
departments in a business-to-business (B2B)
firm to build relationships with major clients
❯ Frequency marketing Promotion aimed
CV CV CV at increasing repeat sales by rewarding
customers for repeat purchases
❯ Direct response (DR) Marketing that
Recruitment markets invites consumers to respond directly to
advertiser by telephone or email
To attract the best
employees, a company may ❯ Transaction marketing Strategy that aims
market itself by offering to persuade customers to make additional
one-time purchases at the point of sale
incentives to staff.
 Outbound
marketing
Also called interruption marketing, outbound marketing involves a marketer
pushing a message to consumers. With this type of marketing, businesses
typically reach out to a wide audience by paying for advertisements on various
media channels. Although the audience may have no interest in the advertisement,
outbound strategy relies on delivering a high-impact message and generating
a response by creating familiarity through repetition.

Outbound marketing process

Outbound marketing takes
a traditional approach to
grabbing consumers’ attention Broadcast Convert
but may use both nondigital
and digital media platforms. Marketers select a media Marketers link offline
There are two stages to the channel with proven outbound campaigns
outbound process. First, the reach to the target audience and then with digital channels as part of
company communicates a communicate the message about an overall strategy to persuade
message to an audience and brand or product to that audience. potential customers to respond.
tries to convert them into
customers; second, it analyzes Communication channels Means of conversion
the results to identify the ❯ Ads on prime-time TV to find ❯ Radio advertisement that repeats
channels and campaigns that widest possible audience—ideal easy-to-recall phone number to
have generated the most sales. for raising brand awareness. elicit immediate action.
❯ Presence at trade events for ❯ Online advertisement that has
increasing corporate visibility prominent position on web page
and reaching a business audience. and clear click-through point that
❯ Banner ads and pop-up ads invites customers to click, find out
on relevant Internet sites or more about product, and buy.
attached to blogs that link to ❯ Flyer distributed door to door that
the company’s website. includes an appealing introductory
❯ YouTube video ads stay in offer on the product for a limited
the viewer’s mind longer than period of time.
static ads and so can be effective. ❯ Direct mail that makes high-
❯ Sponsorship of sporting or impact call for customer response
cultural events puts a name or or delivers strong novelty value;
brand in front of a large audience. includes postage-paid reply form
and customer service contacts.
 HOW SALES AND MARKETING WORKS
Outbound marketing 210 211

86%
of businesses
TYPES OF OUTBOUND MARKETING
Offline

use video as a ❯ Cold calling Campaign can be more effective

if conducted at the right time of day to suit target
marketing tool. audience; message should be scripted carefully and
delivered in a genuine tone. Be aware of rules
governing its use. See pp.218–219.
❯ TV commercials Although many consumers now
switch off TV advertisements, they are familiar with
and open to this type of media, and repetition gets
the message across. See pp.212–213.
❯ Radio This medium is the world’s most popular
mass communication channel with a global reach
and is ideal for outbound messages aimed at an
Analyze international market. See pp.212–213.
Marketers monitor the ❯ Guerrilla marketing The use of a creative
progress of outbound and unconventional approach in high-traffic
campaign, adjust the mix of media public places can be a cost-effective way to raise
or other paid-for channels, and brand awareness. This is a form of engagement
then measure campaign results. marketing. See pp.204–205.

Actions Online
❯ Run control and test streams to ❯ Social media The types of advertising on social
compare the success of different media sites are increasing and include sponsored
media or campaign strategies. posts, promoted pins, and direct forms, such as
❯ Examine click-through-rate banner ads and video ads. See pp.228–229.
analytics, which look at how many ❯ Mobile technology Advertising that is tailored for
customers have clicked through to mobile devices takes the form of text and images, or
find out about or buy product, both, to offer special deals to users; promotions are
to determine online ad success. also made via apps. See pp.214–215.
❯ Analyze sales by outbound ❯ Social lead targeting This strategy taps into
spend to establish which channels individual profiles from social media and tailors
offer the best return on marketing messages, which are sent via online networks, such
investment (ROMI). as Twitter and LinkedIn.
❯ Measure direct mail response ❯ Search engine optimization (SEO) keywords
rates, including breakdown Paying for popular SEO keywords relevant to a brand
of different mailing lists or can improve exposure by raising it in Internet
target demographics. search-engine listings pages. See pp.230–231.
 Traditional offline
advertising
Offline advertising uses traditional media channels, such as magazines,
TV, radio, and billboards, to market a product or service. Online
advertising now rivals it as the dominant form of advertising globally.

71%
How it works Marketers choose different
The common criteria for both channels according to the target
online and offline advertising market defined for the product
are that businesses pay for ads or service being advertised. The
that are intended to catch a choice may also be based on the
consumer’s attention with ROI that a company has previously of advertising
a brand or product message.
Businesses calculate the
experienced for that channel.
However, tracking the response
in India in 2021
success of their advertisement
by looking at the return on
rate of offline advertising is more
difficult and less accurate than
was offline—but
investment (ROI) for every ad
dollar spent. And to maximize
tracking online advertising
(see pp.214–215).
digital is catching
the ROI, they must make sure up, growing 9%
they choose the right channel
for their target audience. since 2019.

OFFLINE ADVERTISING AND RETURN ON INVESTMENT (ROI)

59.5% One of the most important sets of figures for a marketing KEY
department is return on investment (ROI) for advertising Share of
spend, which indicates the success of its campaigns. Data overall offline
compiled by Ebiquity and Gain Theory, UK, in 2018 showed ad budget
that TV boasted the best ROI. Average profit
return on
investment
within three
years per
£ spent
25.3%

£4.20 8.8%
£2.43 5.5%
£2.09
£1.15

TELEVISION PRINT OUT OF HOME RADIO

 HOW SALES AND MARKETING WORKS
Outbound marketing 212 213

Offline advertising channels NEED TO KNOW

Pros Cons ❯ Television rating point (TVR)
Indicates percentage of target
Television Offers local, national, and Expensive; ad repetition
viewers in program audience
global reach; mix of sound may cause viewer fatigue; ❯ Cost per thousand (CPT) Figure
and vision creates viewers are likely to skip used to measure outlay to reach a
high-impact message. ads on recorded shows. thousand people via any channel
❯ Advertising to sales ratio (A/S)
Method of measuring money
Radio spent on advertising and
Inexpensive; quick and Competition for prime sales generated
easy production process; “commute” slots; radio ❯ Share of voice Percentage
most stations play to on as background noise of total activity claimed by one
specific demographic. renders ad ineffective. advertiser for a product sector

70%
Newspapers
Fast publication process; Ads compete for attention
S themed newspaper with other material on
NEW sections allow for more page; usually black and
targeted advertising. white; text-only readership
has declined.
of Europe’s
Magazines
May remain in circulation
for months; niche trade
Real circulation figures
hard to source; securing
population
and special-interest titles
allow focused advertising.
ad slot requires planning
months in advance.
watches
television on
Direct mail
Cost-effective; delivered May be perceived as junk a daily basis,
straight to people’s homes
and offices; targets
mail and instantly thrown
away; response rate averaging three
specific markets; can stand
out more.
usually low; rules limit
who you can target. hours and 39
Billboards
minutes a day.
High reach makes channel Heavy competition
cost-effective; advertiser’s for prime sites; format
message is visible 24 limits message length
hours a day. and complexity.

Movies
Potential to impress with Audience numbers
sophisticated, creative limited; members may
production; it has captive choose to enter theater
audience members. after ads are shown.
 Online advertising
Marketers are increasingly advertising online to push marketing
messages to consumers. Online channels include display and mobile
technologies, email, search engines, and social media marketing.

94%
How it works Search advertising places ads in
When marketers advertise on the the Web pages showing search-
Internet, they have to choose both engine results. While display ads
the form of the ad and a location are likely to get more views overall,
that has an audience matching
their target market. There are
search ads have a better chance of
reaching the target audience. of all Facebook’s
several advertising channels, but
the two most often used are display
Other forms of digital advertising
include mobile advertising, which
ad revenue
advertising and search advertising.
Display advertising includes
embeds ads in mobile content
viewed on smartphones and tablets
comes from
banners with text and images, or sends text messages; email, mobile
which appear on websites which delivers ad copy directly to an
known to be used by target email address; and social media advertising.
consumers, such as news, social advertising, which a company uses
media, or video content sites. to promote products via its social
Online ad tracking aims to target media profile. A major advantage of
ads more precisely, delivering online advertising is that response
more relevant content based on rates can be tracked effectively.
a consumer’s Web activity.

MOST EFFECTIVE ONLINE MARKETING CHANNELS

Which digital marketing method is best for generating sales?
In a 2021 global survey by AWeber, marketers placed email
at the top, thanks to its potential for personalization and 13.5%
0.8%
greater engagement. 27.2%

10% Which digital

1.7% marketing channel
16.3% is best at driving
KEY
traffic to your
Email marketing 10.6% website?
Social media marketing
36.1% Landing pages
7.5% Advertising 10.9% 27%
Content marketing
Web push notifications
8.3% Other / not applicable
KEY
Social media Content marketing
11.2% marketing Web push
18.9% Email marketing notifications
Advertising Other / not
Landing pages applicable
 HOW SALES AND MARKETING WORKS
Outbound marketing 214 215

Online advertising channels NEED TO KNOW

Pros Cons ❯ Clickstream User activity
profile that summarizes what
Display Attention-grabbing; if ad Internet users suffer ad an individual has clicked on
advertising is clicked on, success can fatigue and ignore ❯ Behavioral targeting Process
be tracked with pay-per- advertisements whereby websites capture data
click system from landing page visitors and
use it to improve ad effectiveness
❯ Interstitials Ads that precede
the content page a user expects
to land on or appear right after it
Search Good for targeting Potentially expensive
advertising consumers, as search user if using premium
keywords are matched keywords; can take
xxxx to advertiser keywords time to see results
(see pp.230–231)

CASE STUDY
Mobile Cheaper to develop Different screen sizes and
content for mobile systems can distort ad Click fraud and botnets
devices than for layout; user may feel With pay-per-click (PPC) advertising,
computers; easy annoyed by interruption a business pays a website for every
to track ad effectiveness click made on one of its ads, but click
fraud has become a serious issue.
Fraudsters set up a website, sell PPC
advertising, and then infiltrate the
Email Offers opportunity Recipient may delete computers of unsuspecting users with
to reach millions of email without reading it a computer virus known as
potential customers and is more likely to do a “botnet” to generate fake traffic

@ (see pp.216–217) so if feeling bombarded;

consent normally needed
to the website. Advertisers on the
site end up paying the fraudsters for
the large number of clicks received.
In 2013, one London company
uncovered a botnet that was
Social media Easy to target specific Continual posts and generating nine billion fake clicks
audience; offers chance updates can easily distract per month.
of ad going viral and user’s attention away from
achieving many views placed ad
(see pp.228–229)

19%
of marketing emails are opened on
Fridays—the highest “open rate” of the week.
 Direct mail
By targeting a large number of potential customers via mail or email,
marketers hope to convert some into actual customers. This is achieved
through the timing, design, and wording of the message.

How it works governing text messages, email, and mail, with rules
Direct mail works on the basis of sending a product for postal marketing slightly less restrictive. However,
offer to a large, but targeted, group of potential you may not send personally addressed letters to
consumers in the knowledge that at least some of anyone who is on the Mail Preference Service list or
them will take advantage. The more targeted this who has asked you not to contact them. The most
group is (perhaps by job title, location, or previous up-to-date rules can be found on the website of the
purchase), the better the response rate is likely to be. Direct Marketing Association. Marketers are allowed to
Direct mail relies on lists of names and addresses, send direct mail to businesses, though they are advised
which could be the company’s existing clients, people to keep a list of any that opt out. The percentage of
who have previously made inquiries, or a list managed people who respond to direct mail, take the offer, and
by a specialized agency. It is important to comply with become customers—a category known as the
data protection laws governing the use of personal conversion rate—is extremely low but nevertheless
data. In the U.S., there are slightly different rules proves to be profitable.

Direct mail and email—A/B testing

A/B testing compares the effectiveness of two versions of a marketing email
or direct mail copy. The two versions are sent to different groups of potential
customers, and the response to each is measured.

Group A
WEEKDAY Responds with two clicks
MAILING
on the company’s
See response
from email hit website
APPROACH A on Monday

@
Acquire names Send mail WEEKEND
Set size of sample and APPROACH B MAILING
split in half See response
from email hit
on Saturday

9%
Group B
Responds with
20 clicks on the
company’s website
is the average response
rate to direct mail campaigns.
 HOW SALES AND MARKETING WORKS
Outbound marketing 216 217

HOW TO SEND DIRECT MAIL

1 2 3 4 5
A B

Acquire Prepare direct- Send letters or Determine Evaluate

names mail copy emails response rate effectiveness
Use own customer Write offer/response Send mail (staggered Calculate responses Assess performance
contacts or buy a instructions; include dispatch controls as percentage of campaign
list. Be careful that prepaid envelope. flow of response). of mail sent out. compared to others.
those listed have
given consent.

Campaign B
Send emails to remainder
of the group on Saturday

A B

Data analysis Evaluate effectiveness

Comparison of results shows Full email blast reveals that
that Saturday time slot is approach B yields the
more effective best response

NEED TO KNOW
❯ Cleaning Correcting name and ❯ Print shop Company that ❯ Merge/purge Software system
address details on traditional mailing specializes in printing and mailing that pulls together different mailing
lists and email lists to ensure they out letters and catalogs on behalf lists, searches for duplicates, and
remain current and effective of a client makes corrections
 Telemarketing
Businesses use telemarketing to initiate direct contact with existing and potential
customers. Customers can also contact the company directly. Telemarketing offers
businesses a way to retain and acquire customers.

How it works measure is revenue per call—if agent B makes 60

Telemarketing works in two directions: inbound and calls per hour but $450 worth of sales, the conversion
outbound. A customer making a call to a business (with rate per call is higher for agent B than agent A.
a question or complaint, for example) is referred to as Companies using telemarketing must comply
an inbound call. It gives the business a chance to retain with data protection and other laws. In the US,
a customer who may be dissatisfied with a product or telemarketers cannot call any individual or organization
service or to win over a new customer contacting it for listed on the Telephone Preference Service (TPS) or the
the first time. When a business makes an outbound call, Federal Trade Commission’s Do-Not-Call registry—
it is to sell additional products or services to an existing registers of everyone who has opted out of receiving
customer or to entice a new customer to make a marketing calls. Neither can they call those who have
purchase. Telemarketing sales can be monitored in objected to receiving their calls in the past. Some types
orders per hour; for example, agent A may make 140 of products, such as insurance, are not governed by
calls per hour and generate $400. A more effective telemarketing rules but by other FTC rules.

Outbound and inbound

telemarketing process
Telemarketers usually refer to a list of telephone numbers
retrieved from a database to contact new or existing customers.
Call center agents have access to product information to help Call center
them deal with questions and complaints.
Agents in the call center receive
inbound calls and make
outbound calls.

INBOUND
Customer
telephones
call center
WARM OUTBOUND
Customer inquiry Call made to promote
The customer may have a new products/offers to
question about service existing customer
or billing.

COLD OUTBOUND
Call made to establish
first-time contact with
prospective customer
 HOW SALES AND MARKETING WORKS
Outbound marketing 218 219

MAJOR CALL CENTER LOCATIONS NEED TO KNOW

The Philippines is one of the top call center locations for US firms. ❯ After-call work (ACW) Tasks
This is because of the high number of Filipinos who have a US education the agent has to complete after
and knowledge of American culture. making a call, such as processing
sales forms
❯ Average handling time (AHT)
Typical length of calls made
to customers
Ireland Poland ❯ Automatic call distributor (ACD)
China Computerized telephone system
that connects each call to the
India Philippines correct agent
❯ Average speed of answer (ASA)
Measure of the time it takes
to answer inbound calls

A B

Evaluate effectiveness
Telemarketers constantly evaluate the
effectiveness of calls.

Customer
The person who decides
whether to buy
a product.

Agent A Agent B
May adopt a May use a different
particular sales communication or
strategy or have a selling technique.
personal approach.

Outcome
AGENT A Gatekeeper At the conclusion of a marketing drive,
AGENT B
The person who answers telemarketers appraise strategies and styles
the call and decides to to help them decide on future campaigns.
pass it on.
 Inbound
marketing
Inbound marketing lures customers by offering them appealing content and
engaging with them. The approach pulls customers into a relationship with a
brand rather than “pushing” them into making a purchase, which is how
advertising works. Inbound marketing is also known as permission marketing, as
potential customers are giving a business permission to communicate with them.
In other words, they are actively interacting with the company or brand.

Inbound marketing process Top types of content marketing

Content forms the core of inbound marketing. It 1. Blogs 8. Internet memes
includes text, images, and video that consumers seek 2. How-to guides 9. Email newsletters
out online, especially on social media sites, or in person 3. Images 10. E-books
at events, such as trade fairs, and share with their 4. Infographics 11. Podcasts
network of friends, family, and colleagues. Potential 5. Videos 12. Twitter chat
customers respond to inbound marketing because the 6. Testimonials/reviews 13. Newsjacking (giving
business or brand is offering interesting and relevant 7. Case studies content to news media)
information, entertainment, or content with emotional
value. Businesses expect this interaction to culminate in
a sale or create brand recognition that leads to a sale. Exploration
Publish and actively promote content; use search engine
optimization (SEO) to attract consumers online.

Decision making
Ensure that content captivates potential customers or solves
NEED TO KNOW problems for them; encourage two-way communication.
❯ Top of funnel marketing (TOFU)
Offers content to grab the initial
attention of potential customer Purchase
❯ Middle of funnel marketing Entice interested site visitors to become customers;
(MOFU) Offers more detail and make shopping online an easy and positive experience.
encourages participation
❯ Bottom of funnel marketing
(BOFU) Attempts to win a Advocacy
sale with low pricing or offers or Provide excellent customer service; spur customers to make
via customer recommendations recommendations and share on social media.
 HOW SALES AND MARKETING WORKS
Inbound marketing 220 221

82%
of marketers surveyed
in 2021 say they actively INBOUND MARKETING
STRATEGIES
use content marketing,
up from 70% the Offline
❯ Optimize retail space
year before. Provide a well-designed physical
environment that will both draw
customers in and encourage them to
come back.
❯ Engage media Generate press
releases to gain media coverage.
Focus on topics of real interest,
especially ones that can be backed up
by stats and research.
❯ Interact face to face
Conduct events in-store that
provide a new experience/benefit
@ to customers; hire a stand at a trade
event and offer key information.

Search engines, social media networks, Online

web publishers, and third-party blogs
❯ Post blogs Update company blog
with appealing content to attract
visitors. See pp.224–225.
❯ Create podcasts Produce content
Company website, blog, podcast, relevant to customers searching for
community, and interactive tools information; engage experts to add
value. See pp.226–227.
❯ Produce other content Post
articles, photos, and videos
E-commerce process, product, on social media sites; target
price, discount, and promotion influencers to encourage
viral sharing. See pp.228–229.
❯ Apply search engine optimization
(SEO) Fill search engine listings with
key phrases that answer specific
Customer championing questions; add inbound links from
of product or service popular sites. See pp.230–231.
 Outbound vs.
inbound marketing
Outbound marketing interrupts consumers to promote a product or
brand, but inbound marketing needs consumers’ permission—they
have to seek out information that leads to the marketing message.

How it works interrupting the content the

Before the rise of the Internet consumer wishes to access. NEED TO KNOW
and the phenomenon of social However, because consumers
media, most marketing strategies from all over the world now use ❯ Push or interruption-based
were outbound. In other words, the Internet to search for information Alternative marketing terms used
and entertainment, marketers have to describe outbound marketing
marketers pushed messages at
consumers by interrupting them adopted inbound strategies instead, ❯ Pull or permission-based
Alternative marketing terms used
with advertisements or direct mail. providing content that draws the
to describe inbound marketing
The same principle applies to consumer to the brand or product
outbound marketing that appears rather than pushing marketing
on the Internet, with pop-up ads messages at them.

Pros and cons

Marketers interrupt consumers with hundreds of outbound marketing
messages every day, but they also use subtle inbound marketing tactics
to attract consumers. Each strategy has its advantages and drawbacks.

ound Pros Cons ADVERTISING

tb ❯ Campaign results can ❯ Customer conversion
Ou

be forecast and measured rates are low

❯ Marketing material is ❯ Marketing campaigns are
easier to create expensive to create
❯ Campaigns can be ❯ Effects of campaign are
tightly controlled often short-lived

COMPANY

Pros Cons
nd
ou ❯ More likely to draw ❯ Response from market
Inb

customers with long-term may take longer

interest in the brand ❯ New content must be
❯ Non-intrusive approach generated regularly to
preferred by customers keep customers interested
❯ Cost-effective compared ❯ Campaign results can
to outbound campaigns be difficult to measure BLOGGING
 HOW SALES AND MARKETING WORKS
Inbound marketing 222 223

ROI: INBOUND VS. OUTBOUND

A report compiled by HubSpot in 2018 said that more than half of marketers
find that inbound marketing gives them a higher return on investment (ROI).
74%
of marketers
3% 31% say their
5

16

?
organizations

%
primarily
conduct
16% of marketers 31% could not or
inbound
53% of marketers said
inbound marketing gives
said outbound
marketing gives
do not calculate
ROI/do not know/
marketing.
higher ROI higher ROI not applicable

TRADE SHOWS TELEMARKETING PAID SEARCH DIRECT MAIL

$
Integration of channels
By coordinating the message on all
channels, businesses can optimize
the impact of a marketing campaign.

PODCASTING SEO WEBSITE SOCIAL MEDIA

 Blogging
Businesses post information articles on web logs, or blogs, as a way
to attract consumers to their websites. They may blog on their own
website or rely on independent bloggers to achieve this goal.

How it works publish material online. This type of web content has
Unlike a conventional website, a blog is a site that since become one of the most common sources
consists purely of informational posts or entries that of information and opinion on the Internet. Although
appear in chronological order, starting with the most it was once only individuals who published blogs,
recent. Blogs first started appearing in the mid-1990s, many are now commissioned or professionally edited
when new web tools made it possible for nonexperts to and produced by the company’s marketing department.

Blogging process
Marketers may use SEO tools (see pp.230–231) to gain insight into what’s being
talked about online, which helps them determine the most suitable topics
for blogs. Many companies have the in-house talent to create blog content.
Post
Publish blog entry on Internet
Select key word by using web software or
or question specialized corporate
blogging platforms.
Determine key word, phrase,
or question that appeals
to the target audience.

Create content
Base content on key word/
KEY WORD question and ensure that it
gives readers valuable insight
into the chosen topic.
Add links
Cite industry experts and
research reports; add photos
or videos and provide links
to the original sources.

THE RISE OF BLOGGING

First blog Open Diary Boing Boing “Blog” is Weblogs Microblog

Term Google
(links.net) blog tech blog word of Inc. sold Tumblr
“weblog” is launches
appears launches launches the year for $25m launches
coined AdSense

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
 HOW SALES AND MARKETING WORKS
Inbound marketing 224 225

40%
of all websites are
NEED TO KNOW
❯ Disclosure Statement of whether
blog is sponsored or whether
reviewed products are given to

powered by blogging blogger or bought independently

❯ Splog Spam blog containing
tool WordPress fake articles designed to increase
the search-engine rankings of
specific websites

NG VITAL STAT
Syndicate/share G GI IS

TI
O
Submit blog to syndication

CS
BL

sites and share with social

media networks, such as
Facebook, Twitter, Instagram.
Top five statistics to track Three blogging mistakes
❯ Number of visitors Potential ❯ Obsession with SEO Although
customers visiting blog and their SEO is important, focus should
route in—via links or direct entry be on publishing quality content.
❯ Bounce rate Share of visitors ❯ Omitting facts Posts should
who leave site after one page offer factual information, not just
❯ Pages per visit Number of opinion or repackaged content.
pages viewed by visitor ❯ Lack of legibility Poorly
Track and measure ❯ Conversions Proportion of designed blogs with unclear
visitors who subscribe to blog typography will discourage
Monitor key blog statistics,
customers from reading content.
such as the number of unique ❯ Keywords Common words
visitors and the number who visitors use to find blog site
sign up for RSS feed and email.

AOL buys HuffPo Over 75m .blog domain Over 500m

blog and news WordPress name blogs
website blogs launched

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
BLOGGING

Podcasting/vlogging engage with podcasts or vlogs,

Businesses may post audio or video companies try to sell products NEED TO KNOW
files on the Internet to attract and either via advertising on the
engage website users; the goal podcast or its download page or ❯ Podcast A series of audio or
is to convert first-time users into by sponsoring the podcast or vlog video files that you can download
subscribers. Once consumers to create brand reinforcement. to a personal media player
❯ Vlog A blog in video format,
usually recording a person’s
Podcasting/vlogging process thoughts or experiences
❯ Rich site summary (RSS) Format
In order to get commercial results from a podcast or vidcast, a company used for frequently updating text,
needs to create and publish interesting and informative content. audio, and video content online

Capture content
Decide on topic, create an outline, and
then record audio or video material.

Process content
Edit video footage or audio track for
background noise, mistakes, repetitions;
test and edit further, if necessary.

Select correct format

Save audio in MP3 or AAC format; save
video in MP4 format; compress file size
for optimal download speed.

Publish content
Upload file to hosting service, and embed
on website. Generate feed address via
host or app, and submit to podcast platforms.

Tracking
Count number of subscribers; use web
feed services to access user location, level
of interaction, and other statistics.

1 billion people listen to

podcasts every week
 HOW SALES AND MARKETING WORKS
Inbound marketing 226 227

BUSINESS BLOGGING AND PODCASTING ETHICS

Independent online reviewers often collaborate with businesses, which is beneficial to both.
Bloggers are required by law to disclose payments or gifts they receive in exchange for creating
promotional content, but ethical boundaries can still become blurred.

Blog /podcast reviews include products

such as apparel, hotels and restaurants,
NO and technology.

YES

Business gives free sample of product

Other or service to blogger/podcaster for
content NO testing and reviewing. YES

Business provides support to reviewer through Business provides support to reviewer by

paid content and advertisements. offering further free products and services.

NO YES YES NO

Reviewer writes Possible conflict Possible conflict Reviewer tries

consumer report. of interest of interest to be neutral.

$ $

Blog/podcast helps generate revenue

for both parties.

NO YES

Reviewer site builds own reputation and Reviewer site depends on revenue
has its own agenda. that business provides.

KEY
Business potentially Blog generates revenue for
influences blogger. blogger/business.

Blogger operates
independently of business.
 Social media
marketing
By posting content on social media, marketers try to attract website
traffic and draw attention to their products and services. Sometimes,
interest in the posted content multiplies rapidly across these channels.

How it works compelling enough, it will attract followers, who will

Social media marketers are responsible for generating share it with their audiences. As the content continues
engaging content. Typically, the content provides to be shared, liked, and commented upon, it gets picked
entertainment or offers useful information that social up by Google and other search engines, helping
media users actively look for. If the content is generate more interest.

Social media marketing in practice Content is posted on YouTube as

“new anti-aging skin care.”
The makers of a new health supplement for repairing
sun-damaged skin generate video content showing
the dramatic results of the product and launch it across
two social media channels. Video footage, an image, or
a story that is spread quickly and widely via the Internet
is said to have gone viral.

360 YouTube users

share the content.

FROM SEARCHERS TO
SUBSCRIBERS
One key aim of content marketers is to One major beauty
convert people who have arrived on influencer links to
YouTube post on
a website, blog, or social media page Instagram.
into engaged consumers, who subscribe
and allow two-way communication.

Stage 1 Marketers post content, such

as a video, article, or special offer, to 120 Instagram
draw in consumers. followers share the
Stage 2 They rely on social media users to post via WhatsApp
messaging service.
share content with their friends and spread
their post to a wider audience.
Stage 3 They monitor response rates Thousands more
from consumers and audit their posts. WhatsApp users
see the post and
visit the link.
 HOW SALES AND MARKETING WORKS
Inbound marketing 228 229

Content
90%
of marketers
NEED TO KNOW
❯ Social graph Internet graph that
maps connections between user
groups, such as Facebook friends
created ❯ Social media optimization
say social media (SMO) Use of online communities
to maximize social media coverage
data helps of product or event
❯ Social media monitoring
them stand out Process of tracking the number
of mentions a brand or company
from peers. receives on social media sites

Content is tweeted
to 460 followers #
of the company. #
#
#
#
# #

#
#
#
#
#
Content is
#
# #
retweeted
to 750 other
# followers.
#
#
#
#
# #

Content is posted
on Facebook by
one Twitter user.

Each social
media mention of
the content moves the Content is
company’s website shared among
higher up the listings of 520 Facebook
search-engine results. friends.
 Search engine
optimization (SEO)
SEO is a process marketers use to acquire traffic from search results on
search-engine sites. SEO software tools are available to help the user
create Web pages that will appear at the top of search-engine listings.

32%
How it works coming up with the right keywords,
Companies that have a Web linking to other websites, and
presence must ensure that their generating content that includes
website has a high ranking on frequently searched keywords or
search-engine listings. To achieve phrases so that their website
this, they frequently use SEO remains relevant to a wide variety of people click
tools to monitor where their
website appears when keywords
of search queries.
Search engines offer pay-per-click,
on the top Google
are searched for and take steps
to keep it moving up the search
a service that places a company’s
listing at the top of a search results
search result.
results page. Some of the important page. Every click generates a fee
measures marketers take include payable to the search engine.

SEO process
These tools can be used regularly in a
continuous attempt to move a website Keyword research
higher up the listings. Use SEO tools to research the
most popular keywords.

❯ Brainstorm keywords
Optimize pages ❯ Use tools to expand list
Create pages with the right ❯ Think of how users
elements to rank high. will search

❯ Create similar content to

top-ranked pages for keywords
Structure and ❯ Write compelling title tags
technical SEO ❯ Use descriptive URLs,
image tags, and Keyword selection
Help search engines find, crawl, file names
and index your site. Use intuition and analysis with
SEO tools to narrow your list.
❯ Use logical site structure
❯ Ensure site is mobile-friendly ❯ Analyze traffic for keywords
and fast to load ❯ See how difficult it is to rank
❯ Make site secure for each keyword
with HTTPS ❯ Decide how best to
compete
 HOW SALES AND MARKETING WORKS
Inbound marketing 230 231

NEED TO KNOW SEO TIPS

❯ Robot.txt Text file that stops Avoid single Monitor search
Web crawler software, such as words because statistics using
Googlebot, from crawling certain multiple-word Google Keyword
Web pages phrases rank higher. Planner or
❯ Search algorithm Step-by-step Semrush.
calculation that looks for clues to
decide on search rankings Add blog to offer Prioritize
❯ Metadata Information that content that good content
describes stored data—data search engines and update it
about data will pick up. regularly with
❯ Black hat SEO Frowned-upon keywords.
SEO practices—such as stuffing
in too many keywords—that go
against search-engine guidelines Use reputable Give headings
sites with relevant keywords that
❯ Bounce rate The proportion of
content to link relate to content
visitors who leave a website after
back to your site. on page.
viewing only one page

Reporting and
tracking
Use tools to track traffic and
report on website ranking.

❯ Focus on quality of visits

❯ Check server reports
❯ Tally sales from
Link-building searches Keyword revision
Add links from related websites Monitor search results from
to point back to own site. current keyword selection
and make adjustments.
❯ Link to high-profile sites
❯ Contribute to social media ❯ Make sure terms aren’t broad
❯ Ask partners to link SEO spider ❯ Avoid specialized words
❯ Mimic rivals’ Web links ❯ Alter word order
Software that crawls
the Internet, adding
content to search-
engine databases
 Business
development
The overall goal of sales and marketing teams is to generate customer contact
and convert it into revenue. This is the core of business development, and it
involves a continual process of drawing in potential customers, enticing them to
purchase, and keeping them engaged. During this process, marketers and sales
people use a range of strategies and channels to attract customers and to earn
their long-term commitment to a brand and product.

Collaborative process
Marketing departments generate
brand identity, while sales teams do
the selling. Working together, they
Live events Face-to-face
aim to take potential customers on Social communication
a journey from brand awareness media
to repeat sales, communicating the
message through various channels.

Build brand Generate leads Convert leads

awareness Use a combination of into sales
Target customer groups inbound and outbound Once potential
with content and/or ad marketing strategies customers are
campaigns to inform to entice potential interested, entice
them about the brand customers to seek them to buy
and its values. This will out the brand with targeted
lay the foundation for a or product. messages, offers,
long-term relationship. See pp.236-237. and well-designed
See pp.234-235. e-commerce sites.
See pp.238-239.

Public Telemarketing
relations Email lists
Advertising
 HOW SALES AND MARKETING WORKS
Business development 232 233

63%
of companies do
BUSINESS DEVELOPMENT
STRATEGIES
Business development is reliant on growth. Sales and
marketing teams can increase long-term profitability by
building up a customer base and then trying to retain it.
not have a structured There are several ways to ensure that the customer base
remains buoyant.
approach to optimizing ❯ Chart customer journey from before to after sale.
❯ Think of ways to reduce cost of sale and increase
their business. customer satisfaction.
❯ Integrate sales processes with marketing to gain and
retain customers; think about ideal customer.
❯ Monitor and evaluate these processes regularly.

Loyalty Call center Databases

Analytics Know-how
programs
tools

Retain customers Review Develop

$
Follow up sales with effectiveness intellectual
efficient delivery, Track marketing capital
excellent customer spend on each Nurture talent

$
REVENUE
service, and channel and analyze and foster
personal contact results to gauge creativity in
to reinforce positive return on marketing order to
customer

$
investment (ROMI). optimize ongoing
relationships. See pp.242-243. marketing efforts.
See pp.240-241. See pp.244-245. $

Special
Return on
offers and Traffic Innovation
investment
updates driving
(ROI)
to website
 Branding and
rebranding
A brand is defined by the characteristics that mark a particular
product. Branding is used to communicate a product’s qualities to
a consumer and create a lasting bond between supplier and customer.

How it works The brand works for both the supplier and the
When a supplier develops a brand, it creates a defined customer, aiming to eliminate uncertainty and risk
set of values, expressed in product imagery, colors, and to convey key attributes. Social media helps promote
logo, slogan, jingles, promotional imagery, and how brands—for example, 90 percent of Instagram users
employees relate to customers and suppliers. follow a brand.

The branding cycle

There are typical stages to branding
a product. In order to rebrand Choose brand personality
(redevelop) a product, the supplier
starts over at the beginning.

Develop the
concept
Marketer focuses on
positioning (where Sincere Down to Rugged Tough, Sophisticated
brand sits among earth, honest, kind, strong, outdoorsy, Exclusive, romantic,
competition in terms of thoughtful masculine elegant
function and look) and
building a consistent
and clear personality.

Competent
Bold Reliable,
Carefree, intelligent,
spirited, authentic,
youthful successful
 HOW SALES AND MARKETING WORKS
Business development 234 235
Apply marketing mix
NEED TO KNOW
Product Price Promotion Place ❯ Brand equity Power of
a well-respected brand to generate
more sales than the competition
❯ Brandwidth Measure of the
effectiveness with which a brand
connects across a wide range
of consumers
❯ Brand architecture Overarching
plan to develop one or more
brands and create a hierarchy

Apply promotion mix

Design and Audiovisual

Brand name Tagline
Psychological needs packaging elements
Make brand alluring
$

Physical needs Buying power

Assert product’s Use brand values
usefulness to optimize sales

The consumer

nd
Bra au
Research
di

Is it time for a
t

Audit
rebrand to make passed
product more
appealing?

Rebrand

REDEVELOPMENT: RETURN TO THE BEGINNING OF THE PROCESS

 Lead generation
For a business to grow, one of its basic goals is to acquire new
customers. Lead generation is the strategy it uses to locate, target,
and nurture leads (potential customers).

How it works inclined to become actual customers—known as

The purpose of generating leads is to find consumers high-quality leads. To generate leads, marketing and
who may need or want to buy the product a business is sales departments typically collaborate on a campaign,
selling. Sales teams do not want to waste resources on offline or online, designed to identify and recruit
people who have no interest in the product in the first promising customer prospects. Acquiring contact
place, so the process of lead generation helps define information is the first part of the process. Converting
and capture the potential customers who seem most leads into sales is the next step (see pp.238–239).

Lead-generation process
Generating leads is a multi-step process that involves sales,
marketing, and customer service teams working together
to plan, design, produce, test, and refine a campaign.
Produce campaign
Create and deliver materials
for each medium involved in
the campaign.
RESEARCH
Ascertain which
Plan the approach media and customer SEO/PPC
touchpoints are Integrate search-
Set goals and parameters, including most effective. engine optimization EMAIL LISTS
expected return on investment (ROI) (SEO) efforts and
and number and quality of leads. Include a benefit
pay-per-click spend for the recipient
(see pp.230–231). and a call to action
BIG IDEA
REVIEW (see pp.216–217).
Devise a compelling
OBJECTIVES PLANNING message to engage
Check that they Ensure that sales, and entice leads.
are realistic; marketing, and
compare with customer service are TELEMARKETING
previous efforts. working together. Review key message
TRADE SHOW
and call script
AUDIT Invite potential leads to
SYSTEMATIZE with customer
Assess current visit the company’s
Integrate customer service team.
lead generation. booth and meet face
relationship management (see pp.218–219).
to face.
(CRM) software to manage
the leads.
ADVERTISING
Generate broad
Identify target customer Design campaign interest with ads
on selected media.
Define the characteristics of the Craft a multi-channel message to
customer the business is aiming to entice the lead to opt in and give
capture in as much detail as possible. contact information.
 HOW SALES AND MARKETING WORKS
Business development 236 237

TOP FIVE STRATEGIES FOR LEAD GENERATION NEED TO KNOW

❯ Create content such as a viral video before, during, and after purchase. ❯ Owned media Channel owned
or a newsworthy business report that Touchpoints may range from online by a business, such as a website,
takes leads to a sign-up page. reviews to billing. blog, or social media profile
❯ Use both online and offline ❯ Tailor the call to action to the ❯ Attention, interest, desire,
channels, as most customers channel, such as inviting trade show action (AIDA) Model for
will respond to just one channel. visitors to enter a competition. effective marketing messages
❯ Trace the customer touchpoint— ❯ Design effective opt-in web forms ❯ Cost per lead (CPL) Amount
the point at which a customer comes to capture data, such as asking it costs the company to acquire
into contact with the product— customers to sign up for updates. one potential customer

ANALYZE
QUALIFIED LEADS PERFORMANCE
Determine percentage Identify adjustments
of initial contacts with needed to keep campaign
purchase capability. on track.

Refine
RESPONSE RATES Fine-tune the filtering process to
Tally how many ensure that leads being generated are
leads have been ONLINE high quality and likely to buy.
generated so far. CONVERSION RATES
Calculate percentage of Web
visitors converted to leads.

B2B LEAD GENERATION

Measure Most businesses selling to other businesses (B2B) identify lead
Track and measure the response from generation as one of their most important digital marketing priorities.
the various campaign activities to But which tactics do they find most effective?
gauge effectiveness.
SEARCH (OPTIMIZATION &

TELEMARKETING
PPC/DISPLAY

MARKETING 10%
RETARGETING
ADS 16%

INFLUENCER
MARKETING) 43%

MARKETING 34%

13%
LIVE EVENTS

PRINT
11%
MEDIA 23%

Test campaign
CONTENT

9%

Monitor the initial hours and

SOCIAL

OTHER
EMAIL

days of the campaign and make

50%

32%

19%

any corrections that are needed.

% of B2B firms that place tactic in top three for generating
leads with the highest return on investment in 2020
 Lead conversion
The process of turning a customer’s interest into a sale is called lead
conversion. The task requires not only a sales pitch to promote the
product or service but also an approach tailored to the customer.

How it works
Sales and marketing departments
are responsible for generating sales
income for a company. The first Raw lead
step is to locate or identify potential Potential customers,
customers—lead generation. The perhaps a website
second step is to make contact visitor or a person Pitch Find precise needs
encountered at a of suspect; show product’s
with those potential customers
live event qualities and unique values
and entice or persuade them to
buy—lead conversion. to counter objections.
A sales pitch is used to convert
leads into customers. However,
nowadays, the stereotypical spiel
delivered by an overzealous
salesperson has been largely Pitch Reinforce product’s
replaced by more sophisticated value to prospect; offer
tactics, such as live chats on Prospect payment options; highlight
shopping websites, which inform One step away from becoming customer satisfaction policy.
customers and invite them to a customer, prospects need a final
participate in a dialogue rather enticement to convince them to
buy the product.
than simply pestering them.

Pitch Suggest keeping

in touch (with their
consent) with updates,
offers, product add-ons,
NEED TO KNOW or discounts.

❯ Lead scoring System used to

measure the readiness of leads

2.27%
for conversion
❯ Sales pipeline Visual tracking
of the number of leads, suspects,
and prospects at each stage in
order to monitor sales process
❯ Lead nurturing Informal contact
with a lead designed to gradually
Customer
Raw lead has committed to buy;
the average lead
win them over as a customer
❯ Cost per touch Measurement of
focus is now on retaining the
customer and enticing them
conversion rate
the cost of sales labor each time a
lead is “touched” (contacted)
to make repeat purchases.
via e-commerce
sites in 2021
 HOW SALES AND MARKETING WORKS
Business development 238 239

Online lead conversion

A strategy is required for steering website visitors through every step of the
Pitch Involve raw lead
lead-converting process. It is often presented as a funnel. Once visitors have
in website experience or
arrived at a website, they are enticed to click on a “call to action” (CTA) button,
conversation; identify need
for product; show benefits.
which takes them farther into the funnel.

Visitors to
website 3,000

Suspect
Raw leads show their interest
by remaining on website or by Leads click on
not ending conversation with call to action 600
company representative.
Leads interact
with company 150

Leads qualified
by company 50

Sales closed 10

Inactive
Prospect isn’t ready to buy
immediately but shows enough THREE CLASSIC SALES PITCHES
interest to suggest they might
buy in the future. High concept
Catchy introduction that captures the vision or key idea of a
product or business; intended to grab attention and interest

Elevator
Short summary (under a minute long) that explains the why,
what, and how of a business or product

20-minute deck
Dead lead Presentation that explains the product or business in detail and
Lead will not convert but may be how it can serve the need a prospective customer may have
worth trying to revive in future.
 Customer retention
Existing customers help businesses generate the majority of profit
and growth through making additional sales and referrals, and so
retaining these customers is a high priority for marketers.

+ Identify satisfied
customers
Customer referral
Introduce retention
improvement strategy
Monitor and measure
by analyzing

Measure the number Early warning

of referrals an individual systems
customer generates. Anticipate any
Loyalty problems and
alert customers
Pinpoint customers
in advance.
Track how many customers repeat purchase or buy more products.

who are active in

the brand’s loyalty
program. Recovery Customer satisfaction
programs Assess rate of customer complaints
Measure customer retention level

Apologize for and recommendations.

any mistakes and
make amends to
woo dissatisfied EXISTING EXITING
customers back. CUSTOMERS CUSTOMERS

Customer feed-
back surveys
Listen to
Identify the customers and
Attrition rate
dissatisfied identify people at
risk of defecting. Calculate the number of customers
Defection retained (existing), lost (exiting), or
Find out why certain gained in a given period.
customers have left Loyalty
and which competitor programs
they have gone to. Reward customers
Complaint analysis with improved
incentives for
Examine written
staying loyal.
customer complaints
and call-center records.
Boost customer $ $ $
service
Offer employees Revenue targets
incentives to build Measure revenue targets against

–
customer relations. cost of customer retention efforts.
 HOW SALES AND MARKETING WORKS
Business development 240 241

How it works Practices include identifying the most valuable

There are two stages to the process of customer customers and nurturing relationships with them.
retention: measuring the current rate of retention The least valuable or most costly customers may be
and applying strategies to manage and improve it. dropped if they show little development potential.

TOP FIVE REASONS FOR NEED TO KNOW

LOSING A CUSTOMER
❯ Customer lifetime value (CLV)
Senses Measure of the amount customer
indifference will contribute to company
from provider revenue in the long term
❯ Customer retention rate (CRR)
The number of customers retained
over a given period, expressed as
a percentage
❯ Customer acquisition
Upsell and cross-sell leads Dissatisfied
cost (CAC) The amount
with product
Identify customers who may buy company spends to gain a
or service
larger products or related items. 1-2 3-4 5-6 customer; also called cost of
customer acquisition (COCA)

Unhappy
1-2 3-4 5-6
with price

7-8 9-10

Net promoter score ®

82%
Use management tool to gauge
how likely a customer is to Lured by
recommend company to others. competition

of firms agree
that customer
Natural attrition
retention is
(death,
relocation)
cheaper than
Customer retention savings
Calculate savings made in
acquisition—but
marketing spend by retaining
existing customers.
most focus more
on the latter.
 Return on marketing
investment (ROMI)
Many organizations gauge the effectiveness of the amount they
spend on marketing campaigns by measuring the return they make
on marketing investment, which is commonly known as ROMI.

How it works on social media, which is more

A subset of ROI (return on difficult to quantify than the more NEED TO KNOW
investment), ROMI is one of the clear-cut response received from
key calculations businesses use to advertising or direct mail. ❯ 4P3C1E framework Method
determine the effectiveness of the As a result, many digital that uses several variables
to calculate effectiveness
money they spend on marketing. marketers now factor lag time or
of marketing campaign
ROMI is measured by comparing brand awareness into their ROMI
❯ Success metrics Use of standard
the revenue gained against the calculations in order to quantify less
measure (metric) to help manage
investment made in marketing and tangible benefits and target future marketing process and to assess
is used to assess online campaigns, campaigns more effectively. its performance
in particular. This calculation,
however, only reflects the direct
impact of marketing investment on
a business’s revenue and fails
to take into account other gains,
such as the word-of-mouth effect

ROMI in practice
The diagram shows how a commercial air-conditioning
company might use ROMI to measure the performance
of a marketing campaign. The company spends $2,100
on a direct-mail promotion, which it aims at offices in three
major cities to generate sales leads and secure new contracts.
The direct-mail brochure contains a contact form offering
@
a 10 percent discount to new clients who respond to the
promotion within a specified period of time.

Marketing sends 120 leads

4,000 direct mails respond to offer

GROSS – MARKETING
PROFIT INVESTMENT
= ROMI
MARKETING INVESTMENT
 HOW SALES AND MARKETING WORKS
Business development 242 243

$36 LONG-TERM BENEFITS OF MARKETING INVESTMENT

Some aspects of marketing investment are difficult to measure immediately. The benefits
is generated of providing excellent customer service, for example, or investing in research to help
marketers retain customers may not be evident right away but will reap long-term profits.
for every
$1 spent MARKETING INVESTMENTS

on email
marketing
$ Run marketing campaigns
Cost of market investment

IMPROVED CUSTOMER VALUE AND SATISFACTION

Increased customer attraction Increased customer retention

INCREASED CUSTOMER LIFETIME

VALUES AND CUSTOMER LOYALTY

RETURN ON MARKETING INVESTMENT

Results
Total new customers = 3
Average customer spend = $6,500 (after 10% discount
deducted from average $7,222 total spend)
Revenue from marketing = $19,500 (3 x $6,500)
14 qualified leads 3 of these Campaign spend = $2,100 + $2,167 (3 x $722) cost to
(who are become company of promotional discount = $4,267 total
a good fit for the customers ROMI = $4.57 per customer / per $ spent on campaign
product) become
sales opportunities

$19,500
= $4.57
$4,267
 Intellectual capital
The knowledge within a company that is
used to improve business performance P TALENT
TO
is known as its intellectual capital.
No. 1
How it works
Every business has capital, NT
AN I ELLECT
which refers to the physical, UM

H
tangible assets that appear Difficulty
on the balance sheet of its
financial statements.
A business also has Human capital
intellectual capital—the The combined talents of the staff and
knowledge and skills inside the executives employed by the business.
company. This collective know- It includes skills and abilities, drive,
VO L U

CE
how is hard to quantify and creativity, and innovativeness, all of

EN
measure, but it is essential to M which can be quite hard to measure.

RI
OF E
E
a company’s ability to generate PRA XP
CTICAL E
revenue. For instance, management
must provide training and a
handover period for new staff so
that human capital does not go
down when people leave the Difficulty
company, taking their expertise
with them. Management academics NAL LINK
have identified three main kinds EX
TER S Customer capital
of intellectual capital: human, Goodwill developed between a company
structural, and customer. and its customers, reflected in customer
loyalty to the business and its products.
This relational capital can be extended to
suppliers but is very hard to quantify.
NEED TO KNOW
RELATIONS
KET HI
❯ Strategic capital A company’s R
PS
MA

knowledge of its market and the

business model needed for success
❯ Intellectual property (IP)
Creations or inventions that are
legally recognized as belonging
to a particular entity or individual
on a balance sheet
T
HO

AS

❯ Intangible capital
W

SL

All knowledge assets belonging ON P

HI
L

GR
to a business or organization; ELATIONS
can be audited under various
systems (see far right)
 HOW SALES AND MARKETING WORKS
Business development 244 245
NAL LINK
TER S
MEASURING
IN

ATI
ONAL RO
UT
INTELLECTUAL CAPITAL
IZ
N

IN
A

Measuring intellectual capital precisely

ORG

ES
8am
is impossible because it is intangible,
9am
but its value to businesses means it is
10am
helpful to try to quantify it. There is no
consistent way of doing this, but there are
a few common approaches.

Difficulty
Market Value to Book Value Ratio
This looks at the difference between
the financial value of the company, its
Structural book value—the difference between
capital assets and liabilities—and the market
value, which is the value of its shares.
The support structures developed The difference includes intellectual capital
and held by the company, including and growth prospects.
its own software, databases and IN N
OVATION
other information systems, patents, The Skandia Navigator
copyrights, and trademarks.
Structural capital is nonphysical, This was developed by Leif Edvinsson,
so it can be hard to assess. director of Swedish company Skandia,
who created a model for quantifying
intangible assets under five groupings—
finance, customer, process, renewal and
development, and human. This enables
companies to understand how the
difference between the market value and
the book value of the business is
calculated.

The Balanced Scorecard

“The only irreplaceable Developed by U.S. academics Robert

Kaplan and David Norton, the Balanced
capital an organization Scorecard system (see p.147) uses four
categories—learning and growth, business

possesses is processes, customers, and finance—to

measure intellectual capital alongside

the knowledge financial data. For example, analyzing

learning and growth provides insight into

and ability of a company’s human capital, while looking

at business processes might reveal, say,
whether intellectual capital invested in
its people.” manufacturing improvements is having
an effect.
Andrew Carnegie, industrialist
 Information
management
Monitoring the marketplace and making sense of the vast quantities of data
available have become priorities for businesses; the data are crucial for digital
marketing, which is taking on increasingly sophisticated forms. Most businesses
have a system in place for managing information—and the most successful ones
use data not only to monitor day-to-day performance at every level but to predict
future outcomes and plan accordingly.

External Internal
Outside the business, data flows in Within the business
from production, supply chain, sales itself, data feed into the
outlets, partners, and customers. marketing and IT teams
from operations, Executives
finance, and human
resources.
oduction
Pr

Forecast Analysis
n
pply chai

Marketing and IT
DATA
Su

DATA

DATA DATA
t
les outle

The marketing and IT departments are at

DATA the center of information management. DATA
They are responsible for collecting and
analyzing data and then reporting their DATA
Sa

findings to executives. See pp.252–253.

 HOW SALES AND MARKETING WORKS
Information management 246 247

50%
of organizations TRANSFORMING DATA
employed a chief INTO DECISIONS
digital officer in With relevant data easily accessible (see pp.262–263),
a business can identify its strengths and weaknesses in
2019—up from order to improve its processes and operations as well
as its customer relationships (see pp.264–265).
7% in 2014.
LEGAL COMPLIANCE

Leg
al

Operations
system

Source raw data Gather Store information

customer data. Store data via data
See pp.254–255 and warehousing.
pp.258–261. See pp.256–257.
The legal system
ensures the use of
data adheres to
privacy and other
Finance laws. See pp.266–267.

$ Gain insight Access knowledge

Examine data using Retrieve data with
Pa
r business analytics. business intelligence tool.
See pp.250–251. See pp.248–249.
tn
ers

Human Resources

Cu
s
to

Make decisions
mers

Plan and budget

for future outcome.
 Business intelligence
Business intelligence (BI) is an umbrella term referring to the variety
of software applications companies use to access and analyze the
massive amounts of raw data they have at their fingertips.
How it works the company database.
BI relies on software programs and The marketer then views the NEED TO KNOW
computerized systems for collecting information on a computer screen
and integrating data so that a by using a data visualization tool ❯ Star schema Simplest format
of online analytical processing
business can report on its activities, known as a dashboard, which can
(OLAP) in data warehouse
both past and present. The tools also be used for real-time monitoring
❯ Data quality (DQ) Condition
allow staff to pull relevant data from of business operations.
of company’s master data, which
should be complete and accurate
❯ Slice and dice Process in which
Business intelligence process large amounts of data are broken
BI tools allow retrieval of specific relevant data by specifying the terms of the down to help analysis
intelligence they need (such as real-time sales compared to previous year’s sales).

Collect source data Extract, transform, load: Store data

Company gathers raw data via ETL process Business uses data warehousing
several operation systems. ETL system pulls raw data from the to integrate and bank data in a
source, formats it, and loads readily accessible form.
it for use.
SUPPLY CHAIN
MANAGEMENT
(SCM)
Data from SCM ETL SYSTEM
sources Migrates raw
data to data DATA WAREHOUSE
warehouse Flexible access to data
ENTERPRISE WEB LOGS
RESOURCE Data relating
PLANNING (ERP) to activity on
Manages corporate or
e-commerce sites Data from across
company data
Translates data codes organization

TRANSACTIONAL Data from outside

DATABASE Transposes data organization
Data of current columns and rows
commercial
transactions Current data
Splits and separates
information

CUSTOMER EXTERNAL
RELATIONSHIP DATABASE Historical data
Information Creates data archives
MANAGEMENT
(CRM) gathered from
Data from CRM sources outside
sources the company
 HOW SALES AND MARKETING WORKS
Information management 248 249

21%
of employees
Digital dashboard
Displays regularly updated business results using customized graphics.

TRACKING EMAIL CAMPAIGN

worldwide are This dashboard tracks the percentage of people who open an email,
click on a website, and make a purchase on different days of the week.
YES
NO

fully confident DAYS

Mon
50%

OPENS
about their data Tue
Wed

literacy skills. Thu

Fri
Sat
Sun
Mon CLICKS
Tue
Wed
Thu
Fri
Sat
Sun
Retrieve and analyze Mon PURCHASES
Staff can fetch data to answer Tue
specific questions about what is Wed
Thu
happening in the company. Fri
Sat
Sun
SPREADSHEETS
Form primary BI
tool to display data
(basic or advanced)

OLAP CUBES
Enable 3-D analysis
of three variables

58%
on spreadsheet
Actual sales: $4,700,000
Expected sales: $8,125,000

DATA MINING TRACKING SALES 40% 60%

Allows the sifting of This dashboard shows
data to find patterns the sales a company
and relationships 20% 80%
actually makes as a
percentage of
REPORTING TOOLS expected sales.
Help users
develop and 0% 100%
produce reports
 Business analytics
More cutting-edge than business intelligence (BI), business
analytics (BA) allows advanced statistical analysis of data,
which is used to help make future business decisions.

How it works that analyze current and past data,

BA takes a scientific approach BA allows businesses to forecast Predictive modeling
to interpreting information. with a high degree of confidence.
Businesses use BA’s advanced BA can be applied on a macro
Software program that predicts
patterns of behavior and the
software tools to analyze level to get a broad view of future
likelihood of specific sets of
information about past or current business performance and on a customers, or even individuals,
trends and behavior to predict a micro level to assess, for example, making a purchase.
future scenario. Unlike business the likelihood of individuals in niche
intelligence or predictive analytics markets making purchases.

Business analytics process

A skilled analyst interprets the raw data by using
BA tools. The results influence the business
actions that will be taken in the future.

BUSINESS INTELLIGENCE
AND BUSINESS ANALYTICS

81%
The example of a 5 percent sales dip shows how BI and
BA can be used to examine and understand the situation.
Business intelligence
❯ Type of data investigation Results reveal past and
current events in the business.
❯ Questions answered What has happened in the
of managers
business in the past, and what is happening currently?
❯ Tools used Reporting, dashboards, scorecards,
globally have
online analytical processing (OLAP) access to
Business analytics
❯ Type of data investigation Examines past event in the analytics,
business and applies the patterns discovered to
a future scenario. but only half
❯ Questions answered Why did it happen? Will it happen
again? What can we do to stop it from happening again?
of front-line
❯ Tools used Statistical analysis, data mining, pattern
matching, predictive modeling
employees do.
 HOW SALES AND MARKETING WORKS
Information management 250 251

Data visualization DATA USEFULNESS

Formulation of graphs depicting Some data are more useful than
the results of data analysis; graphs other data; value is determined by
may rank data, group common the extent to which marketers can
attributes, and compare use the info to make confident
relationships. forecasts. Methods of interpreting
data are increasingly sophisticated.

Pattern matching
Predictive analytics
Process of trawling through large Program that conducts
quantities of data to find patterns advanced analysis of data
between variables, which can be to forecast future outcome
applied to other sets of data.

Monitoring
Data mining Process that uses software
to show what is currently
Use of computerized processes happening in a business,
and software programs to find providing real-time results
relevant patterns in large sets to help key operations
of data. make decisions

Statistical analysis
Software that organizes and
investigates every piece of
relevant data and interprets
Ou it to show trends and patterns

t
In

Raw data Analysis Reporting

This includes company records Software tools are used to process Method that draws on
(past and current customer data and study raw data. Analysts historical data to provide
a general overview, revealing,
and transaction histories) and interpret results and make
for example, how the business
external data (economic, trade, forecasts that help future business
performed in a given year
and industry reports). decisions.
 Marketing and IT
The use of digital marketing strategies means that marketers are
working more closely with IT specialists to develop the best ways
of launching and managing online publicity campaigns.

Convergence of marketing and IT

Communicating with customers online is a vital part of
many businesses. As a result, marketing relies so much on
IT that in some companies, marketing teams spend more
money on technology than their IT departments do.
Areas of overlap
Digital marketing ➤
➤

Developing a technology program

for publicity campaigns
Real-time transactions ➤
Installing a system for recording and tracking
online sales as they happen
Big data ➤
➤

Locating key statistics from vast amounts of online

Marketer information to improve marketing
Must grasp
Data analytics
➤
technology required
to execute and track Using advanced tools to gather and analyze data
online campaigns. for developing future marketing strategy
Mobile technology ➤
➤

Understanding and keeping up to date with advances

in mobile applications and e-commerce potential
Data storage ➤
Building infrastructure and software for storing and
retrieving sales, campaign, and customer history
Social media ➤
➤

Developing the best methods for increasing

online traffic via social media channels
Tracking ➤
Following a customer through
the online engagement and
sales process
 HOW SALES AND MARKETING WORKS
Information management 252 253

How it works technology. The responsibilities of marketing

Marketers need to know how to use technology to and IT departments often overlap, with the
increase revenue. At the same time, chief information hybrid professional role of marketing technologist
officers (CIOs) have adapted to changes in external (see below) sitting between the two fields.

8,000 marketing
NEED TO KNOW
❯ MarTech Annual business
conference that focuses on
overlap of marketing strategy
and technology
technology ❯ Actionable metrics
Measurements of campaign
tools are results that enable businesses
to make informed decisions
available to ❯ Vanity metrics Measurements
of campaign results that appear
businesses positive but are not meaningful
❯ Growth hacking Low-cost
online marketing techniques,
such as using social media to
improve sales
IT person
Must find or develop
software tools to
implement and
manage online THE MARKETING TECHNOLOGIST
campaigns.
Online marketers rely on software to monitor and analyze campaigns, generate
content, and extract data. The job of the marketing technologist, who has
knowledge of both marketing and IT, requires a broad knowledge base.

WEBSITE
ARCHITECTURE
SOFTWARE MARKETING
PROGRAMMING SOFTWARE

SOCIAL AND
DATA AND
MOBILE
ANALYTICS
PLATFORMS

IT CONTENT
OPERATIONS MARKETING
AND SEO
 Collecting
consumer data
Capturing key data is a priority for any business seeking
to understand the marketplace. However, it requires
using innovative strategies to overcome consumer
Surveys
concerns about privacy issues. Gather customer
feedback via
email, text,
How it works mail, or
There are a number of methods face-to-face
companies use to collect customer Collecting data to questionnaires.
data. When there is contact between a create consumer profile
customer and the company, marketers
can use the opportunity to gather as
Digital marketing and e-commerce have accelerated
the rate at which customer information is gathered.
much information as possible. This
Some methods require the customer’s input, such as
might happen at the point of sale in a questionnaires that appear online. Others, such as
store or online, where marketers are website tracking, are possible without the need
able to observe customer behavior. to contact the customer.
Marketers may also choose to solicit
information directly by asking their
customers to fill in registration forms Observations
and conducting telemarketing calls Study customer’s behavior
or customer surveys. while they shop in a store
or online.

WARNING
Customer
Data collection errors research
❯ Barraging Using a customer’s data Conduct research on existing
to bombard them with information customers or on those who
on products viewed or sites visited fit the customer profile.
❯ Overlooking technical flaws
Failing to integrate apps properly,
leading to inconsistency (and errors)
in collecting customer data Contact center
❯ Using only automated systems Monitor customer
Neglecting the opportunity to calls and store data
strengthen relationships with on preferences and
customers by communicating purchase history.
with them personally
 HOW SALES AND MARKETING WORKS
Information management 254 255

Social media
View customer’s
profile information
10%
of global
TECHNOLOGY AT
THE CHECKOUT
In this technological age, businesses have
the means to learn about their customers without
bombarding them with questions. Retailers, for
on social media.
Internet users example, typically use three methods in stores
to capture information about the customer.
run ad-blocking
software, which Loyalty program
A company may collect
can stop online loyalty card
information by inviting
customers to register for
data tracking. a loyalty program that
offers an incentive. A
loya
lty c loyalty program also
ard
helps track customer
preferences.
Website trackers
Track website visitor’s
movement around a site and
Point-of-sale
see what attracts interest.
software
Computer software
programs that track a
customer’s purchases
are available, allowing
marketers to tailor offers
Competitions to their spending habits.
Use competitions to collect
information, from opinions
to demographic data.
Mobile technology
The use of smartphones
enables marketers
to compile data, such as
the frequency of
Transactions customer visits and
Ask questions at the amount of time they
checkout—in the store, spend in the store.
online, or on the phone.
 Data warehousing
The process of data warehousing involves information from a
company’s internal system, such as invoices and sales logs, as well as
data from outside sources being filed away in a secure digital vault.

How it works
The data warehouse is a repository
that holds the company’s sales and
be accessed by all areas of a
company—from accounts to
operations to sales. The data are
$51
billion
operational history as well as often used to assess beliefs about
relevant economic and trade the business. For example, the
information from other sources. marketing manager of a power tools
The information goes through three company might presume that 25- to
stages as it enters the warehouse— 35-year-old men are more likely to
first it is extracted from source, then
it is loaded, and finally, it is
purchase its products than women
in the same age bracket. They
predicted size of
transformed into usable formats.
Together, this is known as the ELT
would test this belief by analyzing
sales data and customer records
the data warehouse
process. Once stored, the data may accessed from the data warehouse. market in 2028
Warehousing process
The data stored are regularly updated. When the business requires information from the warehouse,
the information is transformed into an accessible format and analyzed using software tools. Data
can be stored on in-house servers or on external servers in the cloud provided by a third party.

Tapping data sources

OLTP
The information a company collects Includes such
includes online transaction processing transactions as
(OLTP) data, historical data, and data sales and refunds
from external sources. recorded via OLTP
Staging data
The ELT process
HISTORICAL converts raw data
DATA into a usable format.
Repository
of past sales
information

EXTERNAL USABLE
DATA FORMAT
Includes
government
statistics on EXTRACT,
business LOAD,
TRANSFORM USABLE
(ELT) FORMAT
 HOW SALES AND MARKETING WORKS
Information management 256 257

WHO USES THE DATA WAREHOUSE?

$
The key departments of a company
can access the data warehouse to find
out how they are performing. The FINANCE
method by which the data are “What was profit
margin on product MARKETING
formatted and stored makes it possible sold in a region?” “How did online ad compare
for them to seek answers to questions to poster ad campaign?”
relevant to them. Typical questions
various departments might ask include: SALES
“What are average sales
of product by region?”

HUMAN RESOURCES
“How much have we spent
on contract staff this year?”

Storing data
The data are stored in three
categories: metadata, summary
data, and raw data.

Accessing data
Using software tools, the data
METADATA can be analyzed and retrieved in
Information three ways: via online analytical
relating to the processing (OLAP), reporting
data itself
tools, and data mining.

SUMMARY OLAP
DATA Accesses data to
Business activity answer specific
information questions

REPORTING DATA MINING

RAW DATA TOOLS Finds detailed
The original Presents data as patterns in data
form of the tables or graphs for analysis
information
 Customer profiling
Marketers can create detailed portraits of customers by using internal
company data on their purchase habits, preferences, and lifestyles
and cite external data sources to learn about attitudes and social trends.

How it works the marketplace. The information

In order to best understand their they look at includes basic data
audience, marketing departments about a person, such as gender, age,
define their ideal customer by occupation, and salary, as well as
developing a customer profile. more detailed ideas concerning
They build this profile by gathering the person’s typical spending habits,
information about the kind of such as the places where they Psychographic view
person who usually buys the type of like to shop and the amount they ❯ Personality Outspoken; likes
product they wish to introduce to tend to spend. to stand out from the crowd
❯ Attitude Positive outlook and
enjoys the good things in life
Segmentation model ❯ Ethic Works hard and believes
By constructing a segmentation model, layered with a number of variables (different in contributing to social causes
levels of information) about consumers, marketers can gradually create a clear
picture of their ideal target customer—in this case, for a travel company.

Woman, age 35 to 54, with household Demographic

income of $85,000+ variables

Lives in New York City metropolitan area

Geographic
variables

Sociographic
Shares with 125 friends on social media
variables

Wants to get in shape while Psychographic

on vacation variables

Takes two or Behavioral

more getaway variables
trips per year
with family
 HOW SALES AND MARKETING WORKS
Information management 258 259

Behavioral view
❯ Shopping location Prefers
to shop in smaller stores
❯ Purchasing habits Buys in Sociographic view
83%
of consumers
bulk to save money, responds
to discounts
❯ Social media Actively shares
interests with connections
are happy to
❯ Degree of loyalty Faithful
to a brand but open to
❯ Community Influential share their
member who socializes and
better offers contributes to neighborhood data to get a
❯ Groups and clubs Member of
bird-watching and hiking groups personalized
experience.

Geographic view
❯ Continent North America
❯ City Booming metropolis with
work and social opportunities

Customer ❯ Climate Varies from below

freezing in winter to hot and
profile humid in summer

dimensions
What does the ideal customer look
like? Where do they live? What do
they spend their money on?

Demographic view
❯ Age group 35–54 (helps
gauge family priorities and
income)
❯ Status Married (children
affect spending choices)
❯ Occupation and salary
Teacher, $65,000
CUSTOMER PROFILING

Creating a customer profile

By constructing a profile of an existing customer by using data from within the
company, marketers have a clearer view of the buying patterns and habits
of an individual. They can then make projections about the long-term
value of that individual as a customer.

WEBSITE DATA
WWW How often do they visit the site?
Which web pages do they look at?

SOCIAL DATA
Which social media networks are they
connected to? Do they share links?

TRANSACTION DATA
How much have they spent, how
often, and on which products?

CRM DATA
What’s their contact history with call
centers? How have they responded
to campaigns?

Customer
LOYALTY DATA
How loyal are they to the company? Do
they use the company loyalty program?
profile

MAIL DATA

@
What email contact has there been?
What has the response rate to emailed
content been?

$ POINT OF SALE
What observations have sales staff made
from interacting with customer?
 HOW SALES AND MARKETING WORKS
Information management 260 261

“Once you understand SEGMENTATION

SYSTEMS
customer behavior,
everything else falls Once marketers have gathered data
and identified their ideal customer

into place.” profile, they can compare their

customer to a number of commonly
Thomas G. Stemberg, founder of office supplies retailer Staples used systems of segmenting, or
characterizing, consumers. In the
U.S., there are many systems, but
one of the most well-known is the
Nielsen company, which uses more
than 60 segments that have names
like “Boomtown singles”
and “Up-and-comers.”
Assessing customer profile In the U.K., customers may be
Good customer Bad customer compared to the simple system
of socioeconomic class:
❯ Returns frequently to ❯ Bombards call center
make repeat purchases with complaints A Managerial and
professional
❯ Responds to marketing ❯ Frequently returns products
and in-store promotions for full refund B Middle management
❯ Shares favorite products on ❯ Never joins loyalty programs C1 Clerical and junior
social media networks or signs up for newsletters management
❯ Signs up for newsletters ❯ Spends less money than C2 Skilled manual workers
and special offers the cost of courting them D Working class
E Nonworking and
low-paid workers

NEED TO KNOW
❯ Omnichannel customer
Three ways to use a customer profile Consumer who shops using

1 Tailor content to suit customer By sending out multiple channels, including

personalized messages and experiences, businesses store visits, mobile apps,
engage customers and build a long-term relationship. and websites

2
Sell more to existing customer Mining customer ❯ Loyads Customers who are loyal
profiles to see their spending habits, likes, and interests to a provider and champion them,
enables marketers to make personalized offers. bringing in other customers
in the process

3
Reward loyal customers Identifying good customers
and offering gifts and incentives tailored to their tastes ❯ 360-view Profile that gives
increase customer lifetime value. marketer a complete picture of
a customer, making it possible to
predict their needs and behavior
 Big data
Business is trying to harness the huge amount of consumer data now
available online. This information can be analyzed and used to create
detailed profiles to target customers more precisely.

How it works The challenge for most organizations is to sift through

Big data is the huge amount of digital information big data to find information that has the potential to
transmitted via the Internet every day. It is streamed add value to their business. Software tools are available
at high speed and in many different formats, from that can analyze the masses of external data generated
database statistics to video, audio, and email documents. on the Internet.

Internally and externally mined big data

Businesses are able to access data from such sources as mobile Big data
store
communications, social media networks, and commercial
transactions, which show the activity of billions of people.

d a ta source
n al
r
te An ever-expanding amount of data is being
Big data
The volume of data is potentially so
Ex

generated by outside organizations, which vast that it cannot easily be moved

will prove increasingly valuable to businesses. and may overwhelm organizations.

Social media
Data reveal what people are saying about the
organization and its products.

Audio
Data include news broadcasts, interviews, call center
recordings, and podcasts.

Photos and video

Data comprise blogs, images, video recordings
from entertainment media, and surveillance. Big data vendor
Provides services, systems, and
Public data tools enabling companies to
Information shared outside store, access, and analyze data.
the company, such as press Vendor offers applications to
releases, job descriptions, suit individual business needs.
and marketing materials.
 HOW SALES AND MARKETING WORKS
Information management 262 263

50–80%
of data scientists’ time
NEED TO KNOW
❯ Apache Hadoop Open-source software
library for storing and processing big data
❯ Terabyte One trillion bytes

is spent preparing data ❯ Petabyte Unit of digital data equivalent

to 1,024 terabytes (one petabyte equates to
341 million three-minute songs on MP3)
before it can be used. ❯ Exabyte Unit of digital data equivalent to
1,024 petabytes (five exabytes equates
to all words ever spoken by human beings)

Internal
data source
Internal data sent to the big data vault, where it
INFORMATION OVERLOAD
is traced and recorded, are drawn from all parts
The volume of data typically generated
of the organization and form a unified database.
online every second:
❯ Emails 3,048,134 sent
Transactions ❯ Tweets 9,570 sent
❯ Spend per customer ❯ Instagram 1,088 images uploaded
❯ Foot traffic in stores ❯ Skype 5,853 calls
❯ Time spent per visit ❯ Internet 123,432 GB of traffic
❯ Google 93,823 searches
❯ YouTube 90,694 videos watched

Log data
❯ Customer reviews
❯ Customer service DATA MANAGEMENT
❯ Audio files of customer
service calls, for example Organizations can choose either offline or
online options to store big data and various
software programs for access and analysis.
❯ Big storage hardware Servers; storage and
network equipment capable of supporting
Emails

@
many terabytes of data
❯ Internal communications
❯ Software Includes programs for research
❯ Customer contacts and analysis, storage and access, and graphic
❯ Email campaigns visualization of data
❯ Cloud services Third-party providers
that offer storage networks for big data
management and access
 Customer relationship
management (CRM)
CRM (customer relationship management) is a computerized system
used to manage and coordinate marketing, sales, and customer-support
data to maintain good customer relations and improve profitability.

How it works of ways: the sales team may use it to find new business
CRM is a software tool in the company’s IT system leads and improve relationships with existing customers,
that records all interactions the business has with the marketing team may use it to reward loyalty, and
customers. The information can be used in a number customer service may use it to deal with problems.

NEED TO KNOW CRM system Customer

❯ Technology-enabled The system uses reliable Customer data flow into the CRM
relationship management processes that allow system through their transactions.
(TERM) Use of automated companies to connect
processes to manage customer more efficiently with
relationships customers and ultimately
❯ Enterprise resource planning offer better service,
(ERP) Precursor to CRM resulting in long-term
❯ Cloud-based CRM gains for the company.
Computerized CRM system that
exists in a technology cloud

AUTOMATION
CRM can use automation as a tool to respond to customers who visit and use a website.

Customer segmentation Email campaign management

The market can be segmented into groups Different emails are sent automatically to the relevant groups.
relevant to the product the company sells.

@ @
age

Age Location
sp n
inte ecial sio
res ofes
ts pr @ @
@
e ge Gender Family size
siz nd
mily er
location

fa
@ @
Profession Special interests
 HOW SALES AND MARKETING WORKS
Information management 264 265

871%
Marketing
Target groups for special
campaigns; monitor and
Sales
reward loyalty; generate leads
Convert new leads; find
the average return new prospects; cross-sell
and upsell opportunities;
on investment customize pitches

delivered by CRM
Customer contact form
CRM uses the information to group
customers according to their buying
behavior.
Price quote
The company sends a price quote
in response to the customer’s
interest in their product.
Customer feedback
The company asks questions and
monitors social media to glean
information about customers’ views.
E-commerce transaction
The customer pays for the product
via the Internet.
Support ticket
An automated ticket allows
the customer to track delivery
of the product.

Finance
Operations
Generate invoices in a timely
Improve efficiency of
Customer service manner; manage payment
manufacturing, product
process
delivery, ordering, Respond to service issues
and tracking immediately; manage
customer cases; gather
feedback
 Compliance
In most countries, companies have to adhere to laws and industry
regulations that govern how they can sell and market their products.
The rules are there to make sure that businesses operate fairly.

How it works terms and conditions, and spam marketing (sending

Governments impose rules on marketers to prevent unsolicited emails). The regulatory body is able to
any unscrupulous, misleading, or unwelcome practices, investigate any company accused of breaking the rules
such as false advertising, the failure to disclose all and impose penalties if it finds the company guilty.

Marketing regulations
To protect the consumer, regulatory bodies produce guidelines
instructing companies on how they should market their products.

Business areas subject to regulation Example of marketing practice

“Our model is much better than

Comparative claims
our competitors’ models!”

Endorsements “I owe my success to their product!”

Special offers “Buy one, get one free!”

“Enter the prize drawing for the chance to win

Sweepstakes and contests
the vacation of a lifetime!”

“Good evening. Would you like to save money

Telemarketing
on your energy bills?”

Marketing to children “Step right up and enter the House of Toys…”

Customer data “Please fill in the registration form.”

@ Email marketing “Today only—24-hour online sale!”

Use of spam “Congratulations! You have been selected…”

Negative-option billing “Please uncheck the box if you do not wish to…”
 HOW SALES AND MARKETING WORKS
Information management 266 267

NEED TO KNOW

50%
of all email in
❯ CAN-SPAM Act International legal ruling
that establishes commercial email
requirements and penalties for violation
❯ Phishing Fraudulent sending of emails while
pretending to be a genuine entity—to gain
the recipient’s bank details, for example
2020 was spam.

Typical regulations to protect consumers

A marketer making a claim that it’s product is superior to a rival’s must

be able to substantiate it with proof.

A marketer must be able to prove that an endorsement by

a person that they have used to promote a product is genuine.

A marketer promoting a product with a special offer must set out the terms
and conditions in writing.

All competitions and prize drawings must adhere to legal

guidelines to ensure that they are fair and impartial.

Telemarketers in the US must provide key facts before an order is placed, including business
name and contact, cost and quantity, restrictions and conditions, and refund policy.

Marketers must stick to specific guidelines governing how

they advertise and promote products to children.

Customer information must be stored, managed, and

used in accordance with privacy laws.

Marketers in the US must not send emails to individuals unless they have given specific
consent or they are existing customers. Every message must include an opt-out option.

Marketers must never send bulk unsolicited emails, the most

common form of spam, or other types of unrequested messages.

Any item offered alongside the main product purchased must be presented
as an option to buy, not an item the consumer must take action to refuse.
HOW
OPERATIONS
AND
PRODUCTION
WORK
Manufacturing and production ❯ Management
Product ❯ Control ❯ Supply chain
 Manufacturing
and production
Once a firm has decided what goods or services to supply, its directors have to
choose the method of production that best suits consumer demand, the product,
and the market as well as one that will be the most profitable. Companies work
in three general areas of industry, which together form a production chain to
provide consumers with finished goods or services.

Production methods
Before the Industrial Revolution, products were made Primary production
by craftsmen. Then, factories brought people together to The acquisition and processing of raw materials—in this
work on machines. Typically, this was job production, with case, navy beans as well as tomatoes for the sauce
one person making one item. Economist Adam Smith first
introduced the concept of division of labor, which led to
mass production, with carmaker Henry Ford popularizing
the moving assembly line at the start of the 20th century.
Today, manufacturers can combine the best of all methods,
with large-scale production of personalized products.
Production typically involves three stages—here, from
navy bean to canned beans sold in supermarkets. PRODUCTION IN PRACTICE
Native to South America, navy beans are grown either for the
immature green pods, eaten fresh as green beans, or for the
beans themselves. These are dried and used most commonly
in baked beans, a dish that originally came from Boston.

CHOOSING THE BEST METHOD

❯ Job production Items are made individually. ❯ Mass customization Mass product is customized by
See pp.272–273. buyer. See pp.278–279.
❯ Batch production A number of items are all made ❯ Continuous production 24/7 line of production runs for
together at the same time. See pp.274–275. products with consistent demand. See pp.280–281.
❯ Flow production This is suitable for mass-producing ❯ Hybrid processes This mixes batch and flow production
identical items on an assembly line. See pp.276–277. or combines other processes. See pp.282–283.
 HOW OPERATIONS AND PRODUCTION WORK
Manufacturing and production 270 271

$3.85 KEY PRODUCTION FACTORS

To create products, businesses need
resources, including:

trillion
❯ Capital Money invested in business, including
money spent on production tools, such as
equipment, machinery, and buildings
❯ Land Natural resources used to create goods

the value of China’s annual and services—for example, physical land or

extractable resources, such as minerals, lumber,
oil, or gas
manufacturing output in ❯ Labor People who are employed in a business

2020, the highest in the world and have the necessary skills to produce the
goods and services
❯ Enterprise Entrepreneurs and/or leaders
who bring the factors of production together
to make the whole process happen

Secondary production Tertiary production

The manufacture and assembly of raw Services that support the production and distribution
materials to turn them into a product of the baked beans, such as transportation, advertising,
or service; in this instance, baked beans warehousing, and insurance

The raw beans are mixed with tomato The labeled cans are transported to warehouses and from
sauce, sugar, salt, and secret spices. The there to supermarkets and other outlets to be sold. Several
ingredients are cooked in vast pressure brands vie for market supremacy of this popular convenience
cookers, ensuring consistent texture and food, using advertising, price, and taste differentiation.
a long shelf life, and then sealed in cans.
 Job production
In job production, items are made individually. Each item is one job,
which is usually finished before another is started. This method is
often used for small-scale production or for large one-time projects.

How it works is required. Job production can

Job production is best suited to a also be used for complex projects SERVICES
business that has to meet specific and those involving leading-edge
Job production can also apply to
customer requirements. Typically, technology, including film
services, such as hairdressing or
these are unique requests, which production; major construction, processing an order for pickup.
an individual or a team handles such as ships for the navy; Airline flights come under the same
from start to finish. Custom-made architect-designed buildings; umbrella—flight attendants tailor
suits or furniture are examples. The and civil engineering projects, their services to passengers’ dietary
scale may be small, and firms often including bridges and tunnels. requirements and special needs for
start with job production because it such items as wheelchairs.
is simple and little investment

Wedding dress production

A bride-to-be can choose to buy a dress off the rack
(typically made by batch production) or have one specially
designed and made for her, which costs significantly more.

Bride-to-be at the store Dressmaker commissioned Cutting out the dress

The bride cannot find the dress A dressmaker is hired to The dressmaker makes a pattern
of her dreams and opts to pay for design a wedding dress to the and cuts one dress from the
a custom garment. bride-to-be’s specifications. bride-to-be’s chosen fabric.
 HOW OPERATIONS AND PRODUCTION WORK
Manufacturing and production 272 273

JOB PRODUCTION PROS AND CONS

Pros
❯ Products generally of high
quality
Cons
❯ Does not allow for
economies of scale,
$1,600
the average cost of a
so high production costs
❯ Great job satisfaction and
pride in work followed ❯ Labor-intensive wedding dress in the
through from start to finish
❯ Producer can satisfy
❯ Special materials and
investment in skills may U.S. in 2019
individual customer needs be required
$
❯ Can make a profit with only ❯ High price may put off
a few customers customers, especially in $
❯ For small jobs, word-of- times of recession $
mouth recommendations ❯ Heavy reliance on just a
reduce marketing costs handful of customers

Sewing the dress Dress fitting Completing the dress

The dressmaker focuses on stitching After any alterations, the dressmaker The price is high, but the dress is exactly
and finishing this single garment. is satisfied that the dress fits the bride- what the bride-to-be wants. Now, the
to-be and meets her requirements. dressmaker can start on another dress.
 Batch production
When a number of the same items are made together, it is called
batch production. One batch finishes each stage of the production
process before the next begins, using the same equipment and steps.

How it works few as four identical items for a local supplier

Batch production allows a firm to make a quantity to thousands for a department store, and
of items in one production run. Factory equipment batches can be made as often as required.
is geared up in terms of scale and special tools Batch production is common in the food, clothing,
that can be changed for each batch. For example, footwear, paints, adhesive, and pharmaceutical
equipment is set up to make 200 size 8 dresses in ingredients industries. Each batch must be
red fabric and then adjusted to produce 400 size 10 traceable, with clear date stamping, in order
dresses in blue fabric. Quantities can vary from as to comply with laws and standards.

Bread by the batch

Bread is commonly made in batches. A baker might
make 100 white rolls and then 50 large brown loaves.

Mix bulk ingredients

Ingredients for the batch of white Divide dough
rolls are mixed to form a dough. After machine-mixing, the bulk
dough is divided into small pans.

Proof dough
The dough is left to
rise (proof) in pans.

Batch 1

Adjust for second batch

The equipment is recalibrated to
make 50 large brown loaves. Bulk Proof dough
Divide dough
ingredients for the batch of brown The dough is left to
After machine-mixing, the bulk rise (proof) in pans.
bread are mixed to form a dough.
dough is divided into large pans.

Batch 2
 HOW OPERATIONS AND PRODUCTION WORK
Manufacturing and production 274 275

53 BATCH PRODUCTION PROS AND CONS

Pros Cons

loaves
❯ Economies of scale: low unit ❯ Repetitive work (even if
costs, as large number is made automated), so workers
❯ Customer offered choice may be less motivated
of, for example, size, weight, ❯ Costly because may require
and flavor storage of raw materials, work
Average bread ❯ Output and productivity in progress, and finished items
(see p.139)
increases with use of specialty/
eaten yearly per dedicated machinery ❯ Requires detailed planning
and scheduling
person in the US

Bag up to complete
All the rolls finish the production
process together.
Bake rolls De-pan and cool rolls
The whole batch is The rolls are removed from
baked at the same their pans.
time and at the same
temperature.

Slice and
bag loaves
The loaves
are sliced and
Bake loaves packed for sale.
Baking time is longer De-pan and cool bread
than for Batch 1, as
The large brown loaves are removed
the units are larger.
from their pans.
 Flow production
The purpose of flow (mass) production is to produce a large number
of identical, standardized items. This usually happens on a moving
line, which can be interrupted when the product is changed.

How it works example where elements of the car are put together
Flow production typically involves large factories along a line; robot arms may install wheels, and
equipped with conveyor belts and expensive workers may perform specialized jobs. Significant
machinery; the assembly of individual components, output is possible with even a small number of workers.
which may be brought in from other companies; and Newspaper printers, oil refineries, and chemical plants
the automation of tasks. Car manufacturing is an also use flow production.

The production line

In flow production, the item being made, such as a car, moves on a conveyor belt through different
stages until completion. Components to build the car may have been outsourced or produced in
another of the company’s factories. They are all ready to be used along the line.

Chassis assembly Wheel assembly Engine assembly

PARTS ASSEMBLY

Electrical Main body assembly Windshield

assembly assembly

CAR ASSEMBLY
 HOW OPERATIONS AND PRODUCTION WORK
Manufacturing and production 276 277

FLOW PRODUCTION PROS AND CONS

Pros Cons 78
million
❯ Economies of scale: can produce ❯ Expensive machinery requires
large number of goods cheaply significant investment
❯ Unskilled labor and automation ❯ Repetitive work means workers may
keep costs low be less motivated
❯ Materials bought in large quantities, ❯ Reliant on equipment: if line breaks,
so low cost production is halted vehicles were produced
globally in 2020

Transmission assembly Radiator assembly Seat assembly

Ready for
customer
When customer
Door assembly Finishing Inspection demand is high,
car companies
may run their
production lines
continuously.
 Mass customization
Sophisticated technology and manufacturing developments allow
mass products to be personalized. The low unit cost of mass
production pairts with the marketing opportunities of custom-made.

How it works allow consumers to customize their

Mass customization offers new purchases. The price is generally FOOD MIXES
opportunities for the manufacturing higher than for standardized goods.
The generation raised on social
and service industries. Social media, Revolutionary new technologies
media expects to personalize every
online technology, 3-D modeling are expected to further extend aspect of their lives, and food and
tools, e-commerce software, and customization, allowing individuals drink are set to be a growth area
flexible production systems and to, for example, scan their body for mass customization. Websites
processes are allowing customers contours and use augmented reality allow consumers to make their own
to configure products to match their to design and order unique clothing. cereal mixes, which is especially
own tastes and needs. Industries useful for those with allergies, and
to create their own blends of tea
such as footwear (particularly
and coffee.
athletic shoes), clothing, cars,
jewelry, and computers already

Customers design own products

Mass customization has enormous potential to change consumerism. For
example, consumers can buy shoes designed to their own specification
via the Internet. This is a high-status commodity among certain groups.

Lace color

Shoe color Laces

Tools
Name

The customer decides

On the company’s website, a drop-down menu, with
options including style, shape, size, color, and laces, Sends order to factory
allows consumers to design their own pair of shoes. The firm holds no finished stock
but manufactures to order from
a range of parts, getting paid by
the customer before production.
 HOW OPERATIONS AND PRODUCTION WORK
Manufacturing and production 278 279

25.3%
the average
FOUR TYPES OF MASS CUSTOMIZATION
In his book Mass Customization: The New Frontier in Business Competition,
B. Joseph Pine II outlines four distinct types:

❯ Collaborative customization ❯ Transparent customization

amount more that Work with individual customer to
develop specific product to suit
Provide unique products to
individuals without overtly
consumers are their needs. Technology firms, for
example, assemble computers
stating that items are customized.
Many hotel groups, for instance,

willing to pay for to customer’s specification.

❯ Adaptive customization
keep a database of guests’
preferences to help personalize

personalization Produce standardized products

that are customizable by end user.
their stay.
❯ Cosmetic customization Make a
For instance, U.S. company Lutron standardized product, but market it
produces a lighting system that lets differently. Branded bags, T-shirts,
customers choose settings from and pens used to promote a
preprogrammed options. business are examples.

Shoes shipped to customer

The customer receives a differentiated
product and has the psychological benefit of
personalized design—at a price.

s
lace
rned sole fit
te d
Pat hione arrow
Cus 7.5, n
Size
 Continuous production
During continuous production, a product is made 24 hours a day,
seven days a week. The production line runs continuously to keep up
with demand, and staff work around the clock in shifts.

How it works electronic components, and oil products. As with mass

With flow or mass production, the line is stopped to production, processes are automated, staffing levels
change products or models. Continuous production are kept to a minimum, and quality control is essential.
uses the same concept, but it runs throughout the year, There is high competition in industries using
so output is nonstop. This method is used for identical continuous production. Margins may be low, but
commodities with high, consistent demand, including demand is often relatively stable, encouraging
paper, cardboard, packaging, laundry detergent, investment in capital equipment.

The paper trail

Paper is used throughout the world, and factories operate 365 days a year to satisfy
constant demand. Lumber is the raw material for papermaking. Once the lumber
has been debarked, chipped, and pulped, the fibers are washed and dyed. At the
end of its life cycle, some paper is recycled.

Wood Papermaking
Lumber is a renewable In this continuous process,
resource, and logs are automated machinery runs
stockpiled. Trucks make 24 hours a day, 365 days a year.
constant deliveries to
processors for pulping.

Paper recycling
HEADBOX
Recycled paper is Fiber and water are fed
an important resource onto a moving wire mesh.
for the paper industry.

WIRE SECTION
Some of the water is
sucked away to leave wet
fibers that form paper.
 HOW OPERATIONS AND PRODUCTION WORK
Manufacturing and production 280 281

121lbs. TYPICAL USES

Continuous production is used for undifferentiated
commodities required in large and constant amounts.

of paper is used on :E
LEC
TRICITY
A IE
SA
ND CHEM
I
average by every person

GY

OIL REFINER

CA
ND
ENER

L PL TS
GAS
on the planet each year

AN
OD OD
R PR UCTI S PR UCTI
PE AS

O
ON
PA

GL

N
DRYING
The paper is dried off.
COATING AND
CALENDERING FINISHING
PRESS SECTION
The paper is coated, AND SUPPLY
More water is
compressed, and The finished paper is
squeezed out of
smoothed. constantly supplied
the wet sheets.
to printers, packers,
and newspapers.
 Hybrid processes
Manufacturing firms may adapt existing processes or combine two
production methods for optimal performance, particularly if they
make a wide range of products.

How it works capsule, and liquid form and

There are many examples of hybrid in varying doses; each batch NEED TO KNOW
processes. One is linked batch flow flows through a series of steps,
production, where only two or three depending on composition ❯ Increments Small steps of
gradual improvement over a period
pieces of equipment are required and form, from bulk processing
of time rather than breakthrough
and a batch flows from one process to packaging. Another example or transformational change
to another. This is common in the is cell manufacturing, which
❯ Hybridization Replacing several
chemicals and pharmaceuticals combines job production with separate processes with one single
industries. For instance, a company flow (mass) production. hybrid process
may make headache medication
and a hay fever remedy in tablet,

Combining Flow production

methods One process is handled by one or more workers, and that job
On the classic assembly is completed before the product or part moves on to the next
line, each worker is skilled workstation. Worker 1 uses only one set of tools for the process
at producing one type before the product moves on to Worker 2, and so on down the line.
or part of an item. At the See pp.276–277.
other end of the scale,
one person completes all INPUT
stages, creating the finished
product from beginning to
end. Cell manufacturing
combines flow production WORKER 1 WORKER 2
with job production to
create autonomous units.
A number of workers are
dedicated to production,
or partial production, of a
set of goods. PRODUCTION LINE OUTPUT

WORKER 3 WORKER 4
 HOW OPERATIONS AND PRODUCTION WORK
Manufacturing and production 282 283

HYBRID PROCESSES FOR INNOVATION

By combining manufacturing
processes, companies can create
products with new and original
qualities. For instance, a food company
that makes bread and french fries may dough
bread
speed up production of the fries by
baking them in the bread oven first.
This has the unintended but beneficial
consequence of making the fries
healthier. A new product is created,
which may now be marketed as
a new proposition to a different
set of consumers. lighter fries
potatoes
french fries

Job production Cell manufacturing

One worker creates Combining the best of flow and job production, here a group of products
a one-of-a-kind product, or parts is produced in separate small units (cells) made up of a number of
such as a custom kitchen, workers in the factory. Workers are trained to produce all the items in the set.
from start to finish. This Dissimilar items can be produced without slowing the production line. The idea
way of working can be is to improve performance by giving each cell a degree of autonomy.
more rewarding for the
worker, who uses a range
INPUT
of skills, but it tends to be
costly for the customer.
See pp.272–273.
CELL 1 CELL 2

WORKER

PRODUCTION LINE OUTPUT

CELL 3 CELL 4
 Management
Every manager in a business, particularly in manufacturing, has to
ensure that all resources—from materials to equipment and staff—
are used efficiently, while keeping the customer continually in
mind. Managers make key decisions to lay down procedures
and set standards and then work continuously to improve
processes to ensure that the company remains profitable.

Which approach?
How people and processes are organized in making and delivering the product
to the customer is critical if a company is to survive fierce competition and rapidly Agile
shifting consumer demands in a global market. In making decisions about how production
a business can meet its goals, managers may combine a number of approaches, How can we be more
as many are interlinked and achieve similar outcomes. responsive to shifts in
customer demand?
See pp.296–297.

MANAGER OR LEADER?
Management and leadership are not the same but are Time-based
closely linked: management
❯ Managers plan, organize, coordinate, ask questions, How can we use
and motivate; leaders also create a vision and inspire. time effectively?
❯ Managers organize workers to maximize efficiency and See pp.294–295.
nurture skills; leaders also develop future talent.
❯ Managers focus on the bottom line; leaders also
look to the future.

No. 1
❯ Managers explain to workers what needs to be done and
provide the support to do it; leaders also persuade
workers to want to do more than needs to be done.
❯ Good managers require leadership skills; great leaders
know what it takes to be good managers.
The following classic distinction has been attributed to
two different business leaders and writers, Peter Drucker
European country
and Warren Bennis: management is doing things right;
leadership is doing the right things.
for innovation in
2020: Switzerland
 HOW OPERATIONS AND PRODUCTION WORK
Management 284 285

$ $

Economies and
diseconomies of scale
Kaizen
What scale of operation is best
How can we drive for us? See pp.286–287.
continuous
improvements?
See pp.298–299.

Lean
INNOVATE production
How do we
INVOLVE
EMPLOYEES
FOCUS
ON VALUE $ minimize
resources to
reduce costs?
See pp.288–289.

STRATEGIC
ALLIANCES WITH MINIMIZE
SUPPLIERS WASTE

CUSTOMERS
Just-in-time
UNINTERRUPTED AT THE HEART How can we meet customer
WORKFLOW OF WHAT demand and minimize stock?
WE DO
See pp.290–291.

Total quality
management
How do we improve customer
satisfaction? See pp.292–293.
 Economies and
diseconomies of scale
Economies of scale are one of the advantages of large-scale production,
yielding a lower unit cost of each item produced. However, costs can
also go up as the operation grows, resulting in diseconomies of scale.

How it works Supermarkets, for example, buy food in bulk at low

Economies of scale is a simple concept: the more items unit costs, which they pass on to consumers. However,
produced or handled, the cheaper the average (unit) diseconomies of scale may occur when the operation
cost, as efficiencies and fixed costs are shared across all experiences high administration costs, waste from lack
items. This gives a business a competitive advantage. of control, or lack of employee productivity.

Economies of scale
While it may be inefficient for a small dairy to supply milk to a supermarket,
it is cost-effective for a large dairy operation producing thousands of bottles.
If a delivery is too large, though, waste can creep in due to associated costs.

SUPERMARKET
AVERAGE COST AND REVENUE

DELIVERY
OF 100 1 VEHICLE
BOTTLES

Average cost high

DELIVERY
OF 10,000
BOTTLES

Average cost low

$
Few economies of scale Economies
 HOW OPERATIONS AND PRODUCTION WORK
Management 286 287

NETWORK ECONOMY
Online networks, such as eBay and Facebook,
rarely stray into diseconomies of scale. They can
deliver economies of scale even at an international
9%
higher net profit at Netflix
level: the cost of adding one more user to a
network is almost zero. However, the resulting
benefits may be huge, because each new user
in 2020 compared with
in the network can interact or trade with other
members of the network.
2016 after adding 115
million more subscribers

2+ VEHICLES = MORE SUPERMARKET

DRIVERS AND FUEL AND
POTENTIAL WASTE

DELIVERY
OF MORE
THAN
10,000
BOTTLES

Average cost goes up

1 VEHICLE (LARGER, SUPERMARKET

BUT ONLY 1 DRIVER
AND SAME FUEL
COSTS)

of scale Diseconomies of scale

OUTPUT
 Lean production
The goal of lean production is to reduce the resources used to
supply goods and services to consumers. By cutting human effort,
materials, space, capital, and time, lean production cuts costs.

How it works Optimizing the flow of products and

The focus in lean production is on services through value streams— NEED TO KNOW
efficiency to maximize value for which are sequences of activity that
the customer but not affect quality. flow horizontally across ❯ Kanban cards Toyota’s demand-
driven scheduling triggers
Lean seeks to eliminate all activities technologies, assets, and functions
that do not add value to the to customers—allows the business ❯ Value-stream mapping
The process of analyzing how the
production process, including to respond more quickly to
product gets from start to finish
holding inventory (stock), repairing consumer demand. Efficiency also now and the design of an
faults, and unnecessarily moving makes it simpler and more accurate improved flow for the future
people and products around a to manage information.
manufacturing plant.

Case study: Waste Waste

how Toyota Items produced Unproductive
beyond time spent waiting
eliminates
Overproduction

customer for material,

waste demand information,
Lean production is Waiting equipment, tools
about getting rid of
waste, sometimes Lean solution Lean solution
called non-value- Manufacture based upon a pull system, All resources provided
added activities. producing products as customers on a just-in-time ( JIT)
Car manufacturer order them basis—not too early,
Toyota has identified not too late (see
eight areas of waste pp.290–291)
and a lean approach
to counter these.
Waste Waste
Extra, unwanted Consumes materials
stock held in and uses up labor;
Excess inventory

inventory results in customer

complaints
Defects

Lean solution Lean solution

Kanban cards used to Total quality
indicate material order management (see
points: how much, from pp.292–293) used to
where, and to where improve all areas
 HOW OPERATIONS AND PRODUCTION WORK
Management 288 289

CREATING A LEAN COMPANY

In their 1996 book, Lean Thinking: Banish Waste and Create Wealth in Your Corporation, 9.5
million
James Womack and Daniel Jones identify the five principles of lean manufacturing:
❯ Value Use surveys, interviews, analytics, and other sources to define customer value—
what customers really want from your products and what they are willing to pay.
❯ Value stream Map the value stream by determining all company activities that
contribute to creating customer value. Those that do not may still be necessary to the
business, but anything else should be eliminated. the number
❯ Flow Make sure all the remaining steps run smoothly together, without disruption.
❯ Pull Implement a “pull system,” so work only occurs when there is actual demand.
of cars Toyota
Make sure the necessary materials and information are available to create the right
quantity of products at the right time, cutting labor, resources, and storage waste.
sold in 2020
❯ Perfection Make the process of continuous improvement part of the organization’s
culture, and keep trying to get better every day.

Waste Waste
Non-value-added processing
Transportation in stages

Superfluous stages A B C Unprofitable stages

in the in the production
transportation or reworking of
process a product

Lean solution Lean solution

Material shipped A B Map the value stream to
directly from the identify non-value-added
vendor to the steps in the process; get it
assembly line right the first time

Waste Waste
Poor workflow, Underutilization of
poor layout, employees’ mental,
Underused people

and inconsistent creative, and physical skills

Excess motion

working methods and abilities

Lean solution Lean solution

Workplace Organization, a Work cells replace
systematic method assembly line; better use of
for standardizing the labor and employee
workplace involvement
 Just-in-time
The system of production in which an actual order is the trigger for an
item to be manufactured is called just-in-time. It enables a firm to
produce only required items, in the right amount, at the right time.

How it works of frequent deliveries and loss of

Also called demand-pull production, purchasing economies of scale
just-in-time means that stock levels (discounts for bulk buying). The
of raw materials, components, work system dates back to 1953, the
in progress, and finished goods are year Toyota brought in just-in-time
kept as low as possible, reducing manufacturing. The phrase is
costs. The system requires detailed sometimes used in a more general
planning, scheduling, and flow sense today to mean eliminating
of resources throughout the waste of resources.
production process, now assisted
by sophisticated production-
scheduling software. Supplies
have to be delivered directly to
the production line when they
are needed, requiring strong
relationships and interconnected
systems with suppliers. The

5
NEW STOCK IS DELIVERED TO
benefits of reduced inventory STORE TO REFILL SHELVES
are balanced against the cost

JUST-IN-TIME
PROS AND CONS
Pros
❯ Lower stock so less storage space
and less working capital needed
❯ Demand-pull avoids obsolete,
out-of-date stock
❯ Staff spend less time checking and
moving items

4
Cons SYSTEM TRIGGERS
DELIVERY FROM
❯ No room for error—for instance, SUPPLIER WHEN
if there are any faults in the MINIMUM STOCK
LEVEL REACHED
stock delivered, the whole
day’s production is halted
❯ Operation is reliant on suppliers
❯ No cushion for sudden upsurge in
demand
 HOW OPERATIONS AND PRODUCTION WORK
Management 290 291

1
CUSTOMER
SELECTS
ITEM FROM
SHELF
9.7%
the average annual
growth expected in
the global print-on-
demand T-shirt
Just-in-time in retail
To reduce stock levels, many supermarkets
market in 2021–2028
now use just-in-time deliveries, relying on
computer data systems. In manufacturing,
systems are often based on Kanban cards—
dockets for withdrawing and ordering items at
each workstation of the production process.

2
CASHIER SCANS
BARCODE

CASE STUDY
Print-on-demand publishing at Peecho

3
COMPUTER SYSTEM Amsterdam-based Peecho offers just-in-time
SIGNALS WAREHOUSE print-on-demand services, only printing the
products they host, such as books and images,
when ordered by a customer:
❯ Content owner uploads their product, such
as a book or image, to Peecho.com.
❯ Customer places order, and Peecho prints only
the number of copies needed to fulfill order.
❯ Content owner avoids up-front costs
of producing and storing large print run
and can easily distribute their printed
products anywhere.
 Total quality
management
Success through customer satisfaction is the ethos of total quality
management (TQM). Everything a company does is relevant, and the
focus is on managing and improving processes rather than outcomes.

How it works viewed as a series of horizontal

Companies use TQM to create a processes that take inputs from WHAT TQM MEANS
customer-focused organization suppliers through to the delivered
that involves all employees in outputs. Measuring performance data ❯ Total Involves everyone and all
activities in the company
continuous improvement. It is a is critical, as is good communication
strategic and systematic approach to maintain momentum. Although ❯ Quality Conformity to meeting
customer requirements
that puts quality at the heart of the similar to the more widespread Six
business’s activities and culture. Sigma (see pp.320–321), TQM focuses ❯ Management Quality can and
must be managed
Customers determine the level of on internal quality standards rather
quality, measured by their than reducing defects and producing
satisfaction. The organization is quantifiable results.

Case study: The Walt

Disney Company
Manufacturing companies, in which
the focus is on meeting or exceeding
customer expectations by making The Walt Disney Focus on the customer
products within certain specifications, Company Disney incorporated the
are often used as TQM examples. TQM Disney’s goal is to maximize TQM concept of quality into
can also be applied in service industries, long-term shareholder value, its approach to customer
of which Disney is a good example. and part of this involves service. Its visitors are seen
delivering a magical customer as guests and treated as VIPs
experience at its theme parks. and individuals.

“Quality control is Involve everyone Perfect processes

in quality Walt Disney viewed the theme
applicable to any Founder Walt Disney firmly parks as factories producing
kind of enterprise. In believed in quality and saw it delight. He built quality by
designing processes and
as everyone’s job, something
fact, quality control that could not be delegated. repeating them.
must be applied in
every enterprise.”
Dr. Kaoru Ishikawa, engineering professor
 HOW OPERATIONS AND PRODUCTION WORK
Management 292 293

70,000
Disney World “cast members”
NEED TO KNOW
❯ American customer satisfaction
index (ACSI) Cross-industry
benchmarks for customer
work to make guests happy. satisfaction in the US; NCSI is the
UK equivalent
❯ Net Promoter Score (NPS®)
Metric for company performance
Employees Exceptional service from the perspective of customers,
Disney calls its employees “cast Cast members (employees) are who are divided into promoters,
members.” They are trained in focused on delighting passives, and detractors
every aspect of delivery, the customer—their sole job
including posture, gestures, is to make visitors happy.
facial expressions, and tone of
voice.

Suppliers Continuous
Disney collaborates with improvement
suppliers—for example, it has Walt Disney saw the theme
partnerships with McDonald’s parks as an incomplete
and Coca-Cola—to ensure product; today, improvements
consistent quality. come from the bottom up.

“When does the Three Shared purpose Integrated systems

O’Clock Parade start?” Walt Disney started by Technology supports the
Cast members are trained to defining a company culture experience: for example, the
answer this common question based entirely on creating volume of ambient music is
by responding with the time a genuine shared purpose the same in all theme parks,
the parade will be passing a that people would be proud to delivered through thousands
particular point in the park. support. of perfectly placed speakers.
 Time-based
management
The general approach that recognizes the importance and value
of time and seeks to reduce the level of unproductive time in an
organization is called time-based management.

How it works its people have to be multi-skilled and able to move

The fast pace of competition means a business that swiftly between different tasks; its machinery has to
can manage time efficiently will enjoy a significant be flexible so that production runs can be changed at
competitive advantage. This applies to new product short notice; and there has to be a culture of mutual
development, faster response times to meet changing trust between workers and managers. Time-based
market and customer needs, and reduced waste. For a management is a key aspect of lean production.
business to operate a time-based management system,

Case study: managing

time at Amazon
With approximately 398,264,685 square feet of storage
space in its warehouses and hundreds of millions of
customers worldwide, Amazon is an undisputed leader
in online retail. One of its key strengths is being able to
deliver products quickly, with many customers paying a
premium to get their items even faster through its Prime
subscription service. To be able to do this at a reasonable
cost, the company ensures that every process adds value
and takes a minimum amount of time—from making sure
there is enough stock and space to store it to picking the
right product and delivering it. Much of this is achieved
through the use of information technology.

Storage
Amazon uses every available inch of warehouse space
to store inventory by utilizing the idea of “chaotic
storage.” Items are placed in the location that optimizes
the use of space rather than in an ordered categorized
section. The inventory management system keeps note
of where that item is stored and
Analysis can locate it instantly, saving time and space.
The time and cost of each
of these processes is analyzed
to ensure they are completed
in the best possible way.
 HOW OPERATIONS AND PRODUCTION WORK
Management 294 295

34%
of organizations
PART OF PROJECT MANAGEMENT
Time-based management is a critical
part of project management. Timing
aids include:
❯ Tools such as Gantt charts show
❯ Methodologies such as Agile
help project managers working
in software development
respond to the unpredictable;
mostly or the project schedule as a bar chart,
making it easy to plot and monitor
they are often implemented via
the Scrum framework, in which

always complete daily progress and targets.

❯ Project management systems
one person takes charge of constant
reprioritizing. Based on the premise

projects on time. PRINCE2 (PRojects IN Controlled

Environments) and similar methods
that software cannot be built up like
a product on an assembly line, as it
would be out of date before it was
help structure projects step by step in
released, every area of development
logical, organized ways.
is constantly reappraised.

Picking the order Despatch

Computer systems direct the pickers After picking, the product moves along a
to the nearest location for that product, conveyor for packing, weighing, and labeling.
which not only saves time but also This is then tracked and scanned by the
avoids costly and time-wasting picking computer system before being sent to
errors where the wrong product is the sorting center, where packages are
inadvertently selected. distributed by location and delivery speed.
 Agile production
Speed and agility are the key competitive advantages of agile
production: the focus is on rapid response to the customer, enabling
the business to take advantage of short windows of opportunity.

How it works
The goal of agile production is to stay ahead of the
competition. Often incorporating concepts of lean
production (see pp.288–289), agile has an extra
dimension: meeting customer demand rapidly and
effectively. It relies on flexible and collaborative workers,
who can deliver swiftly and effectively. The company
has to be able to change or increase production quickly. Rapid response
Design of products might incorporate modular concepts, Company setup allows it to
allowing for customization, and strong relationships respond quickly and effectively
with suppliers are essential. to customer and market demands

stomer
u
C

Customer
demand is
Agile manufacturing
trigger to start The organization has to create a position from
production which it can alter course as nimbly and swiftly
as a cheetah. It needs to be able to retool
facilities quickly, modify agreements with
suppliers, and continually introduce
new ideas and improvements.

Integrated
Product
technology
reaches Effective information
customer systems, often linked
to suppliers

Continuous innovation
Constant search for new and better
ways to deliver for customer
 HOW OPERATIONS AND PRODUCTION WORK
Management 296 297

Modular LOCAL EDGE

products
Independently Agile production is typically adopted by
companies in extremely competitive
created parts used in
environments with high labor costs,
different/customized
such as North America, where local
products manufacturing can provide a
competitive advantage:
❯ Proximity to customers allows
feedback and response.
❯ Small variations in performance and
Knowledge delivery can make a huge difference
culture in customer satisfaction, company
Capturing reputation, and financial results.
experience, learning ❯ Unprecedented levels of speed and
from mistakes personalization cannot be matched
by offshore competitors.

71%
of organizations use Strategic partnerships
Supplier collaboration rather
agile approaches for than contract negotiation

projects at least sometimes

Transportation
system
Systems, facilities,
infrastructure to
speed product to
customer

Flexible
workforce
Self-organizing,
adaptable teams
 Kaizen
Started in Japan, kaizen is a system of continuous improvement that
involves all employees. From senior managers to store employees,
everyone is encouraged to suggest improvements day to day.

How it works
The kaizen philosophy is “to do it better, make it better, standards and then looking for ways to continually
improve it even if it isn’t broken, because if we don’t, improve those standards. It is supported by
we can’t compete with those who do.” Kaizen is rarely a framework of training, communication,
about ideas for major change but has more to do with and supervision and results in improved
ongoing, systematic, incremental improvement. A efficiency, productivity, quality, lead
relentless attempt to eliminate unnecessary activities, time, and customer loyalty.
delay, or waste (muda), Kaizen starts with setting high

Creating good change e

Kaizen events are implemented through a cycle of activity, at

Innov
known as plan, do, check, act. Central to kaizen are quality,
ongoing effort, involvement of every employee as part of Quality
their daily work, willingness to change, and communication.

BETTER Innovate—find
AND BETTER

29
and implement
better ways to
Kaizen was created in Japan meet requirements and
after World War II. It comes increase productivity.
from the Japanese words kai,
which means “change” or “to
correct,” and zen, which means seconds saved
“good.” Companies such as
Toyota and Canon have seen building each Effort
significant improvements by
involving their employees in car at Toyota UK
e
Gaug

recommendations for change.

from new idea
KAI ZEN
to automate
adding stickers

Gauge measurements against

required standards.
CHANGE GOOD
 HOW OPERATIONS AND PRODUCTION WORK
Management 298 299

FIVE FOUNDATIONS
The five steps of workplace organization,
known as 5S, are the foundations for

andardi continuous improvement in kaizen.

ze
S

Seiri (Sort)
Keep only essential
items in the work area.
Standardize operation Remove and store all
and activities; make unnecessary items.
each improvement
standard practice,
enshrined in the five
foundations, or 5S.
Willingness Seiton (Streamline)
to change Retrieve ordered
items swiftly and
easily to create
efficient workflow.

Communication Seiso (Shine)

Keep the workspace

M clean, because
cleanliness leads
to efficiency.
ea
sure

Seiketsu
(Standardize)
Keep consistent work
practices, tools, and
workstations and make
Measure the roles clear.
People operation—for example,
involvement the length of the
production cycle and Shitsuke (Sustain)
amount of in-process
The four cornerstones
inventory. above become the
standard way to
operate all the time.
 Product
The items that firms sell to satisfy a consumer need and to make a profit for the
business are broadly termed products, whether they are something tangible like
toothpaste or an intangible service, such as an insurance policy. In a typical life
cycle, a product is developed and launched, and a few customers buy it. The
domino effect causes wider distribution. Growth eases as the market becomes
saturated, and sales flatten and decline until the product is no longer viable.

Product evolution
From start to finish, every product,
such as a tube of toothpaste, goes
through a process of testing,
innovation, and quality control to
ensure that it will make the biggest
impact on release and throughout
its life-span. Successful companies
understand the limited life-span of
products and thus invest in the early
stages to maximize growth later on.

“A lot of times, New product idea Testing and

people don’t A company decides to release
a tube of toothpaste with a new
development
A focus group is assembled
know what flavor. Its viability is evaluated and
potential competition researched.
to taste the new flavor, along
with some variations. Their
they want until The new toothpaste also requires
other qualities, such as whitening
preferences and comments
are noted, and the toothpaste
you show it and enamel protection, to capture
its segment of the market. See
is developed into a usable
product. See pp.302–303.
to them.” pp.304–305.
Steve Jobs, Apple Inc. cofounder
 HOW OPERATIONS AND PRODUCTION WORK
Product 300 301

$2.8 PRODUCT LIFE-SPAN

Home entertainment offers different products to

trillion
consumers. These are four examples of products at
different stages in their life cycle (see pp.184–185):
❯ Introduction 8K ultra-high definition televisions
only recently available for the home

the value of goods ❯ Growth Streaming services—more subscriptions

due to convenience, value, and content choice

traded between EU ❯ Maturity Regular high-definition televisions—

challenged by more sophisticated technology
member states in 2020 ❯ Decline DVD players—DVD discs superseded by
cheaper, higher-resolution streaming services

B
Process

1 2 3 4
Product

Packaging and design Quality management Product-process matrix

The toothpaste tube is given a A period of quality control Using a product-process matrix,
bright, clean, and attractive look. begins, in which standards the company identifies the correct
Design considerations include of safety and performance are production method for the
functionality, expense of materials, thoroughly checked. It is far toothpaste. Because the company
and an appeal to current trends. cheaper to correct defects in makes only a few products, each at
See pp.306–307. the design phase than later a high volume, it decides to use
in production. See pp.308–309. assembly-line production.
See pp.310–311.
 New product
development
Companies cannot stand still. In today’s fiercely competitive
marketplace, they have to budget for research into new ideas and
identify new products to bring to market simply to stay in business.

How it works and generate a pool of ideas, a few

New product development is a of which can be explored. They TRENDING CLAIMS
process with a number of critical might work with potential
New products are influenced by
stages to ensure that a business customers and also with suppliers,
trends, reflected in the claims on
focuses its investment on products if part of the manufacturing process packaging and in advertising. The
that will sell and, above all, make is to be outsourced, to refine and top claims on new food products
a profit. It starts with an idea, develop ideas before finally in the U.S. from 2020, for example,
possibly to improve and relaunch an bringing the product to market. were “kosher,” “low allergen,”
existing product. Some companies “gluten-free,” and “no additives.”
run sessions to encourage creativity

The development process

The nature of the idea and the size of the company affect each stage and
how long the product takes to reach the market, but the process is
generally the same.

Ideas can come from Screen ideas

anywhere: customers may Criteria help identify products that fit
express a need, or employees business strategy, will be easy to make,
may make suggestions. and will be profitable to produce.

generati
ea o
d
n
I
 HOW OPERATIONS AND PRODUCTION WORK
Product 302 303

Test concept
Feedback from consumers, using focus
groups, interviews, or online evaluation,
ensures that an idea is worth pursuing.

Analyze market
Analysis of opportunity,
influenced by predicted
growth and trends,
helps build a picture of
potential sales.

Test market
Product is tested on Develop products
section of market,
perhaps a selected
geographic area with
good representation of
target audience.

Features are confirmed, actual product is

designed—taking into account the test-
concept stage—and prototype is developed.

Launch

$5.3
Companies ensure distribution and tell customers
about new product, through social media or
advertising, to kick-start sales.
billion
reported loss by Samsung
after its disappointing Galaxy
Note 7 phone launch
 Innovation and
invention
Innovating is more than just having a bright idea—it is the way that
inventions and ideas reach commercial success. It is the lifeblood of
any company, because staying ahead is essential for survival.

How it works Huawei technology companies, know how to do this.

Innovation needs a culture that encourages people Innovation is not small, incremental changes but
to be inventive and explore ideas. It also requires transformational ones, such as solving an existing
processes that can take initial ideas and develop them. problem in a radically different way or identifying
Successful businesses, such as the Apple, Sony, and an unknown problem and inventing a solution.

From idea to product

Innovation is stimulated by many triggers. The idea then requires people
to be working in a conducive environment to ensure that
it is implemented and makes a difference.

Innovation triggers
Shifts in society, such as leaps in IT
and growing concerns about climate
change, as well as internal company
developments create new needs.

technolo cy/cost sa ity encour

w en iv
Ne

gy

t
vi
i

ag
Crea
Effc

ng

ed
$

blem/cris
ro
is
P

umer nee
Idea ro
n
nme tal is ns ea
m collabo
Co

ds

-t
i

su

ra
Env

Cross

tion
es
 HOW OPERATIONS AND PRODUCTION WORK
Product 304 305

DIFFERENT TYPES OF INNOVATION “Genius is

Sustaining innovation Significantly Breakthrough innovation Product 1 percent
improving existing products, typically
through technology—for example,
or service that simultaneously shifts a
market and has significant outcomes inspiration,
more pixels in cameras, smaller and for the world at large, such cloud
more powerful laptops computing or self-driving vehicles and 99 percent
Sustainable or eco-innovation
New product that has minimal impact
Disruptive innovation Displaces
established competitors or changes perspiration.”
on the environment the norm—for instance, online Thomas Edison, U.S. inventor
Frugal innovation Low-cost gambling replacing betting parlors
product for emerging mass market

Intellectual property (IP) is the expression of an idea.

IP might be a design, an invention, or another type
of intellectual creation, and it can be protected by
law—for example, with a patent.

Brainstorm Action
Individuals and The culture and processes of the
teams need the time company have to be favorable for
and mental space to testing the viability of ideas.
think creatively.

ng at all le lea
r missio rrectly m
ni n co
C

ea
e

t
ve
List

Impac

sure
ls

gement st
ilu
re allowe
ng
-term vie
na Product
a

ru
Lo
Fa

w
d

Flat m

cture
 Design
Any product has to be well designed to succeed. Excellent
designs for everyday items—from the Anglepoise lamp to
reflective road signs—have shaped our modern world.

How it works
H ERS
The starting point for design is RC OM

ST
A
an idea for a product that fulfills

CU
RESE
a need, whether it is a specialty
item or something in day-to-day
use. The designer has to think of
ways in which a product can
serve its purpose and meet other IDE
AS
criteria, including aesthetics, cost, OGY MIN
G
OL
N OR Explore concept
durability, and environmental
NEW ECH

BRAINST
considerations. The design may From scribbles on a piece of
T

be integral to the product, such paper to computer-generated

as Apple’s rectangular devices image technology, it may help to
with rounded corners, for which visualize options.
it obtained a design patent. Some
designs are iconic, such as the
Coca-Cola bottle. Yet design is Product-design process
more than just shape. As well as
Designs for mass-produced items, such as
functionality, it includes materials
furniture, lighting, domestic appliances, and
and color and extends from the
communications technology, take a lot of hard
products to their packaging. work. The process of creating a functional
design that looks good has several steps.

CONSIDERATIONS
FOR DESIGN SUCCESS
❯ Functional Serves a purpose
❯ Aesthetic Enjoyable to use
❯ Innovative Different and
new, possibly using innovative
technology
❯ Easy to use Understandable and
with useful features
❯ Simple Unobtrusive, subtle
❯ Long-lasting Sustainable, not Redesign
too fashion-sensitive Next year, the
❯ Environmentally friendly product may End product
Minimizes resources and pollution need revamping. The design of the final version
that goes on sale may look
very different from the
initial concept.
 HOW OPERATIONS AND PRODUCTION WORK
Product 306 307

Develop concept Make prototype

The design can be broken into components, such as This might be a single
functional requirements and production options, with item or a series of
each evaluated independently. prototypes, to test and
refine the functionality.

32%
higher revenue generated
Feedback
Now is the time to find
out what people think
by the most design-focused of the product and how
it could be improved.
companies over five years RS
(EXTERNAL
TU
RING
)
CUSTOME

C
MANUFA

Design decisions
Before full-scale
production begins, INTERNA
G( L
all decisions have N
)
I
MARKET

to be made, and
paperwork, such as
intellectual property
rights, is finalized.
 Quality management
For businesses, quality is not a vague term but a philosophy of
meeting or going beyond consumer expectations. Excellent quality
management can give a company a key competitive edge.

How it works services. To do this, they have a number of

Many consumers might find it hard to define quality standards or key performance indicators (KPIs) for
because it can be subjective, but they know it when the manufacturing process and continually measure
they see it. However, companies need to define themselves against these. Quality does not apply just
and measure it. They know that to build a good to the product or service itself; it ripples out to the
reputation and thrive, they have to exceed customers’ associated people and processes and across the
expectations in terms of quality for both products and organizational environment.

Cost of quality
Quality management is essential to ensure
COST OF DEFECT

that any defects are nipped in the bud, the During production,
quality management
earlier the better, and definitely before they involves testing,
become apparent to the consumer. evaluating, and
inspecting quality.
Defective items may
be scrapped.
Quality management at
CUSTOMER FIRST the product-design stage is
low-cost and integral to
Before the 1970s, quality was seen the process because it
prevents issues farther
as something to be inspected and
down the line.
corrected. Then, U.S. businesses
began to lose out to Japanese
companies—for example, Toyota
and Honda were able to produce
cars at lower cost and at much
higher quality. The difference
was that quality had a strategic
meaning for Japanese firms—they
made the customer their priority
and were the first companies
to define quality as meeting or
exceeding customer expectations.

PRODUCT DESIGN PRODUCTION

 HOW OPERATIONS AND PRODUCTION WORK
Product 308 309

NEED TO KNOW

60%
❯ ISO 9000 Set of international
quality standards and certification
demonstrating that companies
have met standards specified
❯ EFQM Global Award
of organizations agree that Annual prize recognizing
organizations worldwide for
customers are the key drivers their ability to turn strategy
into action and continuously

of their quality programs. improve performance

❯ Deming Prize Japanese award
given to companies to recognize
efforts in quality improvement

WHAT MAKES QUALITY?

Manufacturing
industry
❯ Conformity to
specifications/standards
❯ Performance
❯ Reliability
❯ Functionality/features
❯ Durability
❯ Serviceability

Service industry
❯ Getting the desired result
Once the product is with
the customer, a defect is ❯ Consistency
expensive. Financial cost
❯ Responsiveness to
includes returns, repairs,
and recalls, but the impact customer needs
on the company’s ❯ Courtesy/friendliness
reputation may be even
more damaging. ❯ Promptness
❯ Psychological factors, such
as good atmosphere

LOCATION OF DEFECT

PRODUCT WITH CUSTOMER

 Product-process
matrix
A product-process matrix is a tool that can help a NOT VIABLE
business identify the best way to make a product,
based on volume and the level of customization.
How it works
Products pass through different
stages, and so does the production
Choosing the best
process. Businesses typically start method
with low volume and are highly A business, or business unit in a large
flexible but not very cost-efficient. company, occupies a particular region
A print shop or dressmaker is an in the matrix. Different processes suit
example of a company positioned in different products, depending on the
the bottom left-hand corner of the stage of their life cycle and the scale of
product-process matrix, where each the business.
job is unique and job production is
most effective. Production stages
then progress through increasing
standardization and mechanization

Product
Low volume
to full automation. Companies in Low standardization; unique,
the top right-hand corner have high- one-off products
volume products and a small range,
so continuous flow production is
the best option.
over
1
4
EVOLVING PROCESS
The product-process matrix
was first introduced by Harvard

29%
academics Robert H. Hayes and Dressmaker
Steven C. Wheelwright in the
Harvard Business Review in 1979.
Since then, some companies
have worked out the apparent
contradiction of how to customize
high-volume products (mass of all goods are
customization). Nevertheless, the
product-process matrix remains
relevant in many industries.
manufactured
in China.
 HOW OPERATIONS AND PRODUCTION WORK
Product 310 311
Process

Sugar refinery

Mass
production
Continuous
flow; nonstop
process
(see pp.280–281)

Car assembly

Assembly line
RARELY VIABLE
Connected line
An assembly line is not normally
flow; process
a suitable process for making
repeated for
multiple products at low or
each product
medium volume.
(see pp.276–277)

Low–medium volume High volume Very high volume

Some standardization; Standardization; products High standardization; single
multiple products manufactured in large quantities commodity product

Batch
production
RARELY VIABLE
Disconnected
Batch production is not normally
line flow;
Bakery a suitable process for making
similar process
standardized products at
adjusted for
high volume.
each batch
(see pp.274–275)

Job production
Jumbled flow;
complex, unique
process design NOT VIABLE
for each order
(see pp.272–273)
 Control
Essential in any type of organization, control is fundamental when the primary
goal is to generate profits. Control needs to cover costs, resources, and quality
of the product or service to ensure that the operation runs smoothly. As well
as crossing departments, control has to run from top to bottom, with directors
formulating strategy while managers allocate resources, people, materials,
and equipment and oversee the work of individuals and teams.

The chain of control

It is simplest to think of a business as an end-to-end chain. farther along the line. Controls are put in place all the way
Leaders have to make decisions on business goals, strategy, along the chain to ensure that the organization is working
and policies at the start of the chain. This is critical for toward its goals, that it meets the desired standards, and
control along the chain. If there is no clear direction from that individuals and teams are clear about what is involved
the start, problems become exacerbated as they travel in specific tasks.

Control in practice: strategic control ABC Management

ABC Cake Company’s goal is to be the top-selling CAKES control
cupcake business. Its directors determine the The management
quantity and quality of cupcakes the company team ensures that
needs to sell and whether to invest in a new everyone meets
factory. They also set the scale of investment and their targets, talks
estimate when it will begin to yield returns and with other links
how long it will take for the project to repay its in the chain, and
full cost (payback period). works seamlessly
to be a top-selling
cupcake business.

FUNCTIONS ALONG
THE CHAIN Investment relies Policies on, say, Processes are Procurement
While directors work on cash flowing maintaining the in place to purchases raw
on strategic investment, back into the optimum level of control costs, materials from
policy, and process business from inventory are with continual companies
control, management the cupcake supported along reviews of the that meet its
may use tools, such sales, balanced the chain by most efficient use of stringent
as Six Sigma, to perfect by the cost of finance, HR, resources. standards.
operational control. production. and IT.
See pp.320–321.
 HOW OPERATIONS AND PRODUCTION WORK
Control 312 313

LEGALLY IMPOSED CONTROL

Many industries are subject to external controls

84:1
as well as their own:
❯ Financial institutions National and
international regulatory controls
❯ Advertising industry National regulations to
protect public interest
the median ratio of CEO ❯ Health and social care National laws to
protect vulnerable members of the public
to employee pay of FTSE ❯ Manufacturing National regulations on health
and safety
100 companies in 2019

“Drive thy business,

or it will drive thee.”
Benjamin Franklin, U.S. statesman and scientist

ABC
ABC CAKES Task control
CAKES
Metrics and key performance indicators
are set for each task. They control, for
example, how long it takes to ice and
decorate a batch of cupcakes.

PANY
KE COM
ABC CA

Goods received Stock control Production Marketing Sales

checks on-time uses sophisticated has metrics for benchmarks the works toward
delivery and that systems to the quantity price and reviews detailed targets.
all inputs are ensure the and quality of the promotion See pp.314–315.
consistently of optimum level the cupcakes. of the product
the right quality. of inventory. See pp.314–315. against competition.
See pp.318–319. See pp.316–317. See pp.332–333.
 Managing capacity
In terms of production, capacity means how much work can be
achieved in a given time. Ideally, a business matches its capacity to
customer demand, using its resources with maximum efficiency.

How it works if and when demand goes beyond capacity.

Every business has to consider how much capacity Businesses may offer consumers incentives to help
it needs for its operation and how to manage manage capacity—for instance, cheaper late-morning
this capacity both day-to-day and in the future. train fares encourage passengers to travel after rush
Management has to choose a priority: whether to hour, easing overcrowding on trains that are full to
deliver excellent customer service by having extra capacity in the early morning. Likewise, many hotel
capacity, and thus price its products or services high, or chains do not charge a fixed price for rooms, pricing
to manage its resources efficiently for a better return on them according to demand to maintain capacity.
investment, at the risk of disappointing customers

Capacity decisions
The fundamental decision is whether to compromise
on demand or capacity—whether to put customers or
the streamlining of operational costs first.

Customer focus
The company—in this case, a car dealer—keeps Manage capacity— Increase demand
more cars in stock than required so it can raise prices To use up stock, pricing
always satisfy customer demand. Customers are happy to have a policies increase demand
product immediately but must by encouraging customers
pay a higher price to cover the to buy fast—for example,
cost of holding excess stock. offering on-site deals
for older car models.
$
$$
$

$
$$

$$
$

$
$$

$
$$

SALE
 HOW OPERATIONS AND PRODUCTION WORK
Control 314 315

HOW CAPACITY AFFECTS A COMPANY NEED TO KNOW

Capacity management is critical ❯ Staffing levels ❯ Potential capacity The capacity that
to ensure, for example, that a ❯ Use of labor—for example, can be made available long-term, a factor
manufacturing operation has shift work that affects investment decisions and
the right level of resources to business growth
❯ Which materials to use, how
work to a production schedule.
much/how often to order ❯ Immediate capacity The maximum
It affects many areas of the
❯ Inventory (stock) levels potential capacity available in the
business, as all are interlinked
short term
and cost the company money: ❯ Production scheduling
❯ Effective capacity The total capacity
❯ Factory or office size ❯ Speed and ease of processes that is realistically achievable when all
❯ What and how much ❯ Type of information resources are being used optimally
equipment is needed technology used

Resource focus
The company uses resources as efficiently as
possible. Wastage is kept to a minimum, but
50%
expected average annual
satisfying demand is hard because work is at full
capacity and output cannot rise. growth in vehicle deliveries
at Tesla to meet demand
Manage capacity—keep stock low
It produces stock according to demand and holds low inventory
to minimize unnecessary spending and storage costs.

Demand not satisfied

Company is unable to meet surges in
demand; customers may have to wait
while production catches up, and
business may be lost to competitors.
 Inventory
Companies have to manage inventory (stock) to meet customer
demand, even if they trade online and have no physical storefront.
Successful inventory management is a complex process.

How it works Effective inventory management involves systems

Stock may include finished goods, work in progress, and programs for sales forecasts, production
and raw materials. Getting the right level is a balance targets, and actual inventory status, plus the
between having enough to meet customer demand and physical tracking and handling of the different
having too much, which is costly in terms of finished items. Bar codes and radio-frequency identification
goods, storage space, and warehouse staff. Stock may (RFID) tags have revolutionized inventory management,
also lose value if it spoils or become unsalable because making it much easier to monitor stock levels.
of changes in fashion or obsolete technology.

Inventory management
Successful inventory management strikes a fine balance between
satisfying customers and minimizing the risk of holding too much stock.
In this example, the clothing company is managing the supply of T-shirts
for a range of sites and for direct delivery to customers.

Make sales forecasts Order from suppliers Production

The company sets production Decisions on the level of raw The quality of raw materials and
targets based on predicted materials to hold are based on lead finished goods is checked at every
demand. times and reliability of suppliers. stage of production.

Smaller storage
The company may use smaller
facilities to hold extra stock—for
example, to meet seasonal demand.
 HOW OPERATIONS AND PRODUCTION WORK
Control 316 317

NEED TO KNOW
❯ First in, first out (FIFO) Oldest inventory items
$1.8
trillion
sold first (or recorded as sold for accounting
purposes rather than physically moving goods)
❯ Last in, first out (LIFO) Most recently produced
items sold first (or recorded as sold)
❯ Stock-keeping unit (SKU) A distinct item that
has its own stock code lost globally in 2020 as a
❯ RFID tag A chip that enables remote tracking
of an item by radio sensors result of retailers’ inventory
mismanagement

Main warehouse
The company may have one main warehouse or a number Delivery to customers
of warehouses as hubs for smaller storage facilities. Efficient and timely delivery is part
of the overall customer experience,
especially as online shopping grows.
Stock is checked in by scanning bar
codes or RFID tags.

Customer returns
Returns are checked out by scanning
bar codes or RFID tags. Batch number
and other data can be monitored.
 Quality control
There is a series of processes to ensure that a business maintains a
required level of quality in its products or services. Quality control
is particularly important in industries where safety is an issue.

How it works Quality control relies on a predetermined percentage of

Businesses measure and manage the quality of their products for inspection, agreed corrective action, and
output against national legal standards and/or internal remedial efforts to minimize future defects. Industries
standards. For example, the manufacturing industry in which safety is paramount, including food, clothing,
sets its own standards. Checking takes place against pharmaceuticals, construction, and car, train, and
these and any national standards at various points aircraft manufacture, are subject to extremely strict
along the production process, such as when raw standards of quality control. Some are there to
materials arrive in the factory, during production, and protect workers—for instance, if they are handling
before shipment of finished goods to the customer. chemicals—while others safeguard the consumer.

The bread and butter

of quality control
Hygiene and safety are essential in the food industry, as in this example of quality
control in a factory making prepackaged sandwiches. Samples are tested all
along the line. Any lapses in quality not only are a dangerous health hazard but
would also be extremely damaging to the company’s reputation.

Delivery to factory Assembly line

Before assembly, weight, chemicals, During assembly, weight,
bacteria, taste, and interaction of temperature, freshness,
individual ingredients are tested. and visual appearance
are assessed.
 HOW OPERATIONS AND PRODUCTION WORK
Control 318 319

GLOBAL FOOD STANDARDS

Ensuring the quality of food products as they cross the globe
is vital for health and economies worldwide. Founded by the United
Nations in 1963, the Codex Alimentarius is an internationally
recognized set of food standards, guidelines, and codes of practice
that helps do just that. Its voluntary, science-based provisions cover
all aspects of food safety and quality, including hygiene,
contaminants, and labeling.

$18
billion
Packaging station
Samples are tested to check that
sealing is accurate, labels are
correctly applied, and overall
presentation is good.
the projected size of
the global prepackaged
sandwich market by 2025

Storage Transportation
The temperature is checked The temperature in
for accuracy and safety, and the vehicles and their
samples are tested for taste, delivery time are
texture, and contamination by checked to ensure
foreign objects. product freshness.
 Six Sigma
Used in organizations to strive for near-perfect products and
services, Six Sigma is a disciplined, data-driven approach for
eliminating defects in any process.

How it works Every Six Sigma project is carefully

The idea is that measuring the documented, follows a defined
number of defects in any process sequence of steps, and has

5
makes it possible to systematically quantified value targets, such as
figure out how to eliminate them increasing customer satisfaction
and get as close to zero defects as or reducing costs. To achieve Six
possible. Individuals are trained to Sigma quality, a manufacturing
become experts in the different process must have 99.99966 Control
methods, creating a cadre of black percent of output free of defects Perform before-and-
belts, green belts, and champions. (3.4 defective parts per million). after analysis; monitor
systems; document
SIX SIGMA ROLES results; determine
recommendations
Six Sigma professionals are experts at improving for next steps.
processes. They drive the implementation of change.

Master black belt Trains and coaches

black belts and green belts; works at
highest level, developing key measures
and the strategic direction 4
Improve
Black belt Leads problem-solving
projects; coaches project teams, assigning Implement
roles and responsibilities; trains green improvements
belts and so address
the root causes of
major problems.
Green belt Leads green-belt projects;
helps with data collection and analysis
for black-belt projects

Champions Translate the company’s

vision, mission, and goals to create an
organizational deployment (OD) plan and
identify individual projects
“The most
dangerous kind of
Executives Provide overall alignment by
establishing strategic focus of the Six waste is the waste
Sigma program within the context of the
organization’s culture and its vision of we don’t recognize.”
what the customer sees and feels Shigeo Shingo, industrial engineer
and Six Sigma expert
 HOW OPERATIONS AND PRODUCTION WORK
Control 320 321

1 CHAMPIONS
Cell phone maker Motorola
pioneered Six Sigma quality
Define in the mid-1980s, using it
Define the project’s purpose and as a goal for its
scope; identify processes that need manufacturing operations;
improvement; determine customer under CEO Jack Welch,
needs and benefits. General Electric was
another early adopter.
Since then, firms as diverse

2
as the Credit Suisse bank,
shipping company

Striving for Maersk, and electronics

manufacturer Samsung

perfection Measure
have adopted it.

The DMAIC methodology Use data on current

(standing for Define, Measure, processes as a
Analyze, Improve, Control) is an baseline; pinpoint
integral part of Six Sigma. It is problem locations
used for improving existing and occurrences;
business processes that are identify potential
falling below targets and where areas for
step-by-step improvements improvement.
can be made.

NEED TO KNOW

3
Analyze
Identify root causes of ❯ Lean Six Sigma A combination
problems and check them of Lean production (see pp.288–
against data; determine 289) and Six Sigma. The Lean part
precise improvements that focuses on removal of waste from
need to be made. all activities, whereas Six Sigma
focuses on reducing the number
of defects.
❯ DMAIC Define, measure, analyze,
improve, control—the cycle for
improving existing processes to
Six Sigma level.
❯ DMADV Define, measure,
analyze, design, verify—the
cycle for designing new processes
or products at Six Sigma level.
Also known as Design for Six
Sigma (DFSS).
 Supply chain
Along the journey from raw material to finished item in the hands of a
consumer, every business needs an efficient supply chain. Supply chain
management involves different organizations, people, activities, and
resources to take, for example, grains of corn from a field to a finished
box of cornflakes on the consumer’s breakfast table. The company may
outsource parts of the chain to other firms.

Supply chain management

The traditional supply chain takes raw materials and the environment along the way, from fair wages for labor
resources through to a finished product for the consumer. at the source to recyclable packaging after consumption.
The company has to manage costs and ensure standards, Supply chain is big business—in the U.S., 5.75 million people
being particularly careful that it does not harm people or are employed in warehousing and transportation alone.

Raw materials and resources Supplier and processor Manufacturer

Whether from a field or a mine, raw The raw materials are processed, Organizations bring resources together
materials start somewhere. often near their source. to manufacture goods, often near the
customer.
 HOW OPERATIONS AND PRODUCTION WORK
Supply chain 322 323

64%
of retailers say they
EXTENDING THE CHAIN
❯ Adding value Companies may try to add value along
the chain rather than just seeing it as a way to transport a
had to adapt their product from A to B. See pp.324–325.
❯ Delegating functions To save money and use
supply chain for specialized expertise, the business can outsource
activities and/or have them done by local companies or a
e-commerce during branch of its own company offshore. See pp.326–329.
❯ Returning goods Part of the supply chain involves an
the COVID-19 pandemic efficient system for dealing with goods returned by the
consumer. See pp.330–331.
❯ Competitive edge At every stage, the company
compares its performance with its competitors to see
how it can improve. See pp.332–333.
❯ Ethics and the environment Taking responsibility for
avoiding pollution and protecting workers’ rights is part
of the package. See pp.334–335.

Distribution Retailer Consumer

Finished goods are transported to The store displays the products for The consumer enjoys the finished
storage depots or retailers. maximum appeal to the consumer. product and, ideally, recycles
the packaging.
 Value chain
Rather than viewing supply chains as a series of activities, organizations
are increasingly paying attention to how value is created at each stage
of the process. Lowering costs or raising performance is key.

How it works of the value chain is that how activities are organized
Harvard Business School professor Michael Porter first and carried out determines a company’s costs and
introduced the concept of a value chain in his book thus its margin (profit). Each link of the chain must
Competitive Advantage. Most organizations have communicate to other departments clearly and
dozens—possibly hundreds—of activities along the promptly. For example, marketing and sales must make
supply chain in the process of converting raw materials accurate sales forecasts and pass them on in time for
(inputs) to products or services (outputs). These can procurement to buy the correct type and quantity of
be classified generally as either primary or support raw materials, which in turn must connect with
activities that all businesses must undertake. The idea inbound logistics so it can organize receipt of goods.

Porter’s value chain

provide necessary information between
value-chain activities to make a profit.
Each department must cooperate and

Primary activities work directly to create

or deliver a product or service, while
PRIMARY ACTIVITIES

support activities help improve their

efficiency. To apply the value chain, a
company has to identify each activity
and either lower its cost or differentiate
it from its competitors to add value in Inbound logistics Operations
the customer’s eye. Involves relationships Activities required
with suppliers, to transform inputs
including all activities into outputs
to receive, store, and
CASE STUDY allocate inputs

Zara’s value chain

The Spanish clothing brand is famous
for rapidly responding to customers’ Company infrastructure 
these support primary activities, improving
Although not directly involved in outputs,

needs along the value chain.

their efficiency and successful function.

❯ Inbound logistics Bulk fabric

orders, quick deliveries
SUPPORT ACTIVITIES

❯ Operations Just-in-time Human resource

manufacturing, near Spanish HQ management
❯ Outbound logistics Twice-weekly
store deliveries, low inventory, fast
online fulfilment
Technology development
❯ Marketing Few ads, strategic
store locations, store data ensure
products match customers’ wants
❯ Support activities Tech to supply Procurement
feedback, customer service training
 HOW OPERATIONS AND PRODUCTION WORK
Supply chain 324 325

ONLINE VALUE CHAIN

More than half of the world’s population uses the
Internet, doing everything from shopping to sharing
photos and watching TV, working, and checking
social media. To handle this volume, a complex value
6,384
the number of local
chain delivers Internet services, made up of global
and local firms with assets as diverse as content
rights, communications and IT infrastructure,
Spanish firms supplying
proprietary software, and global brands. Zara’s parent company
Inditex in 2020

Outbound logistics Marketing and sales Service

Activities required to Activities that inform Activities to keep
collect, store, and buyers, encourage products working
distribute outputs purchases, and facilitate effectively for buyers
transactions after they are received
PROFIT MARGIN
Profit equals the
customer’s willingness to
pay more than the sum
of all the activities in the
Functions such as accounting, legal, finance, planning, value chain.
public affairs, and quality assurance

People activities: recruiting, hiring, training, developing,

compensating, and terminating

Equipment, hardware, software, procedures, and technical

knowledge used in transformation of inputs into outputs

Acquisition of inputs (raw materials) for the company

 Outsourcing
Firms may choose to pay outside suppliers to do work rather than
complete the tasks internally. Handing over part or all of production
or a service to a third party increases flexibility.

How it works functions, such as accounting; or because they do

Outsourcing grew in the 1980s because firms looked to not have the specialized knowledge or skills within
save costs by contracting peripheral business activities the organization. Outsourcing may be to a company
to third parties. But outsourcing today is no longer in the same country, or it may be to an organization in
just about cost savings. It is a strategic tool that is another country. Rapid expansion of logistics networks
increasingly important in the global economy in the and information technology has made it easier to
21st century. Businesses may choose outsourcing for outsource, thus accelerating the growth of outsourcing
elements of the production process; for support over the last decade.
COMPANIES SURVEYED (%)

100
What services are outsourced?
Growth and success for many businesses is underpinned
90 by outsourcing, as a number of companies ask: why do it
ourselves if another company can do it faster, better, or cheaper?
Organizations recognize that using external capabilities,
80 54% capacities, knowledge, and skills opens opportunities. Some
businesses now focus only on their core operation; in a 2021
Information
technology

global survey by Deloitte, these were the main services that

70 organizations outsourced to third-party providers.

60
44%
Finance

50 32% 22%
17%
contact center
Payroll

17%
service or
Customer

40
Procurement

resources
Human

30

20

10

0%
 HOW OPERATIONS AND PRODUCTION WORK
Supply chain 326 327

NEED TO KNOW
❯ Outsourcing Subcontracting work
to another company or buying
components for a product rather
than manufacturing them.
❯ Shared services Practice of
moving specific services that
were formerly carried out in many
parts of an organization (such
80%
of firms say they
❯ Offshoring Practice of moving
a company’s operating base to a
as HR, finance, and IT) into a single
unit. Differs from outsourcing in that
have no plans to
foreign country where labor costs
are cheaper.
no third parties are involved.
move offshore
services back in
the short term.

EXAMPLES OF BUSINESS TASKS THAT CAN BE OUTSOURCED

Outsourcing certain tasks within a
business enables focus to remain on
core business activities, which helps Computer/
Accounting IT support Customer
generate growth as well as income. Manufacturing
Some tasks are better suited to support
Engineering
outsourcing than others due to factors
including expertise, how time consuming
a task is, and how much face-to-face
time it requires. IT operations, for
Research and CORE Health care
example, can be highly expensive, services
development BUSINESS
require expert knowledge, and can easily
be managed remotely. Human
resources, however, is more employee
focused and so better kept in house. Legal
Tax services
preparation
Payroll Web Logistics
17% design

12%
accountancy

4%
Property and

management

7% 5%
facilities
Tax

11%
manufacturing

5%
chain and
marketing

Supply
Internal

and risk

Sales and
Legal

audit

security
Digital

SERVICES
 Offshoring
Moving jobs outside the country where a company is based is called offshoring.
A company will set up operations overseas and recruit local people to do the
work, usually with the support of employees from the parent company.

How it works perhaps to be close to a source of raw materials. They

Offshoring grew in the 1980s as Western companies can also send services offshore, such as call centers, in
with high labor costs realized that they could reap locations with a ready supply of skilled staff. In
significant savings by manufacturing in countries addition, companies can outsource offshore, having
with lower overheads. Information technology (IT) work handled by a third party. Firms that send work
services followed, enabled by the Internet and global offshore must follow ethical practices, such as paying
communications. Some firms send manufacturing local people a fair wage and upholding health and
offshore by setting up a factory in another country— safety standards in the workplace.

Global expertise
Offshoring started in India, Samsung Ford
and today, it still leads the way.
The country’s IT and business South Korean company Samsung runs Ford has manufacturing
processing outsourcing export manufacturing facilities in the U.S., plants and facilities in
industries employ more than which is a big market for its products. Mexico.
four million people and are
worth $147 billion. Other
regions have different areas
of expertise; for instance,
Eastern Europe also specializes Brazil
in IT services. This map shows
examples of the areas of Offshoring benefits
expertise available in different ❯ Attractive hiring costs
countries, and companies that
Levi Strauss & Co.
❯ Skilled labor pool
offshore their operations.
In 2019, Levi Strauss & Co. ❯ Good IT infrastructure
acquired operating assets related
to the Levi’s and Dockers brands
from The Jeans Company (TJC),
its distributor in Chile, Peru, and
Bolivia, to enable it to increase
growth across the region.

55%
India’s share of the global
outsourcing market
 HOW OPERATIONS AND PRODUCTION WORK
Supply chain 328 329

THE PROS OF OFFSHORING THE CONS OF OFFSHORING

❯ Cheaper labor costs ❯ Communication problems
❯ Proximity to raw materials ❯ Working in different time zones
❯ Access to specialized staff ❯ Different working cultures can cause difficulties
❯ Tax benefits ❯ Can be vulnerable to geopolitical unrest

Jaguar Land Rover Ukraine Apple

Jaguar Land Rover has a Offshoring benefits Apple has had substantial
cutting-edge manufacturing ❯ Engineering capability operations in China for
plant in Slovakia. many years.
❯ Access to people with
software development skills
❯ Cost competitiveness India
Offshoring benefits
CloudSimple ❯ Availability of highly trained
technicians
In 2019, Google acquired
CloudSimple, a U.S. company ❯ Access to latest technology
with a base in Ukraine, and ❯ Government offers
subsequently opened an R&D beneficial policies
center there.

Cisco
Cisco has put major
investment into an R&D
center in Bangalore, India.

The Philippines
Zara
Offshoring benefits
Spanish retailer
❯ English is an official
Zara manufactures
language
clothing in Turkey.
❯ High literacy and education
❯ Reliable infrastructure

South Africa
Macquarie Group
Offshoring benefits
Australian financial services
❯ Diverse talent pool
company Macquarie Group
❯ Good infrastructure has an offshore base in
❯ Access to latest technology the Philippines.
 Reverse supply chain
Supply chain takes a product to a customer. Reverse supply chain is
the series of activities it takes to retrieve an unwanted or used
product from a customer and dispose of, recycle, or resell it.

How it works For instance, companies have to manage products that

Companies have to focus on more than bringing a are returned for a refund, products that do not sell and
product to a customer. Now, an efficient reverse supply are returned to producers from retailers, or products
chain is also essential, especially for the large number near the end of their life. In a drive to improve
of online retailers. Manufacturers, too, in industries sustainability, Swedish chain Ikea offers to buy
from carpets to computers, may need reverse supply to back old items of its furniture from customers.
recycle products to meet environmental regulations.
Retrieve

Reverse logistics
The cost to companies of reverse supply is enormous.
For example, in the U.S., statistics from the National Retail
Federation show that consumers returned $428 billion of
goods in 2020—with online returns almost doubling
as consumers switched to Internet shopping during the
COVID-19 pandemic. This represents about 10 percent Companies may have processes in place to
of total U.S. retail sales of $4 trillion for the year. collect used or unwanted items, whether
from the customer or a retailer.

CUSTOMER RETURNS
Retailers Sears and JCPenney were the first
stores to allow consumers to return goods with
no penalty. This pioneering move in the late
19th century encouraged people to shop with
them and helped build a loyal following. These
days, most physical and online retailers allow
customers to return unwanted items within a set
time period and receive an exchange or refund.
Consumers have the right to return faulty goods, $
which also forms part of the reverse supply chain.

Eventual recycling or reconditioning may

Please return be considered at the start of design and
within 28 days manufacturing decisions.

Manage disposal
 HOW OPERATIONS AND PRODUCTION WORK
Supply chain 330 331

NEED TO KNOW
❯ Electronic waste (e-waste)
Electrical or electronic devices
that are unwanted, do not work,
84%
of Brazilian online shoppers
or are obsolete
❯ Warehousing Administrative and are likely to make an extra
physical functions necessary for
storage of goods, either for selling purchase when returning
or retrieval
an item to a physical store
Transport Receive

Customers expect items to be transported Effective inventory management is critical

back to the seller in a straightforward to ensure that inbound items are recorded so
system, in person or by a delivery service. the company can keep track of returns.

Items and components are sorted and Items are carefully checked on return.
separated, ready for reselling, recycling, If they are to be resold, they must be in
or disposal. pristine condition.

Sort Inspect
 Benchmarking
Businesses use benchmarking to improve efficiency by comparing
their performance with that of other organizations. The goal is to
identify and learn from best practices within or outside the industry.

How it works a range of factors, including training, technology

To improve results, a business may look outside the platforms, and manufacturing equipment. For example,
organization, industry, or country to explore others’ Formula 1 is often used as a benchmark for teamwork,
levels of performance and identify how they achieve it. as pit-stop crews have perfected the changing of four
Benchmark areas include unit cost, customer ratings, tires in fewer than seven seconds.
and pay and benefits. The evaluation takes into account

The process of benchmarking

There are several stages to benchmarking performance
before a company can start to see cost
savings and increased efficiency. commer
ns a
w cia
yo l
n

bu
pa

ild
Com

Identify need to ing Compare to

benchmark competition
In this example, a company The company gathers
wants to improve its energy information on others’
efficiency. energy systems and costs.

energy an eplaces l
itors dm any r igh
on p ti
m
ym

Co

ng
on
ey
an

Monitor value
Comp

saved

It measures how much its

energy costs have gone
down and how well the
new lighting system works.
 HOW OPERATIONS AND PRODUCTION WORK
Supply chain 332 333

SOCIAL MEDIA MAKES “Benchmarking is the

IT EASY
search for industry best
It is now easier than ever for organizations
to gather data about their competitors. practices that lead to
Social media can provide data on customer
preferences, brands, and campaigns of other superior performance.”
organizations. Analytical tools are available Robert C. Camp, benchmarking pioneer
to simplify benchmarking across many
different channels.

imilar build ng is more

s at s in uildi en
g e
ok sb

rg
s’

r’
o

tito
en

y-
yl

eff
Compan

erg

Compe
Analyze differences

cient
CO2
y use

or gaps
It sees that a comparable
company has a much lower CO2
carbon footprint.

nergy au
out e dit
s o
ie
fo
rr
ca

wn

Implement changes Identify changes

Company

building

It changes its lighting system required

to the one used by the most It examines its own
energy-efficient company in its energy use to see how
survey. it could improve.
 Corporate social
responsibility
Businesses today must aim not only to do no harm to the environment,
people, or communities but also to show commitment to building a
better society. This is termed corporate social responsibility (CSR).

How it works
For a business, CSR goes further than aiming to be
compliant with national or international regulations,
managing risks, or corporate philanthropy—it has
to be an integral part of every aspect of operations,
helping create a sustainable business. A company
still has to be competitive and profitable but
must avoid making decisions merely for short-
Community
term gain. Instead, it has to consider the future Housing; healthcare;
impact on society, the environment, and a wide infrastructure; partnering with
range of stakeholders. Companies now report local institutions; local supplier
annually on how they have met their CSR and are initiatives; education; training;
benchmarked and ranked against competitors. local employment

100%
of the top 100 Environment
companies in Japan Company’s carbon footprint,
including recycling; water and
and Mexico report waste management; energy use;
transportation
on sustainability
 HOW OPERATIONS AND PRODUCTION WORK
Supply chain 334 335

Workforce
Workplace safety, health, and
well-being; diversity; equal
opportunities; learning and
development; ethical policies Suppliers
and practices Fair trade, supply-chain ethics,
and sustainability (including use
of child labor); code of conduct;
transportation policies

CSR
stakeholders
A number of different
business areas have to be
considered in assessing a
company’s CSR, from how it
affects people working in
and for the company to
wider environmental and
community implications. Operations
Ethical trading, including marketing
practices and pricing; managing
customers; financial reporting;
policies; values

CASE STUDY
AstraZeneca’s biogas stoves
The pharmaceutical firm’s CSR initiatives include funding a project
to test biogas stoves in rural Kenya. The wood and charcoal-fueled
stoves traditionally used by many Kenyans release harmful smoke,
contributing to climate change and causing respiratory problems in
those using them (mostly women and girls). So, the firm partnered
with Kenyan company Biogas International and the University of
Cambridge’s Institute for Sustainability to install smokeless stoves that
run on biogas made from organic waste. AstraZeneca also runs other
projects targeting ill health in developing countries as well as a
health and well-being strategy for its staff.
How companies work
Businesses in the U.S. are registered in the state in which they are
headquartered. The government recognizes four business structures:
sole proprietorship, partnership, corporation, and nonprofit corporation.

Sole proprietorship of stock owners. A publicly held corporation makes

An individual (or married couple) may register their shares available to the public through a stock exchange
business as a sole proprietorship if they plan to conduct or through over-the-counter markets.
operations on their own. This is the simplest form of
business structure. The owner is entitled to all Limited Liability Company (LLC)
revenues and profits, while maintaining personal An LLC combines elements of limited partnerships and
responsibility for all debts and liabilities. Income from corporations in a form that is a type of pass-through for
sole proprietorships is taxed as individual income. sole or multiple owners. It protects the owners from
liability, but not as much as a corporation does.
Partnerships
Partnerships are business entities formed by two or Nonprofit corporation
more individuals. The most basic form is the general A nonprofit corporation engages in activities to further
partnership. Partners in a general partnership the public good, such as works in charitable, scientific,
contribute an agreed-upon share of money, skill, and educational, or artistic fields. Such organizations, most
labor to the enterprise in exchange for a proportionate frequently registered with the Internal Revenue Service
share of the profits. Liabilities are thusly divided as (IRS) through form 501(c)(3), are generally tax-exempt
well. A limited partnership includes general partners at the federal and state levels. They may, in fact, make
and limited partners (also known as silent partners) profits and pay competitive salaries but are prohibited
who share in the profits but whose losses are generally from engaging in political activities.
limited to the size of their initial investment. Similar to
a general partnership, a limited liability partnership In Canada
indemnifies one partner from claims arising from other Businesses in Canada can also be sole proprietorships,
partners’ negligence. Lawyers and doctors frequently partnerships, or corporations. They can also be run as
operate under this structure. cooperatives, a business that it is owned and controlled
by its members. Co-ops are often used by agricultural
Corporation enterprises. Canadian companies must register in the
Federal and state governments recognize corporations province or territory in which they are headquartered.
as business entities that are separate and apart from
employees and shareholders in terms of income and Reporting requirements
liabilities. This structure protects management and Businesses in the U.S. are subject to a range of financial
workers in the case of litigation or other claims but is reporting requirements and regulations, depending
more complex and subject to greater regulation than a on structure. Owners of sole proprietorships include
partnership. Such entities must be registered through income on their individual tax returns filed annually
articles of incorporation. A corporation may be privately with the IRS. Corporations must also report income
held, in which case equity is shared by a limited group to the IRS but are subject to additional requirements.
 U.S.-SPECIFIC INFORMATION
How companies work 336 337

Privately held corporations must, at a minimum, file

charter documents, including name and address, with ORGANIZATIONS AND RESOURCES
the Secretary of State in the state in which they are
headquartered. Publicly traded corporations are subject The Small Business Administration website has information
to considerably greater disclosure requirements. They on the corporate structures permitted under U.S. law.
www.sba.gov
must file with the Securities and Exchange Commission
quarterly (10-Q) and annual (10-K) reports detailing Taxation
revenue, income, profits, and losses. They must also file The Internal Revenue Service provides a number of online
interim reports (8-K) disclosing significant events, such services for business owners, including when and where
as an acquisition or divestiture, as well as reports to file tax returns and how to obtain tax credits.
(Form 4) that disclose significant buying and selling www.irs.gov/businesses
of shares by company insiders. Start-ups
BusinessUSA is a central repository where entrepreneurs
Company law can access a range of services. Its website provides
The U.S. Constitution vests in individual states the information on funding, taxation, hiring, growth
power to regulate commerce and administer and strategies, and more. It also offers advice tailored to
oversee companies that operate within their borders. specific groups, such as women, veterans, and minorities.
business.usa.gov
States maintain a Department of State or equivalent
that acts as registrar for commercial endeavors. The U.S. Department of the Treasury also offers advice
and services for would-be proprietors. In addition, it
Departments of State maintain publicly searchable
operates the Small Business Lending Fund, which secures
databases of registered companies, hold administrative loans made to business owners by private banks.
hearings, and can take enforcement actions. www.treasury.gov/Pages/default.aspx
Registering intellectual property
Taxation
The IRS collects taxes from businesses on behalf of the The main arbiter for determining whether a product or
business method is worthy of exclusivity is the United
federal and state governments. At the time of printing,
States Patent and Trademark Office.
the federal tax rate on corporations range from 15 to 35 www.uspto.gov
percent. Tax rates vary widely among states, and
Immigration
six states impose no corporate income tax at all.
The federal government and states do not collect All employees must be authorized to work in the U.S.
Value-Added Taxes (VAT) from businesses, but many through citizenship or some form of visa. U.S. Citizenship
and Immigration Services, part of the Department of
states impose sales tax on consumers that businesses
Homeland Security, determines visa eligibility and
collect at the point of sale. Several states have no sales enforces immigration rules.
tax. Sales taxes can also vary depending on the item
In Canada
purchased. For example, in New York State, groceries
are tax-free, while takeout meals are taxed at the The Canada Business Network offers information about
prevailing rate of 4 percent. New York City also applies starting and operating a business.
www.canadabusiness.ca/eng/page/2853/
an additional sales tax of 4.5 percent to most items.
www.entreprisescanada.ca/fra/page/2853/
Other municipalities around the country are also free
to establish their own sales tax rates.
How finance works
For publicly traded companies, the Securities Exchange Act of
1934 is the framework for financial accounting and reporting.
The Securities and Exchange Commission (SEC) enforces the act.

The SEC has established reporting requirements for Reporting standards

companies whose shares trade on public exchanges, Companies must log and report financial transactions
such as the New York Stock Exchange, the NASDAQ to the SEC according to Generally Accepted Accounting
Stock Market, and the NYSE Market LLC. Privately held Standards (GAAP) as established by the Financial
companies are subject to fewer requirements. Accounting Standards Board, a private, nonprofit
organization. Due to the increasingly global nature of
Tax reporting business, there is a movement to adopt International
Both private and public companies must file tax returns Financial Reporting Standards (IFRS).
with the Internal Revenue Service on an annual basis. In the aftermath of several events in recent
The due date varies, based on the filer’s status. Sole years, including the bursting of the so-called dot-com
proprietorships follow the same schedule as individuals bubble; the increased use of controversial financial
and must file by April 15 or request an extension. instruments, such as mortgage-backed securities (MBS)
Partnerships must file by the 15th day of the fourth and collateralized debt obligations (CDO); and the
month after the end of their fiscal year. Public 2007–2008 financial crisis, the FASB has adopted
companies must file by the 15th of the third month. a number of new rules aimed at restoring order and
clarity in the markets.
Financial disclosure
Exchange-listed companies must make their financial Accounting periods
records publicly available on a quarterly and annual For sole proprietorships, the reporting period for tax
basis, respectively. They must report unscheduled, purposes runs simultaneous to the calendar year.
material events (such as an acquisition or divestiture). Publicly traded companies may set their own fiscal
Officers and insiders must declare significant purchases years. Public companies must file a report for each fiscal
or sales of company stock, and the terms of issuance for quarter as well as a report at the end of each fiscal year.
corporate notes must be detailed. Reports generally must be released within 45 days after
Regulation Fair Disclosure (Reg FD) stipulates that the close of a quarter.
companies must disseminate financial information
simultaneously to all investors. The SEC amended Corporate fraud
Reg FD in 2013 to include disclosures through social In addition to its regulatory functions, the SEC, through
media channels, such as Twitter and Facebook. its Division of Enforcement, is also the U.S.’s chief
Public companies must retain a licensed auditing firm watchdog when it comes to policing and prosecuting
to verify the veracity of their financial records. Under financial fraud. The SEC is mainly on the lookout for
SEC rule 3235-AI74 (2003), auditors must retain client several types of misconduct:
records, including worksheets, financial data, meeting False statements. Corporations must report financial
minutes, electronic correspondence, and other information that, to the best of management’s
materials used to form an opinion, for seven years. knowledge, is complete and accurate.
 U.S.-SPECIFIC INFORMATION
How finance works 338 339

Insider trading. Corporate insiders, such as officers

and executives, can legally buy and sell shares in ORGANIZATIONS AND RESOURCES
their companies, but not on the basis of nonpublic
information. For example, a CFO cannot unload shares Financial reporting
on the basis of negative financial news that has not yet The Securities and Exchange Commission provides
been released. Insiders are also barred from tipping off information on financial reporting requirements for
friends, family, and business associates. publicly listed companies.
Ponzi schemes. This is the practice whereby a money www.sec.gov
manager distributes returns to existing investors from The Financial Accounting Standards Board website
funds acquired from new investors. These schemes features educational webcasts and seminars for finance
and accounting professionals.
generally collapse once a fund runs out of fresh capital.
www.fasb.org/home
The most infamous Ponzi scheme to date is that
The Association of Chartered Accountants in the
orchestrated by fund manager Bernard Madoff, starting
United States offers online training videos, while the
in the 1990s and continuing until his arrest in 2008. CFA Institute maintains a glossary of finance and
Pump and dumps. This occurs when a brokerage investment terms.
acquires a large amount of stock, spreads false news www.acaus.org
meant to increase the stock’s value, and then quickly www.cfainstitute.org/pages/index.aspx
sells its position before the fraud is uncovered.
Corporate fraud
Front running. This occurs when a brokerage
acquires a block of shares in a particular company Those who wish to report corporate fraud may approach
the SEC directly through its Office of the Whistleblower.
before executing a large, pending buy order from a
www.sec.gov/whistleblower
client. The client’s order, if large enough, will increase
Similarly, the Internal Revenue Service maintains
the value of the stock, allowing the firm to profit from
an office through which the public can anonymously
its foreknowledge of the transaction. report suspected corporate tax cheats.
www.irs.gov
In Canada In Canada
The Toronto Stock Exchange is Canada’s largest and
most commonly used stock market. It is overseen by The Canada Revenue Agency website has information
on the GST and other taxation issues.
the Ontario Securities Commission. Stock markets
www.cra-arc.gc.ca
also operate in Vancouver and Montreal.
The Ontario Securities Commission offers a number
Businesses operating in Canada must file tax returns of online resources for companies considering a listing
with the Canada Revenue Agency. Forms may be filed on the Toronto Stock Exchange.
through the mail or electronically. Unlike in the U.S., the www.osc.gov.on.ca/
federal government in Canada imposes a value-added
tax known as the Goods and Services Tax (GST).
The current rate is 5 percent. The tax is levied on
manufacturers and producers throughout the chain
of production. In some cases, companies can claim tax
credits for tax already paid. In some provinces, the GST
is included in the Harmonized Sales Tax (HST).
How sales and
marketing work
Advertising and marketing in the United States are regulated at the
federal and state levels. The Federal Trade Commission (FTC) sets
national policies and enforces relevant laws passed by Congress.

The First Amendment to the U.S. Constitution restricts At the state level, the Better Business Bureau accepts
the government’s ability to limit or inhibit public and responds to complaints regarding companies doing
speech or communication. However, courts over the business within state jurisdictions.
years have ruled that commercial speech is subject
to less protection than noncommercial speech. In Canada
The Federal Trade Commission (FTC) was Freedom of speech and expression in Canada is
established in 1914 through the Federal Trade protected by Section Two of the Canadian Charter
Commission Act. Much of the FTC’s work involves of Rights and Freedoms. As is the case in the U.S.,
enforcing truth-in-advertising regulations, a commercial speech is afforded less protection than
legislative rubric that requires ads to be truthful, political or other types of expression. Still, the Charter
not misleading, and backed by scientific data, if places numerous limitations on the federal and
appropriate. In a case of suspected false advertising, provincial governments’ ability to abridge marketing
the FTC can sue the perpetrator in federal court to and advertising communications. For example,
obtain a cease-and-desist order, freeze assets, and Canada’s Supreme Court in Ford v. Quebec (1988)
obtain compensation for victims. struck down a Quebec law that required all advertising
The FTC also enforces legislation aimed at electronic signs to be in French.
marketing communications, such as email campaigns Commercial speech in Canada is also governed
and telemarketing. For example, the Commission can by the Consumer Packaging and Labelling Act (1985).
file suit against agencies suspected of violating the The law prohibits the use of misleading ads and claims
National Do Not Call Registry. Telemarketers are on consumer goods.
forbidden from calling consumers who have entered
their numbers in the registry. Similarly, the FTC Data protection
enforces the CAN-SPAM Act of 2003, which requires Unlike Europe, with its centralized Data Protection
marketers to give consumers a way to opt out of Directive, the U.S. does not have a single, overarching
receiving future messages. law on data protection. Rather, Congress has passed
The Federal Communications Commission (FCC) a series of laws that together form a framework
also has some authority to regulate commercial speech. around the safeguarding of consumers’ privacy and
For instance, the FCC enforces the CALM ACT of information. Many of these rules are directed at
2012, which stipulates that broadcasters and cable particular industries. For example, the Department
companies must air commercials at the same volume of Health & Human Services enforces the Health
as regular programming. Insurance Portability and Accountability Act of 1996
Individual states can set marketing and advertising (HIPAA). The act dictates the administrative, physical,
rules, particularly for highly regulated industries, such and technical safeguards that health care insurers and
as health care, financial services, and real estate. providers must follow to protect patient records.
 U.S.-SPECIFIC INFORMATION
How sales and marketing work 340 341

In financial services, the Gramm-Leach-Bliley Act of

1999 stipulates the steps that banks, credit unions, and ORGANIZATIONS AND RESOURCES
other financial institutions must follow to safeguard
customer data. The act is enforced by the FTC. Other Advertising
industries are also subject to specific privacy and data The Federal Trade Commission oversees truth-in-
protection rules. advertising laws and regulations and offers resources
to advertisers and marketers to help keep them
Direct marketing from breaking the rules. On its website, the FTC
publishes advisory opinions on how changes
Direct marketing agencies are subject to laws enforced
to laws or court rulings may have an impact on
by the above-mentioned agencies but are also future enforcement decisions.
supposed to adhere to self-imposed codes of conduct www.ftc.gov/policy/advisory-opinions
adopted by the Direct Marketing Association. The The Bureau of Consumer Protection, an arm of the
DMA is a lobby group for the industry that promotes FTC, operates an online Business Center that advises
“responsible, data-driven marketing.” The DMA businesses how to comply with Do Not Call, CAN-SPAM,
develops member policies on a number of issues, and other rules. It also offers general guidelines on
including privacy, the environment, e-commerce, advertising and marketing basics, marketing to children,
and consumer protection. health claims, and “Made in the USA” claims.
www.ftc.gov/tips-advice/business-center/advertising-
and-marketing
E-commerce
For marketers that conduct campaigns through the Data protection
Internet and social media channels, the Interactive Various federal agencies can provide information
Advertising Bureau (IAB) publishes codes of conduct on rules, regulations, and methods concerning the
that members are expected to follow. For example, protection of consumer data and privacy, depending
on the industry.
the IAB expects all members to be transparent about
the data and personal information they collect from The Department of Health & Human Services publishes
an online FAQ for complying with HIPAA. It also posts
consumers on the Web.
guidelines for covered entities and their business partners
and associates.
www.hhs.gov
For marketers and advertisers who work within the
financial services industry, the SEC has a Web page
devoted to the topic of protecting consumers’ financial
data and personally identifiable information (PII).
www.sec.gov/about/privacy/secprivacyoffice.htm
In Canada
Canada’s Competition Bureau maintains a website
that provides in-depth information on the Consumer
Packaging and Labelling Act as well as other
relevant legislation.
www.competitionbureau.gc.ca/eic/site/cb-bc.nsf/eng/home
How operations and
production work
In the U.S., practices concerning corporate governance, responsibility,
fiduciary obligations, and social responsibility are broadly governed
by the Sarbanes-Oxley Act, passed by Congress in 2002.

Also known as the Public Company Accounting Reform Standards and quality control
and Investor Protection Act, the Sarbanes-Oxley Act of In the U.S., numerous independent standards
2002 (SOX) was passed by Congress in the wake of organizations play a role in ensuring adherence
several high-profile corporate accounting scandals— to standards and quality control in various industries,
most notably at Tyco International, WorldCom, Enron, including manufacturing, services, and health care.
and Enron’s auditor, Arthur Andersen. Many of these standards are issued by the International
SOX established the Public Company Accounting Organization for Standardization (ISO), a
Oversight Board (PCAOB), which regulates auditing nongovernmental organization based in Geneva,
of corporate financial statements. It prohibits auditing Switzerland. ISO 9000 sets out eight principles
firms from operating consulting businesses and for achieving quality control and operational
stipulates that a company may not engage an auditor consistency. ISO 9001 establishes formal processes that
if certain members of senior management worked for companies must adhere to, including the establishment
that company within the prior year. of formal quality-control committees to achieve the
SOX requires Chief Executive Officers and Chief designation. ISO 3100 stipulates procedures for
Financial Officers to sign and attest to the veracity of controlling and managing risk, while ISO 22,000
their company’s financial statements. Board audit concerns food safety.
committees must have at least one independent director. There are other, privately sponsored quality-
In addition to government oversight, the auditing control initiatives in which many large U.S. companies
profession has stepped up self-regulation in the wake participate. Beyond ISO, one of the most widely
of the financial scandals. The American Institute of adhered to is the Six Sigma program, which was
Certified Public Accountants (AICPA) has in recent developed by Motorola and widely deployed by General
years issued several key Statements on Auditing Electric under former CEO Jack Welch. Six Sigma seeks
Standards (SAS). SAS 70 sets audit standards for the to build processes aimed at removing defects from the
services industry, SAS 85 requires auditors to obtain manufacturing process.
written representations from management, and SAS 99
details steps to be taken to detect material Health, safety, and the environment
misstatement and accounting fraud. Companies operating in the U.S. are expected to
operate in a socially responsible manner that attempts
In Canada to minimize environmental impact while protecting
Businesses in Canada are governed by the Competition workers’ health and safety. The federal Environmental
Act. The act prohibits misleading advertising and Protection Agency (EPA) has broad authority to
marketing practices and requires truthful statements interpret, apply, and enforce federal laws concerning
concerning warranties, guarantees, and prices. It environmental impact. The EPA regulates greenhouse
enables wronged parties to sue defendants for fraud gas emissions, estuarial runoff, and wetlands
in civil court, usually at the provincial level. protection, among other things.
 U.S.-SPECIFIC INFORMATION
How operations and production work 342 343

To maintain workers’ safety, corporations and even

small, privately held companies must adhere to ORGANIZATIONS AND RESOURCES
standards set by the Occupational Safety & Health
Administration (OSHA). OSHA regulations require a Compliance and corporate responsibility
workplace that keeps workers safe from everything The Securities and Exchange Commission enforces
from slips and falls to major industrial hazards, such Sarbanes-Oxley compliance.
as exposure to toxic chemicals. OSHA has the power www.sec.gov
to halt production at job sites deemed unsafe. Standards and quality control
Food production and processing are further subject ISO’s site provides full information on all the standards
to health and safety standards set by the Food and overseen by the organization.
Drug Administration (FDA) and the U.S. Department www.iso.org/iso/home.html
of Agriculture’s Food Safety and Inspection Service. Health, safety, and the environment
OSHA’s website offers information on new regulations,
Liabilities, warranties, and guarantees
compliance tips, and enforcement actions.
Companies that sell goods and services in the United www.osha.gov
States must adhere to various consumer protection
The EPA has online tools for checking compliance
laws that are generally issued and enforced at the state with federal environmental regulations.
level. For example, New York State maintains a Division www3.epa.gov
of Consumer Protection, California has its Department Information on food safety laws and practices can
of Consumer Affairs, and the Texas Attorney General be obtained from the FDA’s site.
maintains a Consumer Protection unit. These www.fda.gov
organizations enforce laws concerning the terms and Liability, warranties, and guarantees
conditions under which goods and services are sold to In the U.S., consumer protection generally falls to the
the public. New York State, for instance, requires stores state. Individual state websites provide information on
to post their refund policies in open view, maintain regulations concerning public sales of goods and services.
transparent rebate policies, and limit restrictive Intellectual property law
provisions on gift card redemption.
The USPTO is the main resource for all information
concerning the filing of patent applications.
Intellectual property law and patent www.uspto.gov
protection The U.S. Copyright Office website includes information
Intellectual property laws in the U.S. are upheld and about the copyright process and fees.
enforced mainly through the U.S. Patent and Trademark copyright.gov
Office (USPTO) and the U.S. Copyright Office.
In Canada
The USPTO adjudicates the validity of patent claims
and awards patents on new designs of products, Information on corporate law and operations in Canada
can be obtained from the federal government’s
services, and business methods. The USPTO also
Competition Bureau.
evaluates trademark claims. www.competitionbureau.gc.ca/eic/site/cb-bc.nsf/eng/home
The Copyright Office registers claims and issues www.bureaudelaconcurrence.gc.ca/eic/site/cb-bc.nsf/fra/
certificates for copyrights on literary, artistic, and Accueil
design works, such as a corporate logo.
Index
Page numbers in bold type indicate Apache Hadoop software 263 branding and rebranding 234–235
main entries. Apple 20, 304, 306, 329 brand loyalty 240, 259
appraisal see staff evaluation personal 181
3-D marketing 207 ASA (average speed of answer) 219 break-even point (BEP) 141
4P3C1E framework (marketing) 242 asset financing 158 breakthrough innovation 305
5S (workplace organization) 299 asset stripping 152 brochures and flyers 201, 210
7-Eleven 23 assets and inventory 138–139 budgets 136–137
360-degree feedback 84–85 AstraZeneca 335 bull market 166
360-view, customer profile 261 audit trail 105 bundle pricing 187
auditing 105, 113, 114–115 burn rate 30

A
automatic call distributor (ACD) 219 business accelerators and
incubators 38–39

B
business analytics 250–251
A/B testing (mail marketing) 216 business angels 35, 36–37, 174
absorption costing 142 business cultures 64–65
accounting see financial accounting B2B lead generation 237 business development 232–245
acid-test ratio 149 back-up plan 33 business goals 78–79
acquisition of company 31, 41 balance day adjustment 105 business intelligence software 248–249
actionable metrics 253 balance sheet 116–119 business launch 27
ACW (after-call work) 219 analysis 118–119 business ownership 12–25
adaptive customization 279 current assets 138 business plans 32–33
ad tracking 214 equation 116 business process reengineering
advertising Balanced Scorecard 85, 147, 245 (BPR) 67
advertising to sales ratio (A/S) 213 bank overdraft 34, 133, 158–159 business-format franchise 23
ATL (above the line) 191 batch costing 143 buying and selling businesses 40–49
banner and pop-up ads 210, 214 batch production 274–275

C
BTL (below the line) 190 bear market 166
online 214–215 behavioral targeting 215
traditional offline 212–213 benchmarking 332–333
video ads 210–211 big data 262–263 call to action (CTA) 239
ageing schedule 135 billboard marketing 201, 213 CAN-SPAM Act 267
agents, selling through 188–189 black hat SEO 231 capacity management 314–315
agile business 74 blogging 224–227, 228–229 capital investment and lump sums 132
agile production 296–297 board of directors 52–55 capital markets and securities 170–173
Agricultural Bank of China 161 board members, choosing 19 capital structure evaluation 155
AHT (average handling time) 219 disclosures 109 cascading 76
AIA Group 161 body language in different cultures 97 cash conversion 135
AIDA (Attention, Interest, Desire, BOFU (bottom of funnel marketing) 220 cash flow 132–135
Action) 237 bonds 170–173 corporate failure signs 151
Aldi 18 bookkeeping 104–105 and fraud 152, 153
Alibaba Group 161 book value 124, 150 management 134–135
Amazon 26, 188, 294–295 bootstrapping 14 statement 120–121
amortization and depletion 128–129 botnet virus 215 see also cost accounting; financial
annual review 102, 106–107, 108, 111 bounce rate 231 accounting
Anytime Fitness 23 BP (British Petroleum) 62–63 Century 21 Real Estate 23
 HOW BUSINESS WORKS
Index 344 345

CEO (chief executive officer) 53, 54, cost per lead (CPL) 237 visualization 251
55, 56, 57 cost per thousand (CPT) 213 warehousing 256–257
chamber of commerce 25 cost per touch (lead conversion) 238 debentures 173
channel margin 189 cost-plus pricing 142 debt
charitable donations 109 costs, fixed vs. variable 140–141 bad 104
charity 25 costs and pricing strategy 33 bonds as debt investments 171–172
chart of accounts 105 COVID-19 pandemic 98, 330 and business failures 14
checkout technology 255 credit and creditors 36, 111, 117, capital structure evaluation 155
children’s marketing 266–267 119, 156 corporate failure signs 151
churn rate 204 Credit Suisse 321 debtor categories 119
cinema advertising 213 CRM (customer relationship factoring 158–159
Circle K 23 management) 264–265 gearing ratio 174–175
Cisco 329 crowd funding 34, 35, 36 loan note 158
cleaning (direct mail) 217 C-suite 56–59 loan percentage payment and
clickstream 215 current assets 117 amortization 128
cloud services 263, 264 current ratio 149 ratio 149
CloudSimple 329 customer repayments 132, 133
Coca-Cola 293, 306 acquisition cost (CAC) 241 decentralization 67, 74
cold calling 211, 218 behavior 194–195, 258, 259 decision simplicity (consumers) 204
collaborative customization 279 capital 244 defect measurement 320–321
communication, art of 92, 178 churn rate 204 defensive merger 43
Companies Act 54 complaints 240 deferred ordinary shares 165
company hierarchy 56–59 consumer data collection 254–255 delayed payment 156
company shares 164–165 customer relationship management deleverage 175
comparative claims regulation 266–267 (CRM) 264–265 demand-pull production 290–291
competitive product positioning 182 customer returns 330–331 demergers 44–45
competitor analysis 33 data regulation 266–267 Deming Prize 309
compliance regulation 266–267 decision simplicity 204 departmental hierarchy 68–69
consolidated financial statements 107 expectations, and quality 308 depletion and amortization 128–129
consumer see customer feedback surveys 109, 240–241, 265 depreciation 124–127
content marketing 220–221 lifetime value (CLV) 243 calculation 118, 126–127
continuous production 280–281 loyalty programs 240–241, 255, 260, differential costing 142
contract costing 143 261 digital asset management (DAM) 253
control, chain of 312–321 personalized product design 278–279 digital dashboard 249
control systems 64 profiling 258–261 digital marketing 202–203
convertible bond 172 retention 240–241 direct costs 142
cooperatives 24 segmentation 264 direct mail marketing 216–217
corporate bonds 173 selling direct to 188–189 direct response (DR) marketing 209
corporate failure signs 151 service 146, 190, 265 direct taxes 108
corporate social responsibility “sticky” customers 204 directors 18, 19, 50, 53, 55, 115
(CSR) 334–335 uptake 185 disbursement quota 25
environmental accounting 122–123 disclosure (blogging) 225

D
corporate structure 66–77 disruptive innovation 305
corporate success 150 diversification 42
corporation tax 108 diversity and inclusion (D&I) 78, 82–83
cosmetic customization 279 data dividends see shares and dividends
cost accounting 130–143 data to decisions transformation 247 divisional structure 66, 70–71
see also cash flow; financial mining 153, 249, 251, 257 DMADV (define, measure, analyze,
accounting quality (DQ) 248 design, verify) 321
INDEX

F
DMAIC (define, measure, analyze, franchises 22–23
improve, control) 321 fraud, tracking 152–153
doing business as (DBA) 16 frequency marketing 209
donations 133 F45 Training 23 frugal innovation 305
dotted-line reporting 73 face-to-face marketing 200, 205, 221, full cost pricing 142
double-entry bookkeeping 104, 131 260 functional structure 68–69
due diligence 41, 43 Facebook 287 funding 154–163
factoring 34, 135, 159 external finance 158–159

E
factors of production 271 flotation 160–163
fast-moving consumer goods internal finance 156–157
(FMCGs) 181 shares see shares and dividends
earn-out 48 finance and capital sources 154–175 start-ups 34–37
EBITDA to sales ratio 148 finance leases 159

G
eco-innovation 305 financial accounting 112–129
economic life 124 accounting cycle 104–105
economies of scale 286–287 accounts payable and receivable 135,
mergers see mergers 148 gearing ratio and financial risk
economy pricing 186 accounts receivable turnover 174–175
effective capacity 315 ratio 148 Generation X, Y, and Z 194
efficiency 148, 150, 326–327 conventions 31 General Electric (GE) 60, 321
EFQM Global Award 309 international standards 102 General Motors (GM) 161
electronic waste (e-waste) 331 KPIs 146 geographic pricing 187
ELT (extract, load, transform) 256 see also cash flow; cost accounting globalization 20, 107
email direct mail marketing 216–217 financial forecasts 33 Global Management Accounting
regulation 266–267 financial management 102–111 Principles (GMAP) 131
employee costs 115 financial performance measurement goodwill 129
employee relations 92–93 144–153 Google 26, 79, 99, 215, 229, 329
employment laws 80 financial ratios 148–149 government bonds 173
endorsements regulation 266–267 financial report types 102 governmental accounting 103
Enel SpA 161 financial reporting 102–129 grants 35, 133
engagement marketing 204–205 financial risk and gearing ratio 174–175 green taxes 108
Enron 153 financial statements 106–111 greenhouse gas emissions 123
enterprise portal 30 deconstructing 108–109

H
environmental accounting 122–123 fraud, tracking 152–153
environmental concerns, KPIs 147 for users 110–111
environmental, social, and governance finished goods inventory 139
(ESG) criteria 60–61 first in, first out (FIFO) 317 haptic technology 207
equipment purchase 133 fixed/tangible assets 117–119, 124, Hearst Corporation 18
equity 149, 150, 155, 171, 174 125, 133, 138–139, 153 Hewlett Packard (HP) 15
ERP (enterprise resource planning) flat lattice structure 76 hire-purchase agreements 159
264 flexible working 98–99 holding company 107
Eurobond 158 see also remote working Honda 308
events marketing 200, 205, 210 flotation 160–163 horizontal integration 46–47
exabyte 263 flow production 276–277 Huawei 304
expansion funding 157 Ford 328 human capital 244
expenses 115, 140, 152 forecasting 150–151 human resources 78–97
extension strategy 185 forensic accounting see fraud, tracking cycle 80–81
external finance 158–159 franchise disclosure documents KPIs 147
extrinsic motivation 86 (FDD) 22 human rights, and environment 123
 HOW BUSINESS WORKS
Index 346 347

Hummel 193 inventory 316–317 lean production 288–289

hybrid processes 282–283 inventory and assets 138–139 Lean Six Sigma 321
hygiene and safety, food industry inventory turnover ratio 148 lean start-up 28
318–319 investment returns 120, 121 leasing costs 115
investors 35 legally imposed control 313

I
invoice discounting 158–159 LEGO Group 18
ISO 9000 309 letter of intent 45
IT and marketing 252–253 lettershop 217
IKEA 18, 330 leverage 64

J
immediate capacity 315 Levi Strauss & Co. 328
inbound marketing 220–231 limited companies 16–17
incremental budget 137 line position 58
increments 282 Jaguar Land Rover 329 line relationship 69
incubators 38–39 Jan-Pro 23 LinkedIn 83
indirect costs 142 JCPenney 330 liquidity ratios 149
indirect taxes 108 job costing 143 listed company 163
Industrial and Commercial Bank of job production 272–273 long-tail marketing 198
China 161 John Lewis 93 long-term finance 157–159
influence markets 208 JPMorgan Chase & Co 153 loyads 261
information management 246–267 just-in-time production 290–291 loyalty programs 240–241, 255,
infrastructure assets 118–119 260, 261

K
initial public offering (IPO) 160–163 Lutron 279
innovation and invention 304–305

M
Instagram 234
instant messaging 76, 99–98 kaizen improvement system 298–299
intangible assets Kanban cards 288, 291
amortization and depletion 128–129 key account management (KAM) 209 Macquarie Group 329
inventory 139 key performance indicators (KPIs) Maersk 321
intangible capital 244 146–147 MACRS (Modified Accelerated Cost
integrated marketing KFC 23 Recovery System) 124
communication 190 magazine marketing 201, 213

L
integration, vertical vs. management 284–299
horizontal 46–47 management, and fraud 153
mergers and acquisitions 42–43 management accounting 130–131
intellectual capital 244–245 labor costs 140 management buy-ins and
interactive marketing 191 labor practices, and buyouts 48–49
interest cover ratio 175 environment 123 management shares 164
interest rates and dividends 169 large cap listed company 163 management/cost accounting 130–143
intermediaries, selling through last in, first out (LIFO) 317 management/leadership
188–189 lateral integration 47 differences 284
internal finance 156–157 lateral structure 76 managing capacity 314–315
internal markets 209 lead conversion 238–239 manufacturing franchise 22
internal start-ups 26 lead generation 236–237 manufacturing and production 270–283
international accounting lead nurturing 238 MarCom (marketing communication)
standards 102 lead scoring 238 190
International Financial Reporting leadership strategy and styles 88–89 mark-up comparison 187
Standards (IFRS) 102 leadership for team building 90–91 market correction 166
Internet marketing 202–203 leadership/management market extension 46
interstitials (advertising) 215 differences 284 market penetration pricing 187
INDEX

market research 192–193 net assets 117, 118 patent trolls 26

market segmentation 194–195 net profit margin ratio 149 pattern matching (data) 251
market share 42 Net Promoter Score (NPS) 293 PayPal 44
market value of equity 150 network structure 74–75 pay-per-click (PPC) advertising 215
market value to book value ratio 245 networking 83, 201 Peecho 291
marketing approaches 196–209 new product development 302–303 peer-to-peer (P2P) lending 34
marketing and IT 252–253 newspaper marketing 201, 213 Pemsel test 25
marketing mix 178–195 niche marketing 198–199 Pepsi 70–71
marketing regulations 266–267 Nike 20–21 performance management 81
marketing technologist 253 Nintendo 15 performance measurement 144–147
Mars 18 Nonghyup 24 and budgets 137
MarTech conference 253 nongovernmental organization (NGO) 25 perpetual bond 172
mass customization 278–279 not-for-profit organizations 24–25 person culture 65
mass marketing 198–199 NTT Docomo 161 personal branding 181
matrix guardian 77 personal selling 190

O
matrix structure 72–73 personal warranty 48
McDonald’s 20, 23, 293 petabyte 263
media engagement 221 philanthropic sector 25
members (shareholders) 16 offshoring 328–329 phishing 267
merge/purge software 217 Ohlson O score 151 place and distribution channels
mergers and acquisitions 42–43 OLAP (online analytical processing) 188–189
integration, vertical vs. cubes 249, 257 planning, programming, and budgeting
horizontal 46–47 oligopoly 109 systems (PPBS) 137
Merrill Lynch 71 OLTP tool (online transaction platform corporation 21
metadata 231 processing) 256 podcasting/vlogging 226–227
microfranchising 22 Om Engineering Works 29 point of sale software 255
micropreneur 30 omni-channel customer 261 Ponzi/pyramid scheme 153
mid cap listed company 163 online advertising 211, 214–215, portfolio analysis 185
millennials 194 260 potential capacity 315
mobile technology 215, 255 online value chain 325 power culture 64
MOFU (middle of funnel operating profit 114–115 predictive analytics 250, 251
marketing) 220 operations 33, 121, 147 preference shares 165
Mondelez 44 ordinary shares 165 premium pricing 187
monopoly 47, 109 outbound marketing 210–219 price and pricing strategies 186–187
motivation and rewards 86–87 outbound vs. inbound marketing price to earnings ratio 149
Motorola 321 222–223 primary market 170
multinationals 20–21 outsourcing 56, 326–327 private companies 18–19
mutual organization 24–25 overheads 132 private foundation 24
overleveraged 175 private limited company 17

N
overtrading 151 private placing shares 165
owned media 237 process costing 143
Procter & Gamble (P&G) 72

P
naming a company 13, 28 product
National Customer Satisfaction Index costing 142–143
(NCSI-UK) 293 design 306–307
national employment laws 80 Pacman strategy 43 environmental responsibility 122
negative-option billing 266–267 paradigm 64 evolution 300–311
negotiating strategy 96–97 partnerships 14–15 extension 46
Nestlé 72 patent 129 franchise 22
 HOW BUSINESS WORKS
Index 348 349

levels 180–181 referral markets 209 sensory marketing 206–207

life cycle 184–185 relationship marketing 208–209 sensory testing 207
positioning 182–183 remote working 64, 66, 74, 80, 92, service costing 143
product-process matrix 310–311 98–99 service jobs 272
promotion 190–191 remuneration 109 share capital, raising 165
samples 201 reporting line, altering 67 shared services 327
professional corporation (PC) 16 reporting structure 18, 19, 69 share split 166–167
profit, corporate failure signs 151 research and development costs 115 share of voice (advertising) 213
profit and loss statement 114–115 residual value 124 shareholders 60–63
profit margin 143 retail space optimization 221 demergers 45
profit maximization 60 retailers, selling through 188–189 and financial statements 110
profitability ratios 148 retained earnings 150 funds 117
profits, retained 157, 168 retained profits 157 liability 16, 17
project accounting 103 return on equity (ROE) ratio 148 and management 18, 19
project management 94–95 return on marketing investment (ROMI) shares and dividends
time-based management 294–295 242–243 corporate failure signs 151
tools 94, 295 reverse merger 45 dividends 168–169
promotion of product 190–191 reverse supply chain 330–331 share capital, raising 165
prospective costs 141 rewards and motivation 86–87 share flotation 160–163
psychological pricing 187 REWE Group 24 share value 62, 71, 120, 121, 159
public companies 17, 18–19 rights issue shares 165 share value, establishing 166–167
public issue shares 165 robot.txt 231 types 164–165
public limited company (plc) 16 ROI (return on investment) 242 short-term finance 156–159
public relations 191 RSS (rich site summary) 226 shortage management 135
push/pull strategy 189, 220, 222 silo mentality 68, 69

S
PwC 18, 145 silver surfers 194
single-member company (SMC) 17

Q
Six Sigma control 292, 320–321
salaries and wages 115, 132, 152 Skandia Navigator 245
sales skimming pricing 186
quality control 318–319 and fraud 152, 153 Skype 99
quality management 308–309 KPIs 146 Slack 76, 92, 99
total quality management 292–293 pipeline 238 slice and dice data 248
quality product positioning 182 pitch 239 small cap listed company 163
questionable costs 141 promotion 191, 205 small and medium-sized enterprises
revenue 132 (SMEs) 38

R
tracking 249 social economic scale 261
salvage/scrap/residual value 124 social enterprise 25
Samsung 70, 321, 328 social graph 229
radio marketing 201, 210, 213 Saudi Aramco 161 social lead targeting 211
raw data 251 search algorithm 231 social media marketing 190, 228–229
raw materials costs 140 search engine optimization (SEO) and benchmarking 333
raw materials inventory 139 230–231 big data 262
Recency Bias theory 156 Sears 330 and branding 234
recession, employment turnover 82 secondary market 171 see also blogging
recruitment and selection 82–83 secondary stock offering 19 social organization 24
red flags indicating fraud 152 securities and capital markets 170–173 Softbank Corp 161
redeemable bond 172 selling and buying businesses 40–41 sole traders 14–15
redeemable shares 165 selling price 143 solid-line reporting 73
INDEX

UV
solvency ratios 149 swap ratio 43
Sony 72, 304 sweepstakes and contests
spam use regulation 266–267 regulation 266–267
span of control 58 SWOT analysis 33 unconscious bias 85
special offers regulation 266–267 synergy 47 undertrading 151
spin-offs 44, 45 underwriters 162

T
splog 225 unquoted/unlisted company 19
sponsorship 210 useful/economic life 124
spreadsheets 249 USP (unique selling point) 33
staff evaluation 84–85 Taco Bell 23 valuation of company 18, 19
performance–management cycle tangible/fixed assets 117–119, 124, value 186
64 125, 133, 138–139, 153 Value-Added Tax (VAT) 108
staff position 58 task culture 65 value chain 324–325
stagging 165 Tata Group 122 value product positioning 182
stakeholders 60–63 tax accounting 114–115, 120 value-stream mapping 288
and corporate social responsibility tax payments 108, 111, 114, 119, 120, Valve 59
(CSR) 335 133, 169 vanity metrics 253
and financial statements 110–111 team-based structure 76–77 venture capitalists (VCs) 35, 37
and share value 62 team-building leadership 90–91 video conferencing 76, 92, 98–99
Standard Oil 15 technology, mass customization virement 137
State Farm 24 278–279 Virgin 15
star schema data 248 telemarketing 218–219 virtual business incubator 39
Starbucks 72, 208, 335 regulation 266–267 Visa 161
start-up pivot 28 terabyte 263 vlogging 226–227
start-ups 26–39 TERM (technology-enabled relationship

WYZ
concept development 28–29 management) 264
funding 34–37 term loan 34, 158
incubators see business accelerators ticker symbols 19
and incubators time-based management 294–295 wages and salaries 109, 132
types 30–31 TOFU (top of funnel marketing) Walt Disney 292–293
statistics 111, 251 220 warehousing 331
“sticky” customers 204 total quality management 292–293 warrant 172
stock exchange listing 160–161, 162 quality management 308–309 waste elimination 288–289
stock exchanges, world’s top 162 Toyota 288–289, 290, 298, 308 wholesalers, selling through 188–189
stock-keeping unit (SKU) 317 tracking stock 45 who’s who 50–65
straight-line method of depreciation trade event marketing 200, 205, 210 Wikispeed 287
124–125 traditional marketing 200–202 windfalls 133
strategic capital 244 traditional offline advertising WIP (work in progress) 317
Stratus Building Solutions 23 212–213 Wirecard 153
structural capital 245 transaction marketing 209 WOM (word-of-mouth) marketing 204
subsidiary company 107 transnational corporation 21 working capital/total assets 150
success metrics (marketing) 242 transparent customization 279 WorldCom 153
sunk costs 141 trending product claims 302 YouTube 210
supplier markets 208 trial balance 105 Z-score models, forecasting with 150
suppliers’ payments 133 TripAdvisor 44 Zappos 77
supply chain 322–335 tunneling 152 Zara 324, 329
surplus management 135 turnover 114–115 zero-based budget 137
sustainability, KPIs 147 TV marketing 200, 210, 213 Zeta analysis 151
sustainable investment 108 TVR (television rating point) 213 Zoom 76, 99
 HOW BUSINESS WORKS
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